Summary
Full Decision
ARBITRAL DECISION
REPORT
On 3 August 2018, A..., resident in ..., ..., ..., United Kingdom, with tax identification number ... and B..., resident in ..., ..., ..., United Kingdom, with tax identification number ... (hereinafter referred to as the Claimants and, individually as the Male Claimant and the Female Claimant), came, pursuant to the combined provisions of Articles 2, paragraph 1, subparagraph a) and 10 and following, of Decree-Law No. 10/2011, of 20 January, which approved the Legal Framework for Tax Arbitration (RJAT) and 99, subparagraph a) and 102, paragraph 1, subparagraphs b) and e), to request the constitution of an Arbitral Tribunal, in which the Tax and Customs Authority (hereinafter AT or the Respondent) is the defendant, with a view to declaring the illegality and partial annulment of the assessments of Personal Income Tax (IRS) bearing the numbers 2017... and 2017..., respectively, relating to the year 2016, with the consequent reimbursement of the amounts unduly paid by each of them.
Summary of the Parties' Positions
From the Claimants:
As grounds for the petition for partial annulment of the Personal Income Tax assessment acts identified in the request for arbitral pronouncement, the Claimants invoke the following:
During the year 2016, the year of the sale of a property situated in Portugal, owned by them in equal shares, the Claimants were married to each other, under the marital property regime of accrued gains, and were tax residents in ..., in the United Kingdom;
The property, corresponding to unit B of the urban real estate registered in the land registry of the Joint Parishes of ... and ..., municipality of ... under article ..., acquired by the Claimants in 2012, for € 400,000.00, was sold in 2016 for the total amount of € 750,000.00;
The Claimants, opting for separate taxation of their income, timely filed their respective Personal Income Tax Form 3 declarations relating to the year 2016, in whose Annex G each declared the capital gain resulting from the sale of 50% of the said property, entering the acquisition value of € 200,000.00 and the sale value of € 375,000.00, as well as the sum of € 36,276.17 relating to expenses and charges incurred with the acquisition and sale of their share in the property;
The Claimants obtained no other income in national territory during the year 2016;
The AT taxed the total capital gain realised, at the rate of 28%, having calculated tax in the amount of € 38,842.67 for each of the Claimants, interpreting paragraph 2 of Article 43 of the Personal Income Tax Code, a contrario sensu, that is, without considering the exclusion from taxation of 50% of the capital gain realised, which contravenes the Community principle of free movement of capital and constitutes a violation of the letter and spirit of the law;
The norm of paragraph 2 of Article 43 of the Personal Income Tax Code has been interpreted by Superior Courts in the sense of its application to non-residents in national territory, but residents in another Member State of the European Union, who cannot be subject to differential treatment relative to taxpayers fiscally resident in Portugal;
The Court of Justice of the European Union (CJEU) ruled in Case C 443/06 – Hollmann Judgment – to the effect that paragraph 2 of Article 43 of the Personal Income Tax Code, by establishing a differentiated regime for residents in Portugal and for residents in other Member States of the European Union in the liquidation of a real estate investment, violates the current Article 63 of the Treaty on the Functioning of the European Union (TFEU), as it constitutes a disguised restriction on the free movement of capital;
Article 63 of the TFEU overrides the Personal Income Tax Code, by force of the supremacy of Community law, enshrined in paragraph 4 of Article 8 of the Constitution of the Portuguese Republic (CRP);
And, notwithstanding the fact that direct taxation falls within the exclusive competence of the Member States, its exercise cannot jeopardise the fundamental principles of European Union Law;
Therefore, the Personal Income Tax assessments for the year 2016 should be considered illegal and their partial annulment determined, since they confer a differentiated and discriminatory treatment of capital gains income resulting from the onerous sale of real property rights by the Claimants, as non-residents, in clear violation of European Union law.
From the Respondent:
Notified in accordance with the terms and for the purposes provided for in Article 17 of the RJAT, the AT presented its response and attached the administrative file, in which it came to defend the legality and maintenance of the assessment acts subject to the present request for arbitral pronouncement, referring, in essence, to the grounds of the decision of the administrative claim No. ...2017..., presented jointly by the Claimants against the Personal Income Tax assessments of 2016, subject to the present request for arbitral pronouncement:
The Claimants contend in the request for arbitral pronouncement for a violation of the case law emanating from the CJEU, as well as for the conformity of the request with the case law emanating from Portuguese Courts – Supreme Administrative Court (STA) and CAAD Arbitral Tribunal, invoking the supremacy of European Union Law;
However, since these are non-resident taxpayers, paragraph 2 of Article 15 of the Personal Income Tax Code provides that the tax is levied solely on income obtained in Portuguese territory, in casu, capital gains income, in accordance with subparagraph h) of paragraph 1 of Article 18, and residents of another Member State of the European Union may opt for taxation of such income at the rate which, in accordance with the table of Article 68, would be applicable if residents in Portuguese territory, considering, in that case, all income including that obtained outside this territory, as provided for in paragraphs 9 and 10 of Article 72 of the Personal Income Tax Code;
In the absence of such option, and with paragraph 2 of Article 43 of the Personal Income Tax Code providing that the net balance of capital gains and losses realised in the same year by residents, relating to transfers referred to in subparagraphs a), b) and c) of paragraph 1 of its Article 10, benefit from the exclusion from taxation of 50% of the respective value, the capital gains obtained by the Claimants were taxed in full, at the rate of 28%, in accordance with subparagraph a) of paragraph 1 of Article 72 of the Personal Income Tax Code;
Law No. 67-A/2007, of 31 December, aimed to adapt the national tax system to the decision handed down by the Court of Justice of the European Union in the Hollmann Judgment (Case No. C-443/06), adding paragraphs 9 and 10 of Article 72 of the Personal Income Tax Code;
The CJEU considered that the issue to be clarified was whether the provision contained in Article 56 of the EC Treaty was opposed "to national legislation, such as that at issue in the main proceedings, which subjects capital gains resulting from the sale of real property situated in an MS, when such sale is effected by a resident of another MS, to a higher tax burden than that which would be incurred, in relation to this same type of operation, on capital gains realised by a resident of the State where such property is situated" (No. 22 of the Judgment);
The CJEU's response to this question was as follows: "Article 56 EC must be interpreted as being opposed to national legislation, such as that at issue in the main proceedings, which subjects capital gains resulting from the sale of real property situated in a Member State, in the present case Portugal, when such sale is effected by a resident of another Member State, to a higher tax burden than that which would be incurred, in relation to this same type of operation, on capital gains realised by a resident of the State where such property is situated";
Thus, what is relevant, from the point of view of compatibility with Community Law, is not, simply, the fact that paragraph 1 of Article 43 of the Personal Income Tax Code excludes from the limitation of tax liability to 50% capital gains realised by a resident of another EU Member State, but rather, decisively, the fact that this could result in a higher tax burden than that which would be applicable to a resident for the same type of operations;
Now, as stated in the judgment, what is not admissible from the point of view of Community Law is "unequal tax treatment of non-residents, insofar as it permits, in the case of capital gains realisation, more burdensome taxation and, therefore, a higher tax burden than that borne by residents in an objectively comparable situation" (No. 54 of the Judgment), if "the tax advantage granted to residents, which consists of a reduction of half of the taxable income corresponding to capital gains, in any case exceeds the counterpart which consists in the application of a progressive rate to the taxation of their income" (No. 58 of the CJEU Judgment);
Thus, in order to detect unequal tax treatment of non-residents, regard must be had to the reduction of half of the taxable income of real estate capital gains, but equally to the rate that would be applied with the same level of income by virtue of the progressivity by brackets, relative to residents;
The unlimited and unconditional extension of the advantage resulting from paragraph 2 of Article 43 of the Personal Income Tax Code to non-residents would have the inadmissible and unintended consequence in light of the non-discrimination principle that would be borne, regardless of the value of the taxable income, tax only at a rate of 14% by application of the proportional rate of 28% corresponding to 50% of the net balance of capital gains and losses;
The legal framework for assessing the existence of a higher tax burden than that borne by residents in an objectively comparable situation does not comprise only paragraph 2 of Article 43 of the Personal Income Tax Code, but also the norms relating to aggregation (Article 22) and general rates (Article 68, paragraph 1);
Since the Claimants did not mark the option for the general rates of Article 68 of the Personal Income Tax Code, in accordance with paragraphs 9 and 10 of Article 72, also of the Personal Income Tax Code, which option would imply entering the total income obtained abroad, should they have any, and the respective country, in the case United Kingdom, the assessment was made in accordance with the elements declared;
The AT merely applied the law, and no question of interpretation at the level of non-conformity or incompatibility with Community law arises from such application, nor could it fail to apply a norm on this basis, as it is subject to the principle of legality, in accordance with paragraph 2 of Article 266 of the CRP, combined with Article 55 of the General Tax Law (LGT);
Especially since the current wording of paragraphs 9 and 10 of Article 72 of the Personal Income Tax Code was added following the pronouncement of the CJEU, which did not proceed with the unlimited and unconditional extension of the advantage resulting from paragraph 2 of Article 43 of the Personal Income Tax Code to non-residents.
By arbitral order of 20 November 2018, the holding of the meeting referred to in Article 18 of the RJAT was dispensed with, the Parties being invited, if they wished, to file successive written submissions within a period of 10 days, commencing with the Claimants, and designating 18 January 2019 as the date for the final decision and warning the Claimants that by that date they should pay the subsequent arbitration fee.
The Parties did not file submissions.
II. CASE MANAGEMENT
The sole arbitrator is competent and was regularly constituted on 16 October 2018, in accordance with the provisions of subparagraph c) of paragraph 1 of Article 11 of Decree-Law No. 10/2011, of 20 January, as amended by Article 228 of Law No. 66-B/2012, of 31 December;
The Parties have legal personality and capacity, are legitimate and are legally represented, in accordance with Articles 4 and 10 of the RJAT and Article 1 of Order No. 112-A/2011, of 22 March.
The proceedings are not vitiated by defects that would invalidate them.
The joinder of claims and the joinder of claimants are admissible, in accordance with paragraph 1 of Article 3 of the RJAT, insofar as the claims formulated and their merit depend on the assessment of the same factual circumstances and the interpretation and application of the same legal principles or rules, as is the case in the present matter.
No exceptions were raised that the arbitral tribunal is required to assess.
III. GROUNDS
III.1 FACTUAL MATTER
In the judgment, the judge shall distinguish the facts established from those not established, basing their decisions (Article 123, paragraph 2 of the Code of Tax Procedure and Process [CPPT], subsidiarily applicable to tax arbitral proceedings, in accordance with Article 29, paragraph 1, subparagraph a), of the RJAT), under penalty of nullity, provided for in paragraph 1 of Article 125 of the same CPPT.
A. Facts Established:
The Claimants, married under the marital property regime of accrued gains and resident in ..., United Kingdom, acquired, on 22 December 2012, for the amount of €400,000.00, the autonomous unit designated by Letter B, of the urban property situated in ..., Street ..., ..., ... and..., in..., then registered under article ... of the parish and municipality of ... (Doc. 5, attached to PI);
On 12 August 2016, the Claimants sold, for the amount of € 750,000.00, the same autonomous unit of the urban property now registered in the land registry under article 15,309 of the Joint Parishes of ... and..., municipality of ... (Doc. 4, attached to PI);
On 31 May 2017, the Male Claimant, with tax identification number..., filed Personal Income Tax Form 3 declaration relating to 2016 income (...), with option for separate taxation, in which he declared his status as a non-resident and, in the respective Annex G – section 4, the sale for € 375,000.00, of 50% of the property ...-B, as well as expenses and charges in the amount of € 36,276.17, marking nothing in section 15 (option for aggregation) – Doc. 6, attached to PI;
On 31 May 2017, the Female Claimant, with tax identification number..., filed Personal Income Tax Form 3 declaration relating to 2016 income (...), with option for separate taxation, in which she declared her status as a non-resident and, in the respective Annex G – section 4, the sale for € 375,000.00, of 50% of the property ...B, as well as expenses and charges in the amount of € 36,276.17, marking nothing in section 15 (option for aggregation) – Doc. 7, attached to PI;
The AT issued in the name of the Male Claimant the Personal Income Tax assessment No. 2017... and, in the name of the Female Claimant, the Personal Income Tax assessment No. 2017..., both in the amount of € 38,842.67 (Docs. 1 and 2, attached to PI), paid by the Claimants on 30 August 2017 (Docs. 8 and 9, attached to PI);
In the said assessments, taxable income of € 138,723.83 was determined, corresponding to the total capital gain realised by each of the Claimants, which, by application of the rate of 28%, generated a tax of € 38,842.67 (Docs. 1 and 2, attached to PI);
The Claimants filed, jointly, the administrative claim No. ...2017... against the Personal Income Tax assessments of 2016, whose decision of rejection (order of the Head of the Administrative Justice Division of the Finance Directorate of Lisbon, of 11 May 2018), was notified to them by order of the Finance Directorate of Lisbon, of 15 May 2018 (copies attached to PA).
B. Facts Not Established:
There are no facts of interest for the decision of the case that should be considered as not established.
C. Substantiation of the established and not established factual matter:
Regarding the factual matter, the Tribunal need not pronounce itself on everything that was alleged by the parties; rather, it has the duty to select the facts that matter for the decision and to distinguish the established facts from the not established facts.
In this way, the facts pertinent to the judgment of the case are selected and delineated according to their legal relevance, which is established with regard to the various plausible solutions of the legal question(s) (see former Article 511, paragraph 1, of the Code of Civil Procedure, corresponding to current Article 596, applicable ex vi of Article 29, paragraph 1, subparagraph e), of the RJAT).
Thus, having regard to the documentary evidence produced by the Parties, the facts enumerated above are considered to be established and not established, respectively.
III.2 OF LAW
A. The Question to be Decided
The question to be decided in the present proceedings is whether there is an incompatibility of the norm contained in Article 43, paragraph 2, of the Personal Income Tax Code with the principle of freedom of movement of capital enshrined in current Article 63 of the Treaty on the Functioning of the European Union.
That is, it is important to determine whether the differentiated regime for the taxation of real estate capital gains realised by non-residents in Portuguese territory establishes a discrimination incompatible with the principle of freedom of movement of capital, a fundamental principle of the European Union, notwithstanding the amendments introduced to the Personal Income Tax Code by Law No. 67-A/2007, of 31 December, reflected in the addition of current paragraphs 9 and 10 of Article 72 of the Personal Income Tax Code, in force at the date of the taxable event.
The matter in question has already been dealt with by the Court of Justice of the European Union, prior to those amendments, in Case No. C-443/06, of 11 October, known as the Hollmann Judgment, in which it was decided that "Article 56 EC [current Article 63 of the TFEU] must be interpreted as being opposed to national legislation, such as that at issue in the main proceedings, which subjects capital gains resulting from the sale of real property situated in a Member State, in the present case Portugal, when such sale is effected by a resident of another Member State, to a higher tax burden than that which would be incurred, in relation to this same type of operation, on capital gains realised by a resident of the State where such property is situated."
The CJEU then considered that "although direct taxation falls within the competence of the Member States, they must exercise this competence in compliance with Community law" and that the discriminatory treatment of non-residents was based on the fact that "while a non-resident is subjected to a rate of 25% [28% in 2016] on the taxable income corresponding to the total capital gains realised, the consideration of only half of the taxable income corresponding to capital gains realised by a resident enables the latter to benefit systematically, for that reason, from a lower tax burden, regardless of the rate of taxation applicable to the total of his income, given that, according to the observations made by the Portuguese Government, the taxation of income of residents is subject to a progressive rate table whose highest bracket is 42%" (48% in 2016, plus the solidarity surcharge of 2.5% or 5%).
The Supreme Administrative Court has also made pronouncements of similar tenor on the matter, noting, in particular, that "I - The provisions of the EC Treaty, which govern the European Union, prevail over the rules of ordinary national law, in the manner defined by the bodies of European Union law, provided that they respect the fundamental principles of the democratic rule of law.
II - It is incompatible with Community law, as it restricts the movement of capital which Article 56 of the EC Treaty enshrines, the provision of paragraph 2 of Article 43 of the CIRS, by not applying to residents outside national territory the limitation of taxation to 50% of the capital gains realised which it establishes for residents in national territory." – cf. the Judgment delivered in Case No. 01172/14, on 3 February 2016.
Similarly, several CAAD arbitral decisions have made pronouncements.
However, the Respondent argues that "the legal framework in which to assess, in relation to the taxation of real estate capital gains, the existence of a 'higher tax burden than that borne by residents in an objectively comparable situation'" (No. 54 of the judgment), comprises, beyond paragraph 2 of Article 43 of the Personal Income Tax Code, the provisions contained in Article 22, paragraph 1 and Article 68, both of the Personal Income Tax Code, regarding non-residents and their taxation at the rate of 28%."
Now, paragraphs 8 to 10 of Article 72 of the Personal Income Tax Code provide:
"8 – Income provided for in paragraphs 4 to 7 may be aggregated by option of their respective holders resident in Portuguese territory.
9 - Residents of another Member State of the European Union or of the European Economic Area, provided that, in the latter case, there is an exchange of information in tax matters, may opt, in relation to income referred to in paragraphs 1 and 2, for taxation of such income at the rate which, in accordance with the table provided for in paragraph 1 of Article 68, would be applicable in the case of such income being obtained by residents in Portuguese territory.
10 - For the purposes of determining the rate referred to in the preceding paragraph, all income is taken into account, including that obtained outside this territory, on the same conditions as are applicable to residents."
It was proved in the proceedings that, in the assessments challenged, the AT taxed the total capital gains obtained by the Claimants, at the rate of 28%, being convinced that the provision of paragraph 2 of Article 43 of the Personal Income Tax Code, in its literal interpretation, does not constitute a discrimination of treatment between residents and non-residents, but residents in another Member State of the European Union or of the European Economic Area, provided that, in the latter case, there is an exchange of information in tax matters, since these may opt for aggregation of capital gains income and for its taxation at the general rates of Article 68 of the cited code.
As is noted, among others, in arbitral decisions No. 45/2012-T and No. 127/2012-T, considering the provision of Article 43, paragraph 2, of the Personal Income Tax Code, we are faced with a discriminatory regime and incompatible with Community Law, by violation of Article 63 of the Treaty on the Functioning of the European Union. It remains to be determined whether the option of equalisation, introduced into the Portuguese tax system, following the Hollmann Judgment, contained in paragraphs 8 to 10 of Article 72 of the Personal Income Tax Code, in force at the date of the taxable event, makes it possible to rule out the CJEU's finding of discrimination on the restrictive provision of paragraph 2 of Article 43 of the Personal Income Tax Code relating to resident taxpayers.
We believe not: first, because, as is stated in the arbitral decision handed down in Case No. 748/2015-T, to which we adhere, "In the first place, it must be noted that the solution introduced by the legislature to circumvent the discrimination contained in the aforementioned national norm places an additional burden on non-residents, compared to residents. In addition to this is another observation that results from the complexity of the operation of the tax, aggravated by the 'option for aggregation' of all income obtained in the other country, in addition to other relevant issues associated with the principle of territoriality provided for in Article 15 of the CIRS, the conditions of personalisation of the tax and the progressivity of the tax, hardly compatible with an adequate consideration of amounts obtained in another member state, in the current state of Community law." (…) "The AT alleges that the solution adopted in Article 72, paragraphs 8 to 10, suffices, since for residents in Portuguese territory, this income is also subject to aggregation. Now, such argument does not seem appropriate because it does not take into account all other conditions of taxation inherent to the operation of a tax with the characteristics of personal income tax and evidences an intention of taxation based on income obtained in the other country (when aggregated) well knowing that this involves non-comparable realities, easily distorted by an entire underlying reality that escapes the fiscal sovereignty of the Portuguese state."
Second, because, even if the highest bracket of the general rates referred to in Article 68 of the Personal Income Tax Code is 48%, in 2016, even if possibly increased by the solidarity surcharge of 2.5% or 5%, the taxation of capital gains realised by non-resident taxpayers at the rate of 28% maintains the discriminatory situation at the basis of the Hollmann Judgment, that "the tax advantage granted to residents, which consists of a reduction of half of the taxable income corresponding to capital gains, in any case exceeds the counterpart which consists in the application of a progressive rate to the taxation of their income" and which led the CJEU to declare the norm of paragraph 2 of Article 43 of the Personal Income Tax Code incompatible with the principle of free movement of capital.
In light of the foregoing and, concluding that paragraph 2 of Article 43 of the Personal Income Tax Code is incompatible with Article 63 of the TFEU, which determines the illegality of the assessments challenged, the request for arbitral pronouncement is held to be well-founded.
B. Questions of Prejudged Cognition
In the judgment, the judge must pronounce himself on all questions that he should assess, refraining from pronouncing himself on questions within the cognition of which he should not be aware (final segment of paragraph 1 of Article 125 of the CPPT), such that the questions within the cognizance powers of the tribunal are, in accordance with paragraph 2 of Article 608 of the Code of Civil Procedure, subsidiarily applicable to tax arbitral proceedings, by remission of Article 29, paragraph 1, subparagraph e), of the RJAT, "the questions which the parties have submitted to it for assessment, except those whose decision is prejudiced by the solution given to others (…)".
In light of the solution given to the question to be decided in light of European Union law, its assessment via the Convention for the Avoidance of Double Taxation between Portugal and the United Kingdom is prejudged.
DECISION
On the basis of the factual and legal grounds set out above and, in accordance with Article 2 of the RJAT, it is decided, holding the present request for arbitral pronouncement to be entirely well-founded:
To declare the illegality of Personal Income Tax assessments Nos. 2017... and 2017..., determining their partial annulment;
To condemn the AT to the restitution of the amounts unduly paid by the Claimants as Personal Income Tax for the year 2016, of € 19,421.34, each.
VALUE OF THE CASE: In accordance with the provision of Article 306, paragraphs 1 and 2, of the Code of Civil Procedure, 97-A, paragraph 1, subparagraph a), of the CPPT and 3, paragraph 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the case is set at € 38,342.68 (thirty-eight thousand, three hundred and forty-two euros and sixty-eight cents).
COSTS: Calculated in accordance with Article 4 of the Regulation of Costs in Tax Arbitration Proceedings and Table I attached thereto, in the amount of € 1,836.00 (one thousand, eight hundred and thirty-six euros), to be borne by the Tax and Customs Authority.
Let notification be made.
Lisbon, 18 January 2019.
The Arbitrator,
/Mariana Vargas/
Text prepared by computer, in accordance with paragraph 5 of Article 131 of the Code of Civil Procedure, applicable by remission of subparagraph e) of paragraph 1 of Article 29 of Decree-Law 10/2011, of 20 January.
The wording of this decision is governed by the 1990 spelling agreement.
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