Process: 351/2018-T

Date: December 3, 2018

Tax Type: IRS

Source: Original CAAD Decision

Summary

This CAAD arbitral decision (Process 351/2018-T) addresses whether taxpayers can deduct Category F rental property losses from previous years without opting for income aggregation (englobamento). The claimants had negative rental income of €9,232.48 in 2015 and sought to deduct it from their 2016 Category F income of €13,554.94, which was taxed at the 28% autonomous rate under Article 72 of the IRS Code. The core dispute centers on whether Article 55 of the IRS Code requires taxpayers to opt for englobamento to carry forward Category F losses. The claimants argued that Article 55 imposes no such condition, noting that when the legislator intended this requirement, it did so expressly (as with certain Category G capital gains). They cited consistent CAAD jurisprudence supporting their position. The Tax Authority (AT) contended that loss carryforward presupposes the upstream option for inclusion, arguing taxpayers cannot obtain 'the best of both worlds'—applying the liberatory autonomous rate while simultaneously carrying forward losses tied to an inclusion option not exercised. The AT emphasized that by not checking the englobamento box in Annex F, the claimants chose separate taxation and thus forfeited loss deduction rights. This case exemplifies the ongoing interpretive conflict between literal statutory reading and administrative practice regarding Category F loss deductions, with significant implications for real estate investors managing rental properties generating periodic losses under Portuguese IRS law.

Full Decision

ARBITRAL DECISION

I – REPORT

A..., taxpayer no. ..., and B..., taxpayer no. ..., hereinafter referred to as the "Claimants", have requested the constitution of an Arbitral Tribunal, pursuant to and for the purposes of the provisions of subparagraph a) of paragraph 1 of Article 2 and subparagraph a) of paragraph 1 of Article 10 of the Legal Framework for Arbitration in Tax Matters ("LFATM"), presenting a request for arbitral pronouncement seeking a declaration of illegality of the Personal Income Tax ("IRS") assessment no. 2017... and the partial annulment thereof, with respect to Category F income.

The Tax and Customs Authority (hereinafter referred to only as the "Respondent" or "TCA") is the Respondent.

The request for constitution of the arbitral tribunal was accepted by His Excellency the President of CAAD on 23-07-2018.

The Respondent was notified of the presentation of the request for constitution of the arbitral tribunal on 27-07-2018.

Given that the Claimants did not proceed with the appointment of an arbitrator, pursuant to the provisions of Article 6, paragraph 2, subparagraph a) of the LFATM, the undersigned was designated as arbitrator by the President of the Deontological Council of CAAD, with the appointment having been accepted within the prescribed timeframe and terms.

On 11-09-2018, the Parties were duly notified of this appointment and did not manifest the intention to refuse the appointment of the arbitrator, pursuant to the provisions of Article 11, paragraph 1, subparagraphs a) and b) of the LFATM, in conjunction with Articles 6 and 7 of the Deontological Code.

In accordance with the provisions of subparagraph c), paragraph 1, Article 11 of the LFATM, the Arbitral Tribunal was constituted on 01-10-2018.

The Claimants substantiated the request for arbitral pronouncement by alleging, in summary, the following:

Article 55 of the IRS Code does not impose as a condition for the deduction of losses from Category F income the inclusion thereof;

When the legislator intended to impose this condition and obligation, it did so expressly, as occurred in the case of losses related to (certain) Category G income (capital gains);

Finding no reason to prevent the deduction of the negative net income from Category F determined in 2015, in the amount of €9,232.48, the Claimants consider that the net income of this category in 2016 should be reduced by this amount, thus resulting in a correction of the IRS to their benefit, in the amount of €2,585.09 (amount which results from the application of the autonomous rate of 28%, provided for in Article 72 of the IRS Code, to the losses that should have been deducted in 2016);

The Claimants further add that this is the position that has been repeatedly assumed in the various arbitral decisions that address this matter.

The Respondent presented a Reply, in which it presented a defense by impugnation, in which it sustains the inadmissibility of the request for arbitral pronouncement based on the following arguments:

The Claimants expressly declared, in the IRS Model 3 declaration, to be resident on the Portuguese mainland;

The Claimants expressly declared, in the IRS Model 3 declaration, not to opt for the inclusion of real estate income earned by them;

By not opting for inclusion, the Claimants resident herein chose to tax separately the income of Category F by applying a fixed liberatory rate to that gross income, although the obligation remained for them to include such income in their respective IRS declaration;

Having the Claimants opted not to include Category F income, they are now prevented from having the negative net result of the year 2015 in the amount of €9,232.48 reflected in their total;

Loss carryforward is a downstream operation that presupposes the adoption upstream of the option to include—which did not happen in the present case;

Not having the Claimants opted for inclusion, they cannot now come to "obtain the best of both worlds," that is, the application of a liberatory rate to Category F income and, simultaneously, the carryforward of losses underlying an inclusion option that was not taken;

With respect to the request for compensatory interest, the Respondent understands that these are not owed inasmuch as the TCA merely applied the law in the manner to which it is constitutionally bound, and there can be no talk of error on the part of the services pursuant to the provisions of Article 43 of the General Tax Law.

In its reply, the Respondent further requested from the Tribunal the waiver of the meeting referred to in Article 18 of the LFATM and, if the Claimants did not object, that it proceed directly to the decision of the case.

By Order of 30-10-2018, this Tribunal, pursuant to the principles of autonomy in the conduct of proceedings, expedience, and procedural simplification and informality (Articles 19, paragraph 2, and 29, paragraph 2, of the LFATM), considering that no exceptions were raised and that the arguments of the Parties were clearly presented, decided to waive the holding of the meeting provided for in Article 18 of the LFATM, and to waive the production of allegations, unless the Claimants were fundamentedly opposed to this.

The Claimants did not oppose the waiver of allegations and proceeding directly to the decision of the case, as had been requested by the TCA in its reply.

II – PRELIMINARY RULING

No exceptions were raised.

The presentation of the request for arbitral pronouncement was timely.

The Parties possess legal personality and capacity, are legitimate as to the request for arbitral pronouncement, and are duly represented, pursuant to the provisions of Articles 4 and 10 of the LFATM and Article 1 of Ordinance no. 112-A/2011, of March 22.

No nullities are found to exist, whereby it is necessary to address the merits.

III. MERITS

III.1. FACTUAL MATTERS

§1. Facts Established

The Tribunal considers the following facts to be established:

The Claimants filed their IRS Model 3 tax declaration for the year 2015 on May 28, 2017, having opted for joint taxation of income;

In Annex F of the declaration, real estate income was declared in the amount of €13,983.39, as well as expenses incurred and paid in the amount of €23,215.87, with the Claimants having opted for inclusion of the respective income, as indicated in Box 07 – B of Annex F;

From the combination of real estate income earned and expenses incurred and paid resulted a negative income of this Category F in the amount of €9,232.48;

The Claimants filed their IRS Model 3 tax declaration for the year 2016 on May 30, 2017, having opted for joint taxation of income;

Said declaration contained Annex F (Real Estate Income) with a gross income value of €15,010.44, an amount from which €1,455.50 was deducted as expenses incurred and paid, thus totaling net income of this category at €13,554.94;

All real estate income in question and expenses incurred, in 2015 and in 2016, result from a single property located in ..., municipality of Amadora, it being that the same has been the property of the Claimants for several years, and has also been leased for several years;

Not having the Claimants opted for inclusion of real estate income (as indicated in Box 07 - B of Annex F), such net income was taxed at the autonomous rate of 28% provided for in subparagraph c) of paragraph 1 of Article 72 of the IRS Code, thus contributing to the net collection and amount payable of IRS contained in the IRS assessment note no. 2017...;

From the net income of this category of income indicated above, the negative net income of Category F income determined in the year 2015 was not deducted, that is, €9,232.48;

The Claimants filed a Gracious Complaint, instituted under no. ...2018..., with respect to the Personal Income Tax ("IRS") assessment no. 2017... for the year 2016, by considering this assessment illegal, on the grounds of the non-deduction of losses related to Category F income determined in the year 2015;

The Gracious Complaint was dismissed by Order notified to the Claimants on 06-05-2018, by virtue of the Tax and Customs Authority having considered that the deduction of carried-forward losses is only possible if there is inclusion in the year in which one seeks to effect this deduction.

§2. Facts Not Established

With relevance to the decision, there are no essential facts not established.

§3. Reasoning with Respect to Factual Matters

With respect to the factual matters established, the conviction of the Tribunal was based on the free evaluation of the positions assumed by the Parties on the matters of fact, on the Administrative Proceeding, and on the content of the documents attached to the file, not contested by the Parties.

III.2. LEGAL MATTERS

§1. Questions to be Decided

The disputed question in the present proceeding relates to whether the tax assessed under Category F for the year 2016, resulting from the application of the 28% rate to the positive net income from rented property, should, or should not, have taken into account the negative net result determined in the year 2015, in the amount of €9,232.48.

For the clarification of the aforementioned question, it is important to know whether the carryforward of losses within Category F of the IRS presupposes the option to include real estate income.

In the event the request for arbitral pronouncement is granted, there is a need to decide, further, whether the Claimants are entitled to the payment of compensatory interest.

§2. Application of Law to the Case Sub Judice

Article 55 of the IRS Code, under the heading "Deduction of Losses," provides, in its paragraph 1, as follows:

"1 - With respect to each income earner, the negative net result determined in any category may only be deducted from its positive net results in the same category, as follows:

a) The negative net result determined in Category B may only be carried forward, in accordance with the applicable part of Article 52 of the Corporate Income Tax Code, to the twelve years following that to which it relates;

b) The negative net result determined in a given year in Category F may only be carried forward to the six years following that to which it relates;

c) The percentage of the negative balance referred to in paragraph 2 of Article 43 may only be carried forward to the five years following that to which it relates;

d) The negative balance determined in a given year, relating to the operations provided for in subparagraphs b), c), e), f), g) and h) of paragraph 1 of Article 10, may be carried forward for the five years following when the taxpayer opts for inclusion.

[…]"

It results from the transcribed provision that, with respect to each income earner, a negative net result determined in Category F in a given year may be deducted from positive net results in the same category, provided that it is carried forward to the six years following that to which it relates.

Contrary to what is expressly provided in subparagraph d), of paragraph 1, of Article 55 of the IRS Code, relating to the operations provided for in subparagraphs b), c), e), f), g) and h) of paragraph 1 of Article 10, the legislator does not condition the deductibility of losses determined within Category F [provided for in subparagraph b), of paragraph 1, of Article 55 of the IRS Code] to the option, on the part of the income earner, to include, in the year in which they seek to effect the deduction.

The taxation of Category F income is ordinarily effectuated through the application of a special rate (autonomous taxation rate) of 28%, as provided for in Article 72, paragraph 1, subparagraph e), of the IRS Code.

The special rates, provided for in Article 72 of the IRS Code, have a nature distinct from the liberatory rates, provided for in Article 71, with which they are not to be confused.

Indeed, the application of the rates provided for in Article 72 of the IRS Code does not result in any withholding at the source as final, nor does it release the income earner from the fulfillment of the inherent tax obligations, including the declarative obligation.

The rate of 28% referred to in Article 72, paragraph 1, subparagraph e), is applied to the net income of Category F, that is, to the value corresponding to gross (or net) income subtracted from the amounts corresponding to specific deductions and loss deduction, pursuant, respectively, to Articles 41 and 55, paragraph 1, subparagraph b), both of the IRS Code.

Article 72, paragraph 8, of the IRS Code provides for the possibility of the income earner of Category F to opt for inclusion, but does not provide that the exercise of this option by the income earner is a sine qua non condition for the deductibility of any losses determined in the same category.

Nor does it result from Article 22 of the IRS Code that loss deductions are only admissible when there is inclusion of income.

Moreover, as clearly results from the letter of Article 55, paragraph 1, the legislator does not provide that the deduction of losses in Category F be made to included income, but rather to net income determined in said category.

There is, therefore, no legal basis that permits the Respondent to refuse the deduction of losses within Category F when the taxpayers have not opted for the inclusion of income of this category, as occurs in the case sub judice.

Thus, the IRS assessment no. 2017..., which is the object of the request for arbitral pronouncement, is illegal due to error in the application of law to the facts, whereby it should be partially annulled, and should, on the same grounds, the decision dismissing the gracious complaint instituted under no. ...2018... be annulled.

The Claimants further request that this tribunal determine the reimbursement of the amounts indebitedly borne, and condemn the Respondent to the payment of compensatory interest.

In accordance with the provisions of subparagraph b), of paragraph 1, of Article 24 of the LFATM, "[t]he arbitral decision on the merits of the claim for which no appeal or challenge lies binds the tax administration from the end of the period provided for appeal or challenge, the latter being required, in the exact terms of the merits of the arbitral decision in favor of the taxpayer and until the end of the period provided for the spontaneous execution of judgments of tax judicial courts [...] [t]o restore the situation that would have existed if the tax act that is the object of the arbitral decision had not been carried out, adopting the necessary acts and operations for such purpose."

This norm of the LFATM is coherent with the provision contained in Article 100 of the General Tax Law, whose text is as follows:

"The tax administration is obligated, in the event of total or partial merit in complaints or administrative appeals, or in judicial proceedings in favor of the taxpayer, to the immediate and full restoration of the situation that would have existed if the illegality had not been committed, comprising the payment of compensatory interest, pursuant to the terms and conditions provided for in law."

As to the possibility of the arbitral tribunal recognizing the right to compensatory interest, paragraph 5 of Article 24 of the LFATM provides that "[i]nterest is due for payment, regardless of its nature, pursuant to the terms provided in the general tax law and in the Code of Procedure and Tax Procedure."

And, pursuant to paragraph 1 of Article 43 of the General Tax Law, "[c]ompensatory interest is due when it is determined, in a gracious complaint or judicial impugnation, that there was error attributable to the services from which results payment of the tax debt in an amount greater than legally owed."

In view of the complete merit of the request for arbitral pronouncement, the Claimants are recognized to have the right to reimbursement of the amount indebitedly paid, as such reimbursement is essential for the restoration of the situation that would have existed if the tax act that is the object of the present arbitral decision had not been carried out.

This tribunal further recognizes that the illegality of the assessment in question in the present proceeding resulted from error attributable to the Services of the Tax Administration, expressed in the erroneous application of law, whereby the Claimants are recognized to have the right to compensatory interest, pursuant to Articles 43, paragraph 1, of the General Tax Law and 61 of the Code of Procedure and Tax Procedure, on the amount to be reimbursed.

Compensatory interest is owed from the date of payment until full reimbursement, by application of the suppletive legal rate, pursuant to Articles 43, paragraph 4, and 35, paragraph 10, of the General Tax Law, Article 61 of the Code of Procedure and Tax Procedure, Article 559 of the Civil Code, and Ordinance no. 291/2003, of April 8.

IV – DECISION

In these terms, and with the foundations herein exposed, this Arbitral Tribunal decides:

To judge the request for arbitral pronouncement meritorious;

To declare illegal and to partially annul, with all legal consequences, the IRS assessment no. 2017..., for the year 2016, in the part in which the annulment of the impugned tax act is petitioned, relating to Category F income [subparagraph a) of the request];

To declare illegal and to annul the decision dismissing the gracious complaint instituted under no. ...2018...;

To judge meritorious the request for reimbursement of the amount that may have been indebitedly paid, increased by compensatory interest, at the legal rate, counted from the date of payment until full reimbursement, all as shall be determined in the execution of judgment, condemning the Tax and Customs Authority to effect such reimbursement increased by interest;

To condemn the Respondent to the payment of the costs of the present proceeding.

V - VALUE OF THE PROCEEDING

In accordance with the provisions of Article 306, paragraph 2, of the Code of Civil Procedure and 97-A, paragraph 1, subparagraph a), of the Code of Procedure and Tax Procedure and 3, paragraph 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceeding is fixed at €2,585.09.

VI – COSTS

Pursuant to Article 22, paragraph 4, of the LFATM, the amount of costs is fixed at €612.00, in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be charged to the Respondent.

Lisbon, 03/12/2018

The Arbitrator

(Paulo Nogueira da Costa)

Frequently Asked Questions

Automatically Created

Can Category F rental losses be deducted in subsequent years without opting for income aggregation (englobamento) under Portuguese IRS?
The central controversy is whether Article 55 of the IRS Code requires taxpayers to opt for englobamento (income aggregation) to deduct Category F rental losses in subsequent years. The claimants argue that Article 55 contains no such express requirement, while the Tax Authority contends that loss carryforward inherently presupposes the upstream election of inclusion, preventing taxpayers from benefiting from both the 28% autonomous rate and loss deductions simultaneously.
What does Article 55 of the Portuguese IRS Code say about deducting losses from Category F rental income?
Article 55 of the Portuguese IRS Code governs the deduction of losses from various income categories. The provision does not explicitly state that englobamento is a prerequisite for Category F loss carryforward, unlike certain Category G provisions where the legislator expressly imposed this condition. This textual silence forms the basis of the claimants' argument that no such requirement exists for rental income losses, supported by several CAAD arbitral precedents interpreting the statute literally.
How is the 28% autonomous tax rate under Article 72 of the IRS Code applied to Category F net rental income?
Under Article 72(1)(c) of the IRS Code, Category F net rental income is subject to a 28% autonomous (liberatory) tax rate when taxpayers do not opt for englobamento. This rate is applied directly to net income (gross rental income minus deductible expenses) and is considered final taxation. In this case, the claimants' 2016 net rental income of €13,554.94 was taxed at 28%, but the Tax Authority refused to first reduce this amount by the €9,232.48 loss from 2015 before applying the rate.
What is the CAAD arbitral tribunal's position on requiring englobamento for Category F loss carryforward in IRS?
CAAD arbitral tribunals have repeatedly addressed this issue, with many decisions favoring taxpayers' ability to carry forward Category F losses without mandatory englobamento. The claimants explicitly reference this consistent arbitral jurisprudence supporting a literal interpretation of Article 55. These decisions typically emphasize that the absence of an express legislative requirement for englobamento in Category F loss provisions, contrasted with explicit requirements elsewhere in the IRS Code, indicates no such condition was intended by the legislator.
How do taxpayers challenge IRS assessments that deny Category F loss deductions through CAAD arbitration?
Taxpayers challenge IRS assessments denying Category F loss deductions by first exhausting administrative remedies (such as the gracious complaint/reclamação graciosa filed by these claimants under process ...2018...) and then filing for CAAD arbitration under Article 2(1)(a) and Article 10(1)(a) of the Legal Framework for Arbitration in Tax Matters (RJAT). The arbitration request must identify the contested assessment, specify the legal grounds (typically Article 55 interpretation), quantify the claimed tax refund, and reference supporting jurisprudence. CAAD provides an alternative to judicial courts for resolving IRS disputes, with decisions typically rendered within 6-12 months.