IRS Category B Income: Organized Accounting vs Simplified Regime Dispute (CAAD 370/2016-T)

Arbitration Decision

I. REPORT

A…, TIN…, and B…, TIN…, resident at Street …, no.…, in …, (hereinafter referred to only as the Claimants), filed, on 06-07-2016, a petition for establishment of a single arbitral tribunal, pursuant to articles 2.º and 10.º of Decree-Law no. 10/2011, of 20 January (Legal Regime for Arbitration in Tax Matters, hereinafter referred to only as RJAT), in conjunction with article 99.º of the CPPT, wherein the Tax and Customs Authority is the Respondent (hereinafter designated only as the Respondent).

The Claimants present a petition for arbitral pronouncement with reference to the Personal Income Tax (IRS) assessment act for the year 2011, with a balance due of €30,595.62, and to the decision dismissing the administrative claim filed against said act.

The petition for establishment of the arbitral tribunal was accepted by the Honorable President of CAAD on 07-07-2016 and notified to the Tax and Customs Authority on that same date.

Pursuant to the provisions of subparagraph a) of paragraph 2 of article 6.º and subparagraph b) of paragraph 1 of article 11.º of the RJAT, the Deontological Council designated the undersigned as arbitrator of the single arbitral tribunal, who communicated acceptance of the appointment within the applicable period.

On 06-09-2016, the Parties were duly notified of this appointment and did not manifest any intention to refuse the arbitrator's appointment, pursuant to the combined provisions of article 11.º paragraph 1, subparagraphs a) and b) of the RJAT and articles 6.º and 7.º of the Deontological Code.

In accordance with the provision of subparagraph c) of paragraph 1 of article 11.º of the RJAT, the single arbitral tribunal was established on 22-09-2016.

Notified to respond, the Respondent submitted the relevant response in which it concludes for the total lack of merit of the petition filed by the Claimants.

On 12-01-2017, the hearing provided for in article 18.º of the RJAT took place for examination of the witness called by the Claimants, and the parties were granted a period to submit successive written pleadings.

II. OBJECT OF THE ARBITRAL PRONOUNCEMENT

The Claimants seek the declaration of illegality of the Personal Income Tax assessment for the year 2011, as well as of the decision dismissing the administrative claim filed against said act, as they understand there was an error in determining the taxable income.

Specifically, the Claimants allege that there was an error in determining the taxable income obtained from self-employed activity (Category B) of the husband Claimant, an error arising from the incorrect classification of this activity within the simplified tax regime.

In fact, in the year 2008, the husband Claimant intended to adopt the organized bookkeeping regime for purposes of determining Category B income of the IRS. However, he was informed by the Tax Office of … that, pursuant to the provision in paragraph 6 of article 28.º of the IRS Code, he would be automatically classified in such bookkeeping regime given the fact that, in the tax year 2007, he had exceeded, by more than 25%, the limit provided for in paragraph 2 of the same article.

In the understanding of the Claimants, this regime for determining taxable income would remain in force for a minimum period of three years, and would only be changed in the event of an election by the husband Claimant. As he did not elect the simplified tax regime, in 2011 the organized bookkeeping regime would continue to be the regime applicable to determining the Category B income of the husband Claimant.

It so happened that, in 2011, the Respondent automatically classified the husband Claimant in the simplified tax regime, so the Personal Income Tax assessment for that year was based on this method of determining taxable income.

The Claimants consider that the automatic classification made by the Respondent violates the provision in paragraph 5 of article 28.º of the IRS Code and is, therefore, invalid. Consequently, the Personal Income Tax assessment act made with reference to the year 2011 is also illegal due to an error in determining taxable income and should, therefore, be annulled.

In response, the Respondent sustains the legality of the contested assessment act, alleging that:

"(i) In the case of these proceedings, the application of the simplified regime or the organized bookkeeping regime resulted from legal requirements, in accordance with the limits defined by the legislator for one or the other case;

(ii) The R. never elected the organized bookkeeping taxation regime, pursuant to paragraph 4 of article 28º of the IRS Code;

(iii) In view of the amount of income earned in 2010 (the last year of the three-year period in which he was classified, by legal requirement, in the organized bookkeeping regime), the R. was thus covered, for the year 2011, by the simplified regime;

(iv) The case law invoked by the R. does not apply to the same factual situation present in these proceedings, even though it may be favorable to the AT since it refers to the understanding reflected in the assessments subject to the administrative claim here in question.

(v) 'Simplified regime shall cover taxpayers who, in the exercise of their activity, have not exceeded in the immediately preceding tax period the limits referred to in paragraph 2 of article 28º of the IRS Code and have not elected the organized bookkeeping regime. The election of the organized bookkeeping regime may be made either at the declaration of commencement of activity or annually in a declaration of changes to be submitted by the end of March of the year in which it is intended to change the form of determining income (article 28, paragraphs 3 and 4)' (see, inter alia, judgment of the Administrative Supreme Court of 28/11/2012, Case 709/12).

(vi) The R. therefore lacks reason when, not having made, at any time, the election of the organized bookkeeping regime and presenting, in the last year of the three-year period 2008-2010, a business volume less than €150,000.00, argues for the maintenance, in 2011, of the same taxation regime."

In light of the above, the Respondent argues for lack of merit of the petition and for the maintenance of the contested assessment act.

III. PRELIMINARY ASSESSMENT

The Arbitral Tribunal was regularly established and is competent.

The parties have legal personality and capacity and are legitimate (articles 4.º and 10.º, paragraph 2, of the same statute and article 1.º of Regulation no. 112-A/2011, of 22 March).

The proceedings do not suffer from any defects and there is no obstacle to the consideration of the merits of the case.

IV. FACTS

A. Proven Facts

The following facts are considered proven:

1. During the years 2000 to 2011, the husband Claimant obtained income from professional activity, being classified with the activity code 1003 – Engineer.

2. During the period in question, the business volume of the husband Claimant was:

1. In the years 2006 and 2007, the husband Claimant was classified in the simplified tax regime.

2. In the year 2008, the husband Claimant was automatically classified in the organized bookkeeping regime, pursuant to paragraph 6 of article 28.º of the IRS Code.

3. In the three-year period 2008-2010, the husband Claimant remained classified in the organized bookkeeping regime.

4. In 2011, the husband Claimant was automatically classified in the simplified tax regime.

5. During the period from 2008 to 2011, the Claimant never submitted any declaration of changes for purposes of electing either the simplified tax regime or the organized bookkeeping regime.

6. In 2012, the Claimants submitted the IRS Declaration Form 3 for the year 2011, declaring the income of the husband Claimant in Annex C (Category B Income - Organized bookkeeping regime).

7. The computer system detected filing errors and did not validate the income declaration submitted.

8. In September 2015, the Claimants were notified to submit a new income declaration, replacing Annex C (Category B Income - Organized bookkeeping regime) with Annex B (Category B Income - Simplified regime / Isolated act).

9. The Claimants submitted a new IRS Declaration Form 3 for 2011, declaring in Annex B (Category B Income - Simplified regime / Isolated act) the total gross value of services provided by the husband Claimant in that year.

10. Following the declaration submitted, the Respondent made the Personal Income Tax assessment no. 2015…, in which it determined a value due of €30,595.62.

11. On 08-02-2016, the Claimants filed an administrative claim against the Personal Income Tax assessment identified in the previous item.

12. The administrative claim was dismissed by order dated 21-04-2016, issued by the Chief of the Tax Justice Division of the Finance Directorate of….

13. The Claimants were notified of the dismissal decision by letter no.…, of 21-04-2016.

B. Unproven Facts

No other facts with relevance to the arbitral decision were proven, specifically, it was not proven that in the year 2008, the husband Claimant went to the Tax Office of … to submit a declaration for the purpose of electing the organized bookkeeping regime.

C. Basis of the Factual Findings

The factual findings as proven are based on uncontested documentary evidence. The testimony of the witness called, Mr. C…, official of the Tax Office of…, although spontaneous, was not relied upon by the tribunal because it was not sufficiently specific regarding the times when the Claimant would have gone to the Tax Office.

V. LEGAL MATTERS

In order to assess the legality of the contested Personal Income Tax assessment and the decision dismissing the administrative claim filed by the Claimants, it is necessary to determine whether the automatic decision to classify the husband Claimant in the simplified tax regime, with effect to the tax year 2011, is or is not valid in light of article 28.º of the IRS Code. Its validity or invalidity will imply the correctness or incorrectness of determining the taxable income of Category B obtained by the husband Claimant in the year in question, with inevitable impact on the tax assessed.

At that time, paragraph 1 of article 28.º of the IRS Code provided that "The determination of business and professional income, except in the case of imputation provided for in article 20.º, is made: a) on the basis of applying the rules of the simplified regime; b) on the basis of accounting". These were, thus, the two legally admitted methods of determining taxable income related to professional or business activity of a Personal Income Tax subject.

The application of one or the other regime depended on the option of the taxpayer, which should be made at the time of commencement of activity, always in compliance with legal requirements. If no express option was made, the taxpayer would automatically be classified in the simplified tax regime if it presented a business volume below the limit provided for in paragraph 2 of article 28.º of the IRS Code; if the declared business volume was above such limit, the taxpayer would immediately be classified in the organized bookkeeping regime.

In order to ensure some stability in the tax relationship, paragraph 5 of the same article provided that "The period of stay in any of the regimes referred to in paragraph 1 is three years, renewable for equal periods, except if the taxpayer communicates, pursuant to subparagraph b) of the previous number, the change of the regime by which it is covered". Thus, regardless of the regime applied in the specific case, the stay therein would be mandatory for a minimum period of 3 years, after which the taxpayer could change the classification initially made. If it did nothing, the regime in force would be automatically renewed for another three-year period, and so on successively, except if, in the case of the simplified tax regime, the maximum limit of business volume was exceeded, pursuant to the terms and conditions set forth in paragraph 6 of article 28.º of the IRS Code.

From this it follows that, regardless of whether it is a regime applicable by the taxpayer's option or by legal requirement (for example, in cases where the declared business volume exceeded the maximum permitted limit), its minimum duration would be 3 years, with successive renewals, except for a change in the option exercised by the taxpayer or a change in the respective conditions of admissibility, in the case of the simplified regime.

Contrary to what the Respondent invoked during the administrative claim proceedings, based on the understanding disclosed through Circular no. 5/2007, of 13 March, the minimum period of stay provided for in said rule is applicable to any of the models for determining income provided for in paragraph 1 of article 28.º of the IRS Code, regardless of whether its application, in the specific case, results from an express option of the taxpayer or from a legal requirement. Nothing in the letter of the law allows for a contrary understanding. This is, moreover, now expressly recognized by the Respondent in its response when it states:

• "In the three-year period 2008-2010 the R. remained classified in the organized bookkeeping regime" (see article 27.º);

• "It happens that, in the case of these proceedings, the re-classification occurs after the completion of the three-year period, a consequence of the business volume of the last year not having reached the minimum legal standards established in paragraph 2 of article 28.º of the IRS Code" (see article 38.º);

• "Now, in the specific case, the evaluation of the situation, for purposes of possible re-classification, was made in the last year of the three-year period, with no option by the taxpayer to the effect of wishing to remain in the organized bookkeeping regime" (see article 42.º).

Now, in the case at hand, the husband Claimant was automatically classified in the organized bookkeeping regime with effect from 2008, pursuant to paragraph 6 of article 28.º of the IRS Code, because, in the year 2007, the declared business volume exceeded, by more than 25%, the maximum limit provided for in paragraph 2 of the same article.

By determination of the above-mentioned paragraph 5 of article 28.º of the IRS Code, this regime would remain in force for a minimum period of three years, that is, until 2010, inclusive (as the Respondent also acknowledges), and would be automatically renewed for an equal period "except if the taxpayer communicates, pursuant to subparagraph b) of the previous number, the change of the regime by which it is covered" (see the final part of paragraph 5 of article 28.º of the IRS Code). In the absence of any communication from the taxpayer, the regime in force at the end of the three-year period would be renewed for another period of three years, without any need for re-evaluation or re-classification by the Respondent.

As decided by the Administrative Supreme Court in the judgment of 12-02-2014, issued in case no. 0736/13 (available at www.dgsi.pt), in the case of renewal of the period, there is no need to re-evaluate the taxpayer's situation as if it were commencing activity; the regime in force is renewed automatically, without any need for re-evaluation, as can be seen from the passage we transcribe: "The present appellant made an error in understanding that, due to the fact that the period is automatically renewed for three-year periods and, in the case of these proceedings such renewal occurred, this meant that the taxpayer should be treated as if it were again commencing activity. This understanding, as we have seen, is not correct."

In light of the above, as the husband Claimant did not submit any declaration of change of classification after the end of the three-year period 2008-2010, the regime in force during that same three-year period – organized bookkeeping regime – would again be applicable for the following three-year period, that is, for the period 2011-2013. Thus, the automatic classification made by the Respondent, with effect to 2011, was made in violation of the legal provisions, specifically article 28.º of the IRS Code. Such act is, thus, illegal and invalid and therefore must be annulled. Consequently, the contested Personal Income Tax assessment, because it includes income determined on the basis of a regime for determining income illegally fixed, is also and consequently illegal and, as such, voidable [article 163.º of the Administrative Procedure Code, applicable by force of article 2.º, subparagraph c), of the General Tax Law].

The petition filed by the Claimants therefore merits full acceptance.

VI. DECISION

In accordance with the above, this Arbitral Tribunal decides to find merit in the petition for arbitral pronouncement and, consequently, declares illegal and annuls the Personal Income Tax assessment no. 2015…, for the year 2011, as well as the decision dismissing the administrative claim that was based thereon, due to an error in determining the taxable income of Category B of the husband Claimant (taxpayer A).

Value of the proceedings: In accordance with the provision in article 306.º, paragraph 2, of the CPC and 97.º-A, paragraph 1, subparagraph a), of the CPPT and 3.º, paragraph 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceedings is fixed at €30,595.62 corresponding to the total amount of the Tax Assessment levied and whose annulment is hereby ordered.

Costs: Pursuant to paragraph 4 of article 22.º of the RJAT, the amount of costs is fixed at €1,836.00, in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Respondent.

Let this arbitral decision be registered and notified to the parties.

Lisbon, 09-01-2017

The Single Arbitrator

(Maria Forte Vaz)