IRS Capital Gains on Property Sale: Reinvestment Exclusion and Acquisition Costs in CAAD Case 343/2014-T

CAAD – Administrative Arbitration Center

ARBITRAL DECISION

CASE NO. 343/2014-T

Claimant: A...

Respondent: Tax and Customs Authority

I. REPORT

1. A..., taxpayer no. …, resident in … Lisbon, hereinafter referred to as the "Claimant", came, pursuant to the provisions of subparagraph a) of no. 1 of Article 2 and Article 10, both of Decree-Law No. 10/2011, of 20 January, hereinafter the RJAT, to request the constitution of an arbitral tribunal.

2. The claim was filed with a view to declaring unlawful and consequent partial annulment of the Personal Income Tax (IRS) assessment no. 2013 ..., of 6 August 2013, relating to the year 2009, in which the tax due was calculated at the total amount of € 90,541.53, specifically concerning the taxation of capital gains realized by the Claimant from the sale of the property located on ... Street, no. … and … and ... Street, Parish of Lapa, Municipality of Lisbon, hereinafter referred to as "Property 1", for failing to consider the amount paid for the right to use storage compartments in Property 1, nor the reinvestment of the sale proceeds in the acquisition and works of the property located at ... Square, no. …, hereinafter referred to as "Property 2".

3. The request for constitution of an arbitral tribunal was registered as no. 1164, validated and accepted on 22/04/2014 as a case in the arbitral procedure phase.

4. Having the Claimant opted not to appoint an arbitrator, the panel of arbitrators was designated by decision of the Chairman of the Deontological Board, composed of Judge Manuel Luís Macaísta Malheiros, in the capacity of presiding arbitrator, Dr. Jorge Carita, in the capacity of voting arbitrator, and Dr. Vera Figueiredo, in the capacity of voting arbitrator (see the minutes of constitution of the arbitral tribunal which are attached to the file and are hereby reproduced herein), notified to the parties on 09/06/2014.

5. On 26/06/2014 the Arbitral Tribunal was constituted in accordance with the provisions of subparagraph a) of no. 2 and no. 3 of Article 6 of the RJAT.

6. The response of the Tax and Customs Authority (Respondent), for the purposes of the provision of no. 1 of Article 17 and the administrative proceedings, for the purposes of the provision of no. 2 of Article 17, both of the RJAT, were presented and notified/communicated to the Claimant and the Arbitrators, respectively, on 15/09/2014 and 16/09/2014.

7. The Claimant had timely filed a request for administrative review of the tax act in question on 24/09/2013, considering that it violated the provisions of nos. 5 and 6 of Article 10 of the IRS Code, and therefore, following the express rejection of that request, filed a request for arbitral pronouncement, being at issue, primarily, the relevance of a reinvestment of the sale proceeds from the onerous transfer of a real property used for the Claimant's own dwelling, for purposes of excluding the taxation of the corresponding capital gains.

8. The Tax and Customs Authority filed a response, arguing that the request for arbitral pronouncement should be judged groundless as unproven, and the assessment should be maintained in the exact terms in which it was made, with legal consequences, due to absence of legal foundation, absolving the Tax and Customs Authority of the claim.

9. On the designated date (06/10/2014) the first meeting of the Arbitral Tribunal took place at the headquarters of CAAD - Administrative Arbitration Center. The Claimant declared that he did not waive the witnesses he had listed, and the date of 22/10/2014 was set for the examination of witnesses, followed by the submission of written arguments successively, to be submitted within 10 days, with the date of 01/12/2014 set for the delivery of the arbitral decision.

10. On 22/10/2014 the second meeting of the Arbitral Tribunal took place at the headquarters of CAAD - Administrative Arbitration Center. Two witnesses listed by the Claimant were examined, namely: ... and .... The Claimant waived the third witness he had listed. The Claimant requested the attachment to the file of six documents. The representatives of the Respondent requested that they be given a period to comment on the appropriateness of the attachment and content of the documents. The Arbitral Tribunal admitted the attachment and gave the Respondent a 10-day period to comment, after which the 10-day period for arguments by the Claimant begins to run. The period for delivery was postponed to 10/12/2014, and subsequently postponed to 26/12/2014.

11. The Respondent commented on 05/11/2014 on the appropriateness and content of the documents attached to the file, concluding that the documents lacked appropriateness and relevance, requesting their removal from the proceedings. The Arbitral Tribunal, however, pronounced itself in the sense of admitting the attachment of the six new documents, under subparagraphs c) and e) of Article 16 of the RJAT.

12. Successive arguments were then presented by the Claimant on 13/11/2014 and by the Respondent on 28/11/2014.

13. The Arbitral Tribunal decided to request from the Claimant the following additional evidence, by order of 24/11/2014: i) building works licensing permit; and ii) IMI Model 1 declaration relating to the alteration of the matrix of Property 2 (... Square no.…, Unit …) following completion of the works.

14. On 10/12/2014, the Claimant submitted justification for the non-existence of the building works licensing permit, from which he would have been exempt under subparagraph c) of no. 1 of Article 6 of the Legal Framework for Urban Planning and Building (version in force at the date of the events, as per Law No. 60/2007, of 4 September). Regarding the IMI Model 1 declaration, the Claimant informed that he was unable to locate a copy of said declaration, as it was delivered in paper to the tax office and does not appear in the system for reasons unknown.

15. The Respondent being notified to comment on the Claimant's request, submitted its response on 16/12/2014.

16. Considering the necessity of additional evidentiary proceedings and the complexity of the case, the Arbitral Tribunal decided to extend by two months, pursuant to Article 21, no. 2 of the RJAT, the period for delivery of the decision.

II. DETERMINATION OF ISSUES

1. No preliminary questions were raised.

2. The Arbitral Tribunal is competent (subparagraph a) of no. 1 of Article 2 of the RJAT) and no nullities are present.

3. The parties have procedural personality and capacity, are legitimate and are legally represented (Articles 3, 6 and 15 of the Tax Procedure and Procedural Code, under Article 29 no. 1 a) of the RJAT).

III. FACTS

a. Facts Established as Proven

With relevance to the decision on the merits, the following factuality was proved:

1. The Claimant acquired on 04/08/1989, by public deed of purchase and sale with loan and mortgage, the autonomous unit with the letter ... of the urban property registered in the property matrix of the parish of …, in Lisbon, under article ... ("Property 1"), for the price of € 22,445.91, having declared the acquisition of the property for own permanent dwelling.

2. Regarding the same Property 1, on 14/01/1994, the Claimant entered into an onerous agreement that gave him exclusive use of four storage compartments belonging to Unit "C" and contiguous to his unit (Unit "E"), accompanied by authorization for alteration of the horizontal property regime, by the owners of said storage compartments.

3. The alteration of the constitutive title of horizontal property was executed by public deed dated 31/05/1994, pursuant to which Unit "E" came to be composed of a bedroom, a living room and six storage compartments.

4. In 2009 the constitutive title of horizontal property was altered again, with Property 1 coming to be composed of 3 floored divisions.

5. By deed executed on 31/07/2008, the Claimant acquired another property (hereinafter "Property 2") located at ... Square, no. …, unit …, in Lisbon, for the price of € 182,500.00, having for that purpose obtained a bank loan in the amount of € 150,000.00 and having declared the acquisition of the property for own permanent dwelling.

6. Property 1 was sold on 28/09/2009 for the price of € 480,000.00.

7. On 20/01/2010, BANK... declared having received in the year 2009 from the Claimant the following amounts in the form of early payment of Loan no. ..., obtained for acquisition of Property 1: capital amortization of € 56,318.36.

8. On 20/01/2010, BANK... declared having received in the Year 2009 from the Claimant the following amounts regarding loan no. ..., obtained for acquisition of own permanent dwelling: capital amortization of € 70,000.00. BANK... further declares on 18.09.2013 that as of 27/04/2011, regarding loan no. ..., the Claimant had outstanding the amount of € 80,000.00, in the form of loan for acquisition of Property 2, and the amount of € 29,270.42, in the form of loan for works on the same Property 2.

9. The Claimant on 1 February 2011 altered his tax domicile to the address of Property 2.

10. The Claimant did not request registration of the alterations made to Property 2 in the matrix within 24 months following the date on which he initiated the works relating to said alterations.

11. On 21/05/2010, the Claimant filed his periodic income tax return for IRS purposes for the year 2009, which resulted in tax due of € 2,914.94. In that declaration, the Claimant registered the sale of Property 1 for the amount of € 480,000.00 and the intention to reinvest the sum of € 480,000.00.

12. On 01/08/2013 Building Use Permit no. …/UT/2013 was issued authorizing the use of the building located at ... Square no. … and …, parish of ....

13. The Tax and Customs Authority, considering that the Claimant did not actually carry out the reinvestment, proceeded on 06/08/2013 to issue IRS assessment no. 2013 ..., relating to the year 2009, in which tax due was calculated at the amount of € 90,541.53, whose balance shown in the accounts reconciliation statement is € 87,626.59, including a statement of calculation of compensatory interest in the amount € 9,150.52.

14. On 10/09/2013, the Claimant filed a Model 3 replacement declaration for 2009, having altered Annex G.

15. On 25/09/2013 the Claimant filed the request for administrative review against the IRS assessment act no. 2013 ..., with the following grounds: reinvestment of the sale proceeds of € 312,016.25 was carried out within the preceding 24 months; by oversight, in the IRS declaration for 2009, the reinvestment within the preceding 24 months was not declared and the description of the property was not correct.

16. On 04/12/2013, the Claimant made voluntary payment of part of the assessment in the amount of € 16,737.25.

17. Notified of the draft decision on the request for administrative review and for exercise of the right of prior hearing, the Claimant exercised the same on 19/12/2013.

18. By order of 30/01/2014, the Administrative Justice Division of the Finance Directorate of Lisbon pronounced itself in the sense of rejection of the request.

19. On 17/03/2014, the Claimant was cited in the context of tax enforcement proceedings no. … for realization of attachment on Property 2, effected on 21/02/2014, due to non-payment of the IRS amount assessed, with the total amount of the claim plus costs in the value of € 71,859.78. In order to lift said attachment and suspend the tax enforcement proceedings, the Claimant provided bank guarantee.

b. Facts Not Proven

1. Of the facts of interest for the decision of the case, contained in the challenge, those not contained in the factuality described above were not proved.

2. Of the facts of interest for the decision of the case, the Tribunal considered that the acquisition by the Claimant of four storage compartments belonging to unit C of the property located at ... Street, no. … and … and ... Street was not proved.

c. Reasoning for Proven and Unproven Facts

1. The determination of facts was made on the basis of examination of documents and official information.

2. The fact established as proved in point 112 resulted from witness testimony produced, which proved to be sound and credible. Indeed, both witness ... and witness ... stated that the Claimant came to reside in Property 2 in late 2010.

3. As to the illegality invoked by the Tax and Customs Authority regarding the order admitting the attachment of documents by the Claimant.

4. Faced with the arguments presented by the Tax and Customs Authority without demonstrating the alleged illegality and with the utmost respect for the learned jurisprudence cited, it is important to note that:

• In the report of the Legal Framework for Tax Arbitration (Decree-Law No. 10/2011 of 20 January) it is stated: "... in order to confer on tax arbitration the necessary procedural speed, a procedure without special formalities is adopted, in accordance with the principle of arbitrators' autonomy in the conduct of proceedings...",

• In subparagraph c) of the aforementioned Article 18 of the RJAT it is provided that it constitutes a principle of arbitral proceedings: "The 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 substantive pronouncement on the claims filed", and in its subparagraph e) it is further stated that the arbitral tribunal has the power: "The free evaluation of facts and the determination of evidence production proceedings necessary, in accordance with the rules of experience and the free conviction of the arbitrators".

• All of this is in consonance with the principles of official action and inquisitorial procedure that inspire tax proceedings: Article 13 of the Tax Procedure Code - V. Lopes de Sousa, Tax Procedure Code, vol. I, 2011, p. 173, annotation to this article.

• Regarding the scope of the inquisitorial principle, it is addressed in Article 99 the General Tax Law, Annotated and Commented, by Diogo Leite Campos et al., 2012, p. 859, where it is read in note 2 that "the inquisitorial principle applies to all tax tribunals that know of the matter of fact".

1. The Tax and Customs Authority's argument regarding the admission of attachment of documents is therefore unfounded.

IV. LAW

1. It falls to the constituted Arbitral Tribunal to decide on the alleged illegality of IRS assessment no. 2013 ..., of 6 August 2013, relating to the year 2009, whose balance shown in the accounts reconciliation statement is € 87,626.59, including justifying note of calculation of compensatory interest in the amount of € 9,150.52.

2. With the facts established, the Arbitral Tribunal will decide on the subsumption of the established facts to the applicable law.

A. Issues for Decision

1. The following constitute the issues for decision in the present proceedings.

a. On the acquisition value of Property 1 for purposes of calculating the capital gain

1. Regarding the first issue raised with the Arbitral Tribunal concerning the value to be considered as the acquisition value of Property 1, which will be relevant for purposes of calculating the capital gain.

2. Article 46 of the IRS Code, in the version in force before Law No. 55-A/2010, of 31 December, provided as follows:

"1 - In the case of subparagraph a) of no. 1 of Article 10, if the real property has been acquired for valuable consideration, the acquisition value shall be the one that was used for purposes of transaction tax (sisa) calculation.

2 - Absent transaction tax calculation, the value that would serve as basis therefor, if due, shall be considered, determined in accordance with the rules specific to that tax.

3 - The acquisition value of properties constructed by the taxpayers themselves corresponds to the property value registered in the matrix or to the value of the land, plus construction costs duly proved, if higher.

4 - For purposes of the previous number, the value of the land shall be determined by the rules contained in nos. 1 and 2 of this article."

1. The acquisition value for purposes of determining the capital gain taxable in IRS is thus, as a rule, the value that served as the basis for calculation for purposes of Municipal Tax on Onerous Transfers of Real Property (IMT and no longer sisa), on the date of acquisition. Should there be no IMT calculation, it shall be the value that would serve as the basis for IMT calculation if due. And, in the case of properties constructed by the taxpayer, it is the taxable property value (land and construction) registered in the matrix.

2. In the case at hand, the value that served as the basis for IMT calculation is the value of € 22,445.91.

3. A different question is whether the value of the consideration paid for the exclusive use of the four additional storage compartments and authorization for alteration of the horizontal property constitutive title should or should not be part of the acquisition value of Unit "E", in light of the aforementioned Article 46 of the IRS Code.

4. The Claimant invokes, already in the Arguments phase, the Decision of the Arbitral Tribunal functioning at CAAD in case no. 86/2012-T, from which we transcribe the parts relevant to the case at hand:

"(…)Therefore, what is relevant for purposes of ascertaining whether there is acquisition of a new property right generated through construction by the owner is only the type of works performed, there being acquisition when it can be affirmed that the property right ceased to have the content it had previously. That is, we will be faced with a property constructed by the taxpayer when the result of the works performed can be considered as a property different from the pre-existing one.

In the interpretation of that concept of 'acquisition of properties constructed by the taxpayers themselves', it is not necessary to understand that only total construction of properties is relevant, nor would such understanding be reasonable, for there would be no reason to distinguish between situations of entirely new construction of a property and others in which there was construction from ruins or with maintenance of only an insignificant part of a pre-existing property).(…)

Therefore, without resorting to analogy, it may and should be clarified, through mere declarative interpretation, the scope of that concept of 'acquisition of properties constructed by the taxpayers themselves', clarifying in what situations the works performed by the taxpayer in his property should be understood to generate a new property right, fulfilling the concept of acquisition for purposes of capital gains. (…)

In fact, it would not be congruous a tax system in which works of modification of properties were given relevance for purposes of municipal contribution and it was understood, for other purposes, that the respective property right remained unaltered.

In light of Art. 14, no. 1, letter d), of the Municipal Contribution Code, the registration of properties or updating of the matrix is mandatory when building, improvement or other alteration works are completed that may result in some variation of the taxable value of the property.

And, pursuant to no. 2 of Art. 13 of the same Code, 'each floor or part of a property susceptible to independent use shall be considered separately in matriculation, which shall also distinguish its respective taxable value', regardless of whether or not horizontal property is constituted.

It results from this no. 2 of Art. 13 that it should be understood that there is a new property right over a property, for tax purposes, when the works performed created in a pre-existing property a part susceptible to independent use (whether or not horizontal property is constituted). And, it is implied in Art. 14, no. 1, letter d), of the Municipal Contribution Code, that there will be an alteration of the content of the property right, relevant for tax purposes, whenever building, improvement or alteration works result in an alteration of the taxable value of the property."

1. The currently in force version of subparagraph d) of no. 1 of Article 13 of the IMI Code provides that "The registration of properties in the matrix and the updating thereof are effectuated based on a declaration presented by the taxpayer, within 60 days counted from the occurrence of any of the following events: (…) When building, improvement or other alteration works are completed that may result in variation of the taxable property value of the property;"

2. In the case at hand, we are faced with a situation different from that in the aforementioned Decision, given that there are two legal alterations to the horizontal property constitutive title, the first in 1994, with the attribution of the four storage compartments of the pre-existing Unit "C" to Unit "E" (Property 1), and a second alteration in 2009, with the modification of the composition of Property 1, in which said storage compartments came to form an integral part of the unit as new floored divisions.

3. Each of the aforementioned alterations would have had consequences for IMI purposes, with the consequent updating of the matrix and alteration of respective tax assessments.

4. Thus, we consider that those updates, with immediate impact for Municipal Contribution and/or IMI purposes cannot fail to have impact also for purposes of acquisition value, for calculation of capital gain taxable in IRS.

5. Indeed, the legal object (Property 1) owned by the Claimant acquired in 1989 is not the same legal object sold in 2009, given the alteration of its composition at two distinct moments: i) in 1994, with the attribution of four storage compartments to Unit "E", and ii) in 2009, with transformation of said storage compartments into floored divisions.

6. It should be noted that, although this is not the object of the present judgment, it is the conviction of the Arbitral Tribunal that it was not legally possible to transfer the property right over the four storage compartments, insofar as they were not autonomous units of the property in horizontal property ownership of which Unit "E" formed part.

7. Thus, the legal transaction realized between the owners of Units "C" and "E", which consisted of the first ceding its right of exclusive use over the four storage compartments in favor of the second, by means of payment of consideration in money, and consequent formalization by alteration of the horizontal property constitutive title, permanently altered the composition and value of Units "C" and "E", such that it would be difficult to understand that such should not be relevant for purposes of consideration as acquisition cost of the same.

8. It should thus be concluded that for purposes of calculating the capital gain taxable in IRS the respective acquisition cost of € 22,445.91 should be deducted from the sale price of Property 1, as well as the consideration paid in 1994 for exclusive use of four storage compartments, which came to be integrated in Unit "E", through successive alterations of the horizontal property constitutive title, in the amount of € 42,397.82.

9. Consequently, it is to be concluded that two relevant modifications of Unit "E", object of the Claimant's property right, occurred in 1994 and 2009, which, as such, should be relevant for purposes of calculating the capital gain, pursuant to Articles 10, no. 1, subparagraph a), and 46, no. 3, of the IRS Code.

10. Insofar as the acquisition of the property right over Unit "E" occurred in 1989 and the acquisition of the right of exclusive use of four storage compartments occurred in 1994, the date of the first alteration of the horizontal property constitutive title, the currency devaluation coefficients provided for in Article 50 of the IRS Code and in Ordinance No. 772/2009, of 21 July (and not Ordinance No. 785/10, of 23 August, cited by the Claimant, which applies to property sold in 2010) must be applied.

11. Thus, the acquisition value of Unit "E" shall be € 22,445.91, updated with the currency devaluation coefficient applicable to 1989, plus the value of € 42,397.82, this value equally updated in accordance with the currency devaluation coefficient applicable to 1994.

b. On the Reinvestment of Sale Proceeds in the Acquisition of Property 2

1. Having determined the acquisition value relevant for calculating the capital gain, the question arises of whether there was reinvestment of the sale proceeds resulting from the onerous transfer of Property 1, intended for the Claimant's own dwelling, for the purpose of excluding taxation of said capital gain.

2. Indeed, the foundation of the tax act is the non-fulfillment of the reinvestment stated in the Model 3 IRS declaration of the year 2009, filed on 21/05/2010, this reinvestment declared in the amount of € 480,000.00.

3. As the Respondent states in the proposed decision on the Claimant's request: "Not having actually carried out the reinvestment, the services proceeded to reassess on 06-08-2013, without considering said intention to reinvest, which resulted in tax due in the overall amount of € 87,626.59 (…)."

4. It is incumbent upon the Arbitral Tribunal to assess the correct interpretation of the provision of Article 10 of the IRS Code.

5. In this context, nos. 1, 5 and 6 of Article 10 of the IRS Code, as revised by Law No. 64-A/2008, of 31 December[1] (State Budget Law for 2009), provide as follows (emphasis ours):

Article 10

Capital Gains

1 - Capital gains are gains obtained which, not being considered business and professional income, capital or property income, result from:

a) Onerous transfer of real rights over real property; (…)

5 - Excluded from taxation are gains from the onerous transfer of property intended for own and permanent dwelling of the taxpayer or his family group, under the following conditions:

a) If, within 36 months counted from the date of sale, the sale proceeds, deducted from the amortization of any loan obtained for acquisition of the property, are reinvested in the acquisition of ownership of another property, land for construction of 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 European Economic Area, provided that, in the latter case, there is exchange of information on tax matters;

b) If the sale proceeds, deducted from the amortization of any loan obtained for acquisition of the property, are used in payment of the acquisition referred to in the previous subparagraph provided it is effected in the 24 months preceding;

c) For purposes of the provision of subparagraph a), the taxpayer must manifest the intention to proceed with reinvestment, even if partial, mentioning in the tax return for the year of sale the value he intends to reinvest;

d) (…)

6 - The benefit referred to in the previous number shall not apply when:

a) Where reinvestment is in the acquisition of another property, the acquirer does not dedicate it to his dwelling or that of his family group within six months after the end of the period in which reinvestment must be made;(…)

c) Where reinvestment is in the construction, expansion or improvement of property, the works are not initiated within six months after the end of the period in which reinvestment must be made or registration of the property or alterations in the matrix is not requested within 24 months from the date the works began, and, in any case, dedicate the property to his dwelling or that of his family group by the end of the fifth year following the year of sale."

1. The situation at hand is provided for in subparagraph b) of no. 5 of Article 10 of the IRS Code, insofar as the acquisition of Property 2 – the object of the supposed reinvestment – occurred prior to the realization of the capital gain.

2. Considering the date of acquisition of Property 2, which occurred on 31/07/2008, and the date of sale of Property 1, which occurred on 28/09/2009, the temporal requirement of reinvestment may be verified, that is, the acquisition of Property 2 occurred within 24 months preceding the realization of the capital gain from the sale of Property 1, specifically said acquisition occurred 14 months before the sale.

3. Contrary to what was alleged by the Respondent, the version in force of Article 10 of the IRS Code applicable to the case sub judice is the version resulting from the approval of the State Budget for 2009 (Law No. 64-A/2008, of 31 December), above transcribed, and it should equally be considered the transitional provision of Article 69 of the State Budget Law for 2009, which establishes that the new version is applicable to situations where the period of 24 or 12 months is still in force or expires in 2009.

4. There are thus no doubts as to the reinvestment period applicable to the case at hand: 24 months, in the situation of "retroactive" reinvestment.

5. However, the temporal element is not the only one that should be observed for compliance with the conditions of the reinvestment regime.

6. Thus, it is necessary to assess what amount could be subject to reinvestment in the acquisition of Property 2.

7. Pursuant to subparagraph b) of no. 5 of Article 10 of the IRS Code, first of all, the amortization of loan obtained for acquisition of the same property shall be deducted from the sale proceeds for purposes of reinvestment.

8. Now, in the case at hand, it was demonstrated by the declarations issued by BANK... on 20/01/2010 (Document no. 7 attached to the request for arbitral pronouncement) that the Claimant made payments for amortization of debts with acquisition of own permanent dwelling (Loan no. ...) and on 20/09/2013 (see document attached by the Claimant in the hearing for examination of witnesses held on 22/10/2014, whose attachment was admitted by this Arbitral Tribunal) that Loan no. ... was paid in advance by the Claimant in the amount of € 56,318.36 (see Document no. 7 attached to the request for arbitral pronouncement).

9. It is concluded that for acquisition of Property 1, a bank loan was obtained in the amount of € 56,318.36, and the outstanding balance in 2009 should be deducted from the sale proceeds for purposes of calculating the value of relevant reinvestment (value that obligatorily must be reinvested to generate exclusion of capital gains taxation).

10. Thus, considering the sale price of Property 1 of € 480,000.00, deducted from the value of the bank loan obtained for acquisition of the same Property 1 and still outstanding and subject to amortization in 2009, the sale proceeds that must be subject to reinvestment amount to € 423,605.60 (€ 480,000.00 - € 56,318.36 = € 423,605.60).

11. The question that then arises is whether the Claimant reinvested all or part of that amount in the acquisition of Property 2.

12. Indeed, Property 2 was acquired for the value of € 182,500.00, in part through recourse to credit, in the amount of € 150,000.00.

13. Thus, the amount of payment of the acquisition price of Property 2 that resulted from bank loan, that is, € 150,000.00, should be excluded from reinvestment, being relevant for reinvestment purposes only the amount of € 32,500.00 (€ 182,500.00 - € 150,000.00 = € 32,500.00).

14. However, the Claimant argues that relevance should be given to the amortization of the loan obtained for acquisition of Property 2, realized with the proceeds from the sale of Property 1. In this way, it would be necessary to consider as the value reinvested in the acquisition of Property 2, the amount of € 102,500.00 (€ 182,500.00 - € 150,000.00 + € 70,000.00 = € 102,500.00).

15. The Claimant cites for this purpose Decision 892/08 of the Superior Administrative Court, dated 11/02/2009, whose summary is transcribed below:

I - The gains from the onerous transfer of property intended for dwelling of the taxpayer or his family group are excluded from taxation in IRS (capital gains) in the case where the acquisition of a new property with the same purpose occurred within 12 months preceding the date of realization of the proceeds from said transfer (subparagraph b) of no. 5 of Article 10 of the IRS Code).

II - However, this exclusion does not occur if the taxpayer resorted to bank credit for the acquisition of the new property.

1. It is therefore important to analyze in greater detail the conclusions reached by the Superior Administrative Court in this Decision:

"We do not believe the claimant is correct, notwithstanding his argumentative effort focused on explicating the financial flows that took place in his sphere as a taxpayer (conclusions J. to M.), since, both in the situation configured in subparagraph a), and in subparagraph b), what is decisive is that proof be made that the proceeds from the transfer have been used in the acquisition of the new property intended for dwelling.

In fact, the law leaves no doubt in requiring that it is the proceeds from the transfer that must be reinvested and not any other amounts, even if obtained by means of bank credit. (…)

And it is certain that the answer to that question necessarily must be found in the proof, being only from the factuality established therein that it becomes admissible to establish the nexus of causality between the new investment and the proceeds from the transfer of the property intended for dwelling.

Now, in truth, it cannot be affirmed that there is a reinvestment, but rather a different investment in the case of acquisition of a second dwelling with recourse to bank credit, even though that acquisition occurred before the transfer of the first.(…)

Nexus of causality that, as we have seen, cannot be established in the case of that acquisition having been realized by recourse to bank credit. (…)

In reality, what becomes decisive, in light of the law, for the exclusion of taxation in IRS (capital gains) is proof that reinvestment was made, that is, that the proceeds from the transfer were used in the acquisition of another property intended for dwelling, a burden that falls equally upon all taxpayers in identical circumstances, and there is no questioning of the eventual difference in their overall taxable capacity."

1. The Claimant cites the commentary to this Decision contained in the Fiscalidade Review, no. 38, April-June 2009, p. 163 et seq., which defends that "although the Decision did not mention the possibility of resorting to credit provided that it is amortized upon the subsequent realization of the capital gain, we understand that the emphasis placed by the Superior Administrative Court on the question of proof makes it admissible. This is because said amortization would allow demonstrating the nexus of causality, required in the Decision, between the acquisition of the new property and the proceeds from the transfer of the old one" (p. 166, with emphasis ours)".

2. It should further be noted that Decision 950/12 of the Superior Administrative Court, dated 16/11/2013, establishes that "Being established that in order to acquire the new property they also resorted to a bank loan, the amount of the loan cannot be part of the capital reinvested. This is because that amount has no nexus of causality with the proceeds from the transfer, being a 'new' amount invested in another property. Regarding the impact that the bank loan has on the exclusion of capital gains taxation, there has been established jurisprudence to the effect that 'the reinvestment referred to in Article 10, no. 5 subparagraph a) of the Corporate Income Tax Code and which led to exclusion of taxation, was only the reinvestment of the proceeds from the transfer, excluding reinvestment of a bank loan' (see decisions of the Superior Administrative Court of 12/3/2003, appeal no. 01721/02, of 28/1/2004, appeal 01359/03, of 3/3/2004, appeal no. 01774/03, of 20/4/2004, appeal no. 01876/03, of 2473/2004, appeal no 02053/03, of 28/9/2006, appeal no. 0125/06, of 24/3/2010, appeal no 01241/09). Only the difference between the value of the loan and the value of the property acquired is that constitutes reinvestment for purposes of integration in the negative definition expressed in no. 5 of Article 10 of the Corporate Income Tax Code." (underlined ours).

3. And Decision 07529/14 of the South Central Administrative Court consecrates, "This means that what is reinvested is the proceeds from the transfer. If the seller of the first dwelling (which generates the capital gains) purchases a second dwelling with money borrowed by a bank, strictly speaking there is no reinvestment, but a new investment without nexus of causality with the first sale; In these terms, for purposes of the tax exclusion provided in Article 10, no. 5 of the IRS Code, provided that in the acquisition of the new property intended for dwelling of the taxpayer loan proceeds for that purpose are used, only the difference between the amount of the loan and the value of acquisition of the new dwelling may be considered as value of sale proceeds reinvested; (…)"

4. In light of the above, for there to be considered relevant reinvestment there would have to exist a nexus of causality between the value of realization of the capital gain resulting from the sale of Property 1 and the extraordinary amortization of the loan obtained for the acquisition of Property 2.

5. Not having this nexus of causality been proved, only the part of the acquisition value of Property 2, excluding the amount of the bank loan granted for that purpose, could be considered as relevant reinvestment, that is, the amount of relevant reinvestment shall be the difference between the acquisition value of Property 2 (€ 182,500.00) and the amount of the bank loan granted for that acquisition (€ 150,000.00), that is, € 32,500.00.

6. Equating the amortization of the loan to a "reinvestment", despite all the merit that the same may have, appears to this Arbitral Tribunal to be an interpretation that goes beyond the letter and spirit of the norm, all the more so when said nexus of causality does not appear to be proved.

c. On the Dedication of Property 2 to the Claimant's Dwelling

1. Continuing the analysis of verification of the requirements of the capital gains tax exclusion regime, it is necessary to assess whether, pursuant to subparagraph a) of no. 6 of Article 10, understood a contrario of the IRS Code, the Claimant dedicated the property to his dwelling (or that of his family group) "within six months after the end of the period in which reinvestment must be made".

2. The Respondent sustains in the decision rejecting the request that, given the acquisition of the new property occurred before the transfer of that which gave rise to the capital gain, the period for establishment of own permanent dwelling in the property in which reinvestment was realized is six months counted from the end of the 24-month period to realize the reinvestment. In the case (given the reinvestment is prior to the transfer) that period would be counted from the date of purchase (31 July 2008), thus ending that period (globally of 30 months) on 31 January 2011. The Claimant only altered his tax domicile to the property located at ... Square, no. …, unit .. on 01/02/2011, outside the six-month period he had available. Therefore, the benefit of tax exclusion provided in no. 5 of Article 10 of the IRS Code does not apply to the Claimant.

3. A different position is held by the Claimant, who argues that given Property 2 was acquired on 31/07/2008, the 24-month period for reinvestment ended on 31/07/2010, and that the six months should be counted after the end of this period, that is, they end precisely on 01/02/2011, the date when the Claimant altered his tax domicile. On the other hand, the Claimant argues that taxpayers do not have the duty to alter their tax domicile on the very day of their move.

4. The Arbitral Tribunal has already pronounced itself on the calculation of the period of subparagraph a) of no. 6 of Article 10 of the IRS Code.

5. Thus, in Case no. 60/2012-T, this learned tribunal decided that "From the calculation of both periods by reference to the moment of sale, it results that, strictly speaking, the legislator foresaw then, and continues to foresee now, not actually two periods, but rather a single period, at the time with a total duration of 36 months, for the realization of relevant reinvestment, which began 12 months before the moment of sale and ended 24 months after it. And this conclusion is relevant for the proper interpretation of no. 6 of the same article, specifically for the calculation of the periods established therein by reference to the end of the period established in no. 5.(…), by end of the period referred to in no. 5 of Article 10 of the IRS Code should be understood the end of said single period with a total duration of 36 months, which is the same as saying the end of the 24-month period counted from the moment of realization of the capital gain in question." (Decision of CAAD Case no. 60/2012-T).

6. In the same sense, the arbitral decision in Case 61/2012-T, which provides that "(…)It does not appear that there are doubts that the period for dedicating the acquired property to own and permanent dwelling of the claimants is 42 months (36 months + 6 months), counted from January 2010, that is, from the date of transfer of the autonomous unit which was the own dwelling of the taxpayer claimants. In the same sense see the Tax and Customs Authority itself, in response to a request for binding tax information, in the content of information no.…/07 of 02-11-2007, with approving order from the Director of IRS Services, in stating that 'for such benefit to take place and being a matter of reinvestment in acquisition of another property, the claimant should dedicate it to his own dwelling or that of his family group within six months after the end of the period in which reinvestment must be made, i.e. 24 + 6 months,…'. (It should be noted that the response to the request for binding tax information aforementioned refers to tax events that occurred before the entry into force of Law 64-A/2008 of 31 December, which extended from 24 to 36 months the period to carry out reinvestment. In other words, the period legally provided for carrying out reinvestment, regarding the tax events analyzed in the request for binding information aforementioned was 24 months, counted from the date of transfer of the property intended exclusively for own and permanent dwelling of the taxpayer)."

7. Thus, in light of the above, it must be decided whether the 6-month period to dedicate Property 2 to the own and permanent dwelling of the taxpayer is counted from the date of transfer of Property 1 or from the date of acquisition of Property 2.

8. Both the Claimant and the Respondent appear to agree that the calculation of the 6-month period for dedication of Property 2 to own and permanent dwelling should be made from the date of acquisition of Property 2, that is, from the date the reinvestment was realized.

9. Thus, the Claimant and the Respondent conclude that the period for dedication to dwelling should be 30 months (24 months + 6 months) in total, counted from the date of acquisition of Property 2, that is, ending on 31/01/2011 or 01/02/2011, respectively.

10. This is not, however, the position stated in the decisions of the arbitral tribunal cited above, which indicate as the relevant date for calculating the period the date of transfer of Property 1, which generates the capital gain. Only from this date is the tax event – capital gain – verified and it is from the realization of the same that the periods for reinvestment should be calculated.

11. Thus, the reinvestment cannot retroactively precede by more than 24 months, nor be postdated by more than 36 months, from the date of transfer of the property from which the capital gains derive.

12. Being verified that reinvestment was realized within this 24-month period preceding the transfer, how should the periods of no. 6 of Article 10 of the IRS Code be calculated?

13. Resorting again to the decisions of CAAD cited above, the periods of no. 6 of Article 10 of the IRS Code should be calculated from the date of transfer of the property generating the capital gain and not from the date of acquisition of the property which is the object of reinvestment.

14. Thus, being verified that the acquisition of the property which is the object of reinvestment occurred within 24 months preceding the transfer of the property generating the capital gain, for purposes of verification of the periods of no. 6 of Article 10 of the IRS Code, the period for reinvestment provided in subparagraph a) of no. 5 of the same article should be given relevance, that is, 36 months.

15. In light of the above, the dedication of Property 2 to the own and permanent dwelling of the Claimant should have occurred within the period of 42 months (36 months + 6 months), counted from the transfer of Property 1, that is, by 28/03/2013. Therefore, this is a condition that is deemed to be verified in the case at hand.

16. Regarding the disputed question of whether "own and permanent dwelling" can be confused with "tax domicile", the prevailing jurisprudence denies this conclusion.

17. By way of example, it is cited Decision 590/11 of the Superior Administrative Court of 23/11/2011, referred to by the Claimant, according to which, "The fact that the taxpayers have not communicated the change of domicile to the property regarding which they requested IMI exemption, by itself, does not indicate that they do not have their own permanent dwelling in that property. The residence in a certain place, the habitatio, may be demonstrated through 'justifying facts' that the beneficiary established in the property the center of his personal life".

18. As well as the arbitral decisions in cases 37/2013-T and 103/2013-T.

19. In this way, the change of tax domicile, as provided in Article 19 of the General Tax Law, should not be relevant in an exclusive and determinant manner for purposes of calculating the period for dedication of the property to dwelling.

20. As was demonstrated by the documentation submitted to the proceedings and by the witness testimony produced, the Claimant has resided in Property 2 since late 2010, such that the formality contained in the communication of change of tax domicile per se does not invalidate the conclusion that he dedicated Property 2 to his own and permanent dwelling still during 2010.

21. It is thus concluded that the requirement of subparagraph a) of no. 6 of Article 10 of the IRS Code is verified, such that it should be considered that the Claimant dedicated Property 2 to his own and permanent dwelling within the legal period provided, such that the tax exclusion provided in subparagraph c) of Article 10 of the IRS Code should be considered applicable.

d. On the Reinvestment Effected in Works Realized in Property 2

1. Finally, the Claimant argues that, given the state of partial ruin of Property 2 and the profound works performed, which entailed its partial demolition, it should be considered that the Claimant effected the reinvestment of the proceeds from the realization of the transfer in the acquisition of Property 2, acquired a few months before the realization of the capital gain, and in the realization of works in that same Property 2.

2. The value of this reinvestment would amount to € 209,516.25, a value resulting from the difference between the cost of the works and the amount of financing obtained for that purpose (credit in the amount of € 29,270.42).

3. In this regard, it is necessary to analyze whether it will be admissible, in light of the provision of subparagraph c) of no. 6 of Article 10 of the IRS Code, the reinvestment in "improvement of another property" acquired prior to the date of realization of the capital gain, that is, to the transfer of Property 1.

4. It should be cited, from the outset, Decision no. 996/07 of the Superior Administrative Court, of 13/02/2008, which decided as follows: "Subparagraph b) of no. 5 of Article 10 of the Personal Income Tax Code only contemplates the 'acquisition referred to in the previous subparagraph' – that is, that of 'ownership of another property' or 'land for construction' -, not 'construction, expansion or improvement of another property'."

5. This position was followed by this learned tribunal in the Decision handed down in Case no. 84/2012-T, which determined in a situation of reinvestment in the construction of a property prior to the transfer of the property generating capital gains, "(…) only the amounts sustained in the twenty-four months after the transfer, duly proved and excluding resort to bank credit, may be considered.".

6. In this regard it should be noted that the Draft Reform of the IRS prepared by the Commission for IRS Reform, dated July 2014, concludes the following: "The regime for exclusion of taxation of capital gains resulting from the transfer of properties intended for own and permanent dwelling does not contemplate the possibility of the reinvestment of the proceeds occurring partially, before and after the transfer. This harms taxpayers who opt for construction of property for own and permanent dwelling, acquiring the land or initiating construction before the transfer and concluding it on a later date. Thus situations arise of manifest inequality, both in relation to cases of direct acquisition and in situations where the acquisition of land and construction occur at a moment after the transfer, which is important to correct. (…)".

7. The situation described above was corrected with the entry into force of the new version of nos. 5 and 6 of Article 10 of the IRS Code, given by Law No. 82-E/2014 of 31 December.

8. However, Article 17 of said Law provides that the new version of Article 10 of the IRS Code shall apply only to capital gains assessed as of 1 January 2015. The new version of Article 10 of the IRS Code was not thus given an interpretive nature.

9. Thus, considering the provisions in force at the date of the practice of the taxable event, for purposes of the reinvestment provided in the provisions of subparagraph b) of no. 5 and subparagraph a) of no. 6 of Article 10 of the IRS Code, only the amounts incurred with the acquisition of Property 2 and not with the works performed on the same property shall be considered.

10. For the purpose of the reinvestment in works performed on Property 2 to be considered, only the provision of subparagraph a) of no. 5 and subparagraph b) of no. 6 of Article 10 of the IRS Code is relevant, that is, the expenses duly proved to have been incurred with the works on Property 2 within the 36-month period counted from the transfer of Property 1, that is, from the tax event generating the capital gain.

11. It will thus be necessary to analyze verification of the remaining requirements of subparagraph c) of no. 6 of Article 10 of the IRS Code understood a contrario, namely: i) the works being initiated within six months after the end of the period in which reinvestment must be made; or ii) registration of the alterations in the matrix having been requested within 24 months from the date the works began; and in any case, iii) having dedicated the property to his dwelling by the end of the 5th year following the year of realization.

12. As stated above, this Tribunal considers that the periods of no. 6 of Article 10 of the IRS Code should be calculated from the date of realization of the capital gain, such that the first period to be taken into account is that of initiation of works within 42 months after the transfer of Property 1.

13. This period is deemed to be verified in the case at hand, given that the work shall have been initiated with demolition work, which shall have begun between 27/04/2009 and 27/05/2009, constituting the period foreseen in the building demolition licensing permits and occupation of public way for realization thereof.

14. Regarding registration of the alterations in the matrix within 24 months from the date the works began, no proof was made of the submission of the IMI Model 1 Declaration.

15. Finally, regarding the dedication of Property 2 to own and permanent dwelling within five years from the date of realization of the capital gains, that is, by 2014, there are no doubts regarding the same.

16. It is thus concluded that the admissibility of partial reinvestment, pursuant to the provisions of subparagraph b) of no. 5 and subparagraph a) of no. 6 of Article 10 of the IRS Code, but considering only the amounts incurred with the acquisition of Property 2, as described above in point 83, that is, € 32,500.

17. Regarding reinvestment in works performed on Property 2, pursuant to subparagraph a) of no. 5 and subparagraph b) of no. 6 of Article 10 of the IRS Code, only the expenses duly proved to have been incurred with the works on Property 2 within the 36-month period counted from the transfer of Property 1, that is, from 28/09/2009 until 28/09/2012, deducted from the amount of the loan for works of € 29,270.42, in the total amount of € 209,516.25, shall be considered, as described above in point 115.

V. DECISION

In light of the above, the arbitrators constituting this arbitral panel agree in judging the request partially founded regarding the tax exclusion of the capital gain obtained from the transfer of the own and permanent dwelling of the taxpayer Claimant herein.

Consequently, it is decided to partially annul the tax assessment act for IRS no. 2013 ..., of 6 August 2013, relating to the year 2009, in which the tax due was calculated at the amount of € 90,541.53, whose balance shown in the accounts reconciliation statement is € 87,626.59, including the statement of calculation of compensatory interest in the amount € 9,150.52, based on the defect of violation of law, in the part in which:

a) The amount of € 42,397.82 was not considered as forming part of the acquisition value of Property 1, corresponding to the consideration paid for the right of exclusive use of four storage compartments, updated in accordance with the currency devaluation coefficient applicable to 1994;

b) The acquisition of Property 2 (€ 182,500.00), excluding the amount of the bank loan requested for acquisition of the same (€ 150,000.00), in the total amount of € 32,500.00, was not considered as relevant reinvestment;

c) The amount reinvested in works of improvement of Property 2 (€ 238,786.67), excluding the portion corresponding to the bank loan granted for realization of the same (€ 29,270.42), that is, the amount of € 209,516.25, was not considered.

The value of the case is set at € 70,889.34 (seventy thousand, eight hundred eighty-nine euros and thirty-four cents), pursuant to Article 97-A, no. 1, a), of the Tax Procedure Code, applicable under subparagraphs a) and b) of no. 1 of Article 29 of the RJAT and no. 2 of Article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

The amount of the arbitration fee is set at € 2,448, pursuant to Table I of the Regulation of Costs of Tax Arbitration Proceedings, to be paid by the parties in proportion to the extent of defeat, that is, 57% for the Respondent and 43% for the Claimant, pursuant to Articles 12, no. 2, and 22, no. 4, both of the RJAT, and Article 4, no. 4, of the cited Regulation.

Notification shall be made.

Lisbon, 12 February 2015

The Arbitrators,

Manuel Luís Macaísta Malheiros
(President)

Jorge Carita
(Voting Member)

Vera Figueiredo
(Rapporteur)

Document prepared on computer, pursuant to no. 5 of Article 131 of the Civil Procedure Code, applicable by reference of subparagraph e) of no. 1 of Article 29 of the RJAT, written in accordance with the spelling of the Portuguese Language Orthographic Agreement, approved by Resolution of the Assembly of the Republic no. 26/91 and ratified by Decree of the President of the Republic no. 43/91, both of 23 August.

[1] Pursuant to no. 3 of Article 69 of Law No. 64-A/2008, of 31 December, "The alteration of the reinvestment period referred to in subparagraphs a) and b) of no. 5 of Article 10 of the IRS Code, in the version given by the present law, is applicable to situations where the period of 24 or 12 months is still in force or expires in 2009."