CAAD 375/2017-T: VAT Deduction Rights on Furniture and Maintenance Expenses for Business Activity

ARBITRATION DECISION

I – REPORT

On 16/06/2017, A…, Ltd., with Tax Identification Number… and registered office at…, filed a request for constitution of an arbitration tribunal with a view to annulling the dismissal decision of the hierarchical appeal and, consequently, the declaration of illegality and consequent annulment of the tax acts regarding additional assessment and compensatory interest on Value Added Tax (VAT) with the numbers…, relating to period 1112T, …, relating to period 1203T, …, relating to period 1206T, …, relating to period 1209T, …, relating to period 1212T, …, relating to period 1303T, …, relating to period 1306T, …, relating to period 1309T, …, relating to period 1312T, in the contested amount of € 269,600.66, as well as the annulment of the corresponding compensatory interest assessments nos. 2015…, 2015…, 2015…, 201…, 2015…, 2015…, 2015… and 2015…, in the amount relating to the additional VAT assessments contested, the inclusion of the amount of € 166,938.37 in the current account, relating to the tax credit used by the Respondent for purposes of offsetting the debt resulting from the issuance of the aforementioned additional VAT assessments, and the restitution of the amount paid of € 103,202.29, plus compensatory interest.

The request for constitution of the arbitration tribunal was accepted on 19/06/2017.

The Claimant did not select an arbitrator, the signatories being appointed by the CAAD Ethics Council; the appointment having been accepted within the legal deadline, and in the absence of opposition to the appointment, the arbitration tribunal was constituted on 29/08/2017.

Notified to respond on 29/08/2017, the Tax Authority (AT) did so on 02/10/2017, after the relevant administrative file was attached.

On 16/11/2017, the meeting referred to in article 18 of the Legal Regime of Tax Arbitration (RJAT) took place, with examination of the witnesses presented by the Claimant, after which the parties made oral arguments and the tribunal announced the decision for 28/02/2018.

Subsequently, by an arbitration order, the Tribunal decided to extend the deadline for rendering the arbitration decision by two months, pursuant to article 21, no. 2 of the RJAT.

To support its request, the Claimant alleges, in summary, the following:

The corrections made by the Tax Authority with respect to the deduction of VAT incurred with the acquisition of furniture goods from… and remaining conservation and maintenance expenses, in the total amount of € 269,600.66, lack legal foundation, and are therefore illegal, by violation of the provisions of articles 19 and following of the VAT Code (CIVA), whereby the corresponding additional VAT assessments should be annulled, given that such goods and services:

Were acquired by the Claimant in the context of its business activity (and not in a private context, even though they are used in the provision of accommodation services to its proprietor), whereby the requirements set forth in subsection a) of article 20, no. 1 of the VAT Code are fulfilled;

Are necessary for the realization of the operations carried out by the Claimant which, being subject to VAT, confer the right to deduction in accordance with articles 19 and following of the VAT Code;

Do not relate to immovable property, whereby the deduction of the respective VAT could never be limited by virtue of the provisions of article 19, no. 7 of the VAT Code (moreover, such rule was not in force at the date of the facts and as the intention at the time of their acquisition was to allocate such goods to the enterprise, the VAT incurred is deductible, with the use for private purposes being treated as an onerous service provision);

Constitute normal operating expenses in relation to the activity carried out, whereby, regardless of the nature and amount, they cannot be classified as luxury, and thus the presumption contained in subsection e) of article 21, no. 1 of the VAT Code is rebutted.

The AT, for its part, responds, in summary, alleging:

The VAT borne by the Claimant with "the acquisition of works of art and furniture goods (furnishing of the palace)," € 6,492.00 in period 0906T and € 197,928.00 in period 0912T, is summarily excluded from the right to deduction, in accordance with subsection e) of article 21, no. 1 of the VAT Code.

The VAT on expenses for the residential, social, garden and other non-agricultural exterior areas of…, more specifically the expenses in the composition and maintenance of the gardens, the building and swimming pool, corresponds to an exclusively private use of the aforementioned areas, making deduction impossible in accordance with subsection a) of article 20, no. 1 of the CIVA.

II – PRELIMINARY EXAMINATION

The arbitration tribunal is materially competent and is regularly constituted, in accordance with articles 2, no. 1, subsection a), 5 and 6, no. 1, of the RJAT.

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 Ordinance no. 112-A/2011, of 22/3.

The case is not affected by nullities, and there are no nullities, exceptions or preliminary issues that should be examined and which would prevent the examination and decision of the case.

III – THE FACTS

III – 1 – Proven Facts

a) The Claimant began its activity on 15/05/2009, with the corporate purpose of administration, management and operation of real estate, management and operation of "…", purchase and sale of real estate and agricultural operations, viticulture, production of common wines, liqueur wines and sparkling wines. (see document no. 2 attached by the Claimant with its arbitration petition).

b) Its main activity is framed, according to the Portuguese Classification of Economic Activities — CAE, Rev 3, in the Activity Code 01210, which is characterized by "Cultivation of table and wine grapes," and the secondary activity in Activity Code 68200 which is characterized by "Rental of real estate."

c) The Claimant is part of Group B…, which operates in the sectors of activity of healthcare, real estate, technology and wine production and marketing, with C… as President (see testimony of witness D…).

d) The Claimant acquired the property called… or…, on 31/08/2009, through a financial leasing agreement with Bank E… (see document no. 3 attached by the Claimant with the arbitration petition).

e) The aforementioned property consists of a vineyard area and a palace with support installations.

f) The Claimant also acquired, still in 2009, various furniture and works of art that made up the historical collection of the palace, with the objective of keeping it properly equipped, preserving its historical value, incurring VAT in the amount of € 204,420 and recording it in accounting as a fixed asset (see document no. 4 attached by the Claimant with the arbitration petition and administrative file attached by the Respondent).

g) The payment of the value relating to furniture and furnishing of the palace, including VAT, was made by C…, being subsequently converted into financing of the amount in question granted to the Claimant. (see document no. 5 attached by the Claimant with the arbitration petition).

h) The Claimant concluded, on 01/10/2010, with F…, Ltd., a company of Group B…, a contract for transfer of exploitation of the agricultural area of… together with the equipment, utensils and machines used in such agricultural exploitation, with a view to the development of wine-making activities by that entity, for five years, beginning on 01/10/2010 and ending on 30/09/2015, for the amount of € 600,000, corresponding to sixty monthly installments of € 10,000 monthly each, plus VAT. (see document no. 6 attached by the Claimant with its arbitration petition).

i) The Claimant is the owner of national trademarks, for class 33 of the Nice classification, no.…, "…" and no.…, "…", which are used by F… in its activity, as provided for in the transfer of exploitation contract.

j) The Claimant and F… agreed, on 01/01/2011, in an amendment to the aforementioned transfer of exploitation contract with a view to including access to and use by the transferee of the residential and social part of the palace, including gardens and other non-agricultural exterior areas, for a period of 180 days in each year of the duration of the initial contract (see document no. 8 attached by the Claimant with its arbitration petition).

k) Access to and use of the residential and social part of the palace of… also include services of two employees of the Claimant and the use of services, tableware and other equipment and furniture existing in the palace (see document no. 8).

l) F… began to use in the promotion and sale of its products the image, both exterior and interior, including the furniture of…, according to the Group's strategy of positioning the wines produced at… by F… in the high-end wine market. (see testimony of witness D…).

m) The presence in this market segment by F… requires a support structure for the various activities involving the production and marketing of wines (such as meetings with clients and press, presentations of products marketed by it and wine tastings), which must be in line with the image of prestige that it intends such brands to convey to the market, which is why the aforementioned amendments were made that allowed the use of and access to the residential and social part of the palace of… (see testimony of witness G…, although he was unable to specify the number of annual events.).

n) For the additional services to be provided by the Petitioner to F…, which were amended to the contract concluded between the parties, an increase in the overall price of the same was agreed, in the amount of € 285,000, to which corresponded an increase in the monthly rent for the use of and access to the palace of…, in the monthly amount of € 5,000, plus VAT (see document no. 8 attached by the Claimant with the arbitration petition).

o) On 01/01/2013, and with effect from this date, a second amendment to the aforementioned transfer of exploitation contract was made, with a view to extending its period of validity, initially 60 months, to 147 months, until 31/12/2022 (see document no. 9 attached by the Claimant with the arbitration petition).

p) A reduction was agreed in the value of the monthly rent payable by F…, relating to the agricultural part, from € 10,000 to € 2,750 (to which VAT is added), as of 01/01/2013 (see document no. 9 attached by the Claimant with the arbitration petition).

q) The overall price of the contract in question remained at € 600,000 (27 months x € 10,000 + 120 months x € 2,750).

r) As for access to and use by F… of the residential and social part of the palace…, including gardens and other non-agricultural exterior areas of…, the parties decided to reduce the period of use by F… of the services in question and, consequently, the respective price, establishing that the right of F… to access and use the residential, social, gardens and other non-agricultural exterior areas of the palace of…, would be limited to 120 days per year, for a monthly amount of € 2,250 plus VAT (see document no. 9 attached by the Claimant with the arbitration petition).

s) The transfer of exploitation contract concluded with F… does not prevent the Claimant from transferring, on dates not set by the first, the residential area, social area, gardens and other non-agricultural exterior areas of… to third parties (see document no. 9 attached by the Claimant with the arbitration petition).

t) The residential facilities of the palace of… are used for accommodation of the managing partner of the Petitioner when he travels to Portugal, without the Claimant having charged any consideration for these accommodation services.

u) The Claimant was subject to an external inspection (inspection orders nos. OI2015…, OI2015…, OI2015…, OI2015… and OI2015… which, with respect to VAT, covered the years 2011 to 2013, from which the disputed assessments emerged (inspection report attached by the Respondent).

v) The inspection report contains:

"VAT

a) Technical corrections

i) VAT deducted improperly in the years 2009, 2010, 2011, 2012 and 2013

III — 1. Corrections in VAT

III — 1.1 Corrections in VAT — periods of 2009 and 2010

Subsection a) of article 20, no. 1 of the CIVA only allows the deduction of VAT borne on goods and services that are directly and exclusively allocated to the exercise of the taxpayer's economic activity, whereby the VAT deducted on expenses relating to the residential, social, gardens and other non-agricultural exterior areas of "…" is not deductible either because it is intended for purposes unrelated to the taxpayer's activity, or because the facts reveal an intention of personal use.

In addition to the foregoing, a significant portion of the expenses, namely the furnishing of the Palace, with respect to which VAT was deducted, relates to luxury goods, whereby the VAT is not deductible in accordance with subsection e) of article 21, no. 1 of the VAT Code.

III — 1.1.1 Tax Credit Formed in 2009

III — 1.1.1.1 — Account 24321 —Inventories

The VAT borne and deducted from inventories in 2009 is not deductible as regards the amount borne with maintenance expenses for the palace gardens (Annex 12 fls. 1 to 2), given that they are not directly and exclusively allocated to the exercise of economic activity by the taxpayer and are intended for personal use of the proprietor of the taxpayer and generally for purposes unrelated to the activity carried out.

(…)

III — 1.1.1.2 - Account 24322 - Fixed Assets

With respect to acquisitions of fixed assets and assets under construction, the VAT borne on the acquisition of works of art and furniture goods (furnishing of the palace), as well as the expenses for the composition and maintenance of the gardens of the building and swimming pool, recorded in the company's accounts as Assets under Construction (Annex 12 fls. 3 to 4), is not considered deductible, given that they are not directly and exclusively allocated to the exercise of economic activity by the taxpayer. Moreover, these are luxury goods intended for personal use of the proprietor of the taxpayer and generally for purposes unrelated to the taxpayer.

(…)

It should also be noted that with respect to the purchase of works of art and furniture made from E… on 2009-08-25, in the amount of 989,640.00 € plus VAT of 197,828.00 €, the payment was recorded in the taxpayer's accounting, but was made directly by private bank account of the managing partner, on 2009-08-34 (Annex 12 fls. 5 to 7).

III — 1.1.1.3. Account 24323 — Other goods and services

The VAT borne and deducted from other goods and services is not deductible as regards the amount borne with heating diesel (of the palace and swimming pool), maintenance of gardens and various palace expenses (such as, for example, kitchen utensils, light bulbs, repairs), Annex 12 fls. 8 to 11, given that it is not directly and exclusively allocated to the exercise of economic activity of the taxpayer and is intended for personal use of the proprietor of the taxpayer and generally for purposes unrelated to the activity carried out.

(…)

III — 1.1.2. Tax Credit Formed in 2010

III — 1.1.2.1. Account 24322 - Fixed Assets

This account includes the deduction of VAT relating to two designer invoices (recorded as tangible assets under construction) that are not allocated to the taxpayer's activity. Nevertheless, from April onwards these invoices continue to exist, but accounted for as fees, account 622412. These invoices are issued by H…, however they do not relate to services actually provided by the issuer of the invoices, given that their purpose is to justify monthly payments in favor of I… as evidenced by the bank transfers and declarations of the same.

(…)

III — 1.1.2.2. Account 24323— Other goods and services

With respect to VAT borne and deducted in 2010 on expenses for other goods and services relating to expenses for the residential part and leisure space surrounding… is not deductible the amount of 7,573.78 € according to the following table and Annex 13 fls. 1 to 20, given that it is not directly and exclusively allocated to the exercise of economic activity of the taxpayer and is intended for personal use of the proprietor of the taxpayer and generally for purposes unrelated to the activity carried out.

(…)

Moreover, they relate to a fixed monthly amount of 1,200.00 € plus VAT (at the rate of 20% until June/2010 and 21% until December/2010) but the actual holder of the income is I…, whereby this is a simulated operation and in which VAT is also not deductible in accordance with article 19, no. 3 of the CIVA (Annex 13 fls. 1 to 20).

Moreover, VAT relating to two invoices (one for transportation, internal document no. 30/90016 and another for agricultural supplies) issued in the name of another J…, Ltd., was deducted, whereby VAT deducted is also not accepted in accordance with article 19, no. 2 of the CIVA.

III — 1.2. Corrections in VAT — periods of 2011, 2012 and 2013

In 2011, 2012 and 2013, the transfer of exploitation contract applies in which it was agreed that F… Ltd. is responsible for all and any expenses and charges arising from exploitation, whereby the VAT on the expenses referred to in the following points is not deductible in accordance with article 20, no. 1, subsection a) of the CIVA, which only allows the deduction of VAT that has been applied to goods or services acquired by the taxpayer for the realization of transfers of goods and provision of services subject to Tax.

III — 1.2.1. VAT improperly deducted in 2010

III — 12.1.1. — Tax Credit Formed in Previous Periods

The taxpayer in the January 2011 declaration presents (field 61) a VAT credit in the amount of 226,986.91 € which relates to the years 2009 and 2010, that is, since the beginning of activity. In accordance with article 45, no. 3 of the General Tax Law, the period for exercise of the carry-forward right is applicable.

Given the provisions of points III 1.1.1. and 1.1.2., the tax credit contained in the VAT Return 2011 03T (field 61) in the amount of 218,414.83 € relates to improperly deducted VAT, whereby the VAT carry-forward from 03T11 is corrected in that amount, according to the following table:

(…)

III — 1.2.1.2 - Account 24322 - Fixed Assets

The Tax improperly deducted in 2011, with respect to fixed assets, relates to a grass cutting machine and land preparation for the palace gardens (Annex 14 fls. 1 to 3), given that they are not directly and exclusively allocated to the exercise of economic activity by the taxpayer and are intended for personal use of the proprietor of the taxpayer and generally for purposes unrelated to the activity carried out.

(…)

III — 1.2.1.3. Account 24323 — Other goods and services

The VAT borne and deducted in 2011 relating to expenses accounted for as other goods and services is not deductible as regards the amount relating to expenses for the residential part and leisure space surrounding… in the amount of 17,059.14 €, according to the following table (Annex 14 fls. 4 to 58), given that they are not directly and exclusively allocated to the exercise of economic activity by the taxpayer and are intended for personal use of the proprietor of the taxpayer and generally for purposes unrelated to the activity carried out.

(…)

Moreover, they relate to a fixed monthly amount of 1,200.00 € plus VAT of 276.00 € (at the rate of 23%) in designer fees, however they do not relate to services actually provided by the issuer of the invoices, given that their purpose is to justify monthly payments in favor of a private individual, as demonstrated by the email collected from the taxpayer's accounting and self-declarations of the private individual (I…) it is demonstrated that this is a simulated operation and VAT is also not deductible in accordance with article 19, no. 3 of the CIVA.

Moreover, the supporting document is not valid, as it was issued to another taxpayer (F…), therefore VAT is not deductible in accordance with article 19, no. 2 of the CIVA.

According to the contract for transfer of exploitation of the vineyard, these expenses are the responsibility of the transferee company (F…, Ltd.), therefore it is verified that they are allocated to the surrounding space and not to the vineyard.

III – 1.2.2. VAT deducted in 2012

III – 1.2.2.1 – Account 24321 - Inventories

Expenses recorded in the deductible VAT account — inventories relate to trees and maintenance expenses for the Palace gardens (Annex 15 fls. 1 to 2), given that they are not directly and exclusively allocated to the exercise of economic activity by the taxpayer and are intended for personal use of the proprietor of the taxpayer and generally for purposes unrelated to the taxpayer.

(…)

III — 1.2.2.2. Account 24323 — Other goods and services

The expenses that resulted in VAT deduction are, in the majority, associated with palace and surrounding space expenses, whereby VAT is not deductible given that they are not directly and exclusively allocated to the exercise of economic activity by the taxpayer and are intended for personal use of the proprietor of the taxpayer and generally for purposes unrelated to the activity carried out. With respect to water, electricity, agricultural diesel and farmer fees expenses, these are also considered expenses of the property allocated to the surrounding space of the palace and not of the vineyard. Taking into account that the expenses of exploitation of the vineyard are the responsibility of the transferee, according to the transfer of exploitation contract (Annex 15 fls. 3 to 74).

(…)

Moreover, they relate to a fixed monthly amount of 1,200.00 € plus VAT of 276.00 € (at the rate of 23%) in designer services (January to September), architecture (October) and engineering (November and December), however they do not relate to services actually provided by the issuers of the invoices, given that their purpose is to justify monthly payments in favor of a private individual (I…), as evidenced by the email collected from the taxpayer's accounting and self-declarations of the private individual it is demonstrated that this is a simulated operation and VAT is also not deductible in accordance with article 19, no. 3 of the CIVA.

III — 1.2.3. VAT improperly deducted in 2013

III — 1.2.3.1. — Account 24322 - Fixed Assets

In 2013 the taxpayer recorded in the tangible fixed assets account an expense of "Pumping of palace sewage for the inn". The inn in question has the same tax address as the taxpayer's registered office, but it is an asset of another company (K… Ltd.). Although it can be considered an improvement related to the Palace, it is not associated with the taxpayer's productive activity (Annex 16 fls. 1 to 2).

(...)

III — 1.2.3.2. Account 24323 — Other goods and services

Expenses relating to other goods and services whose VAT was deducted in 2013 are almost entirely relating to Palace expenses, whereby VAT is not accepted given that they are not directly and exclusively allocated to the exercise of economic activity of the taxpayer and are intended for personal use of the proprietor of the taxpayer and generally for purposes unrelated to the activity carried out. Expenses related to water, electricity, agricultural diesel and farmer fees, are considered allocated to the Palace and surrounding areas since, according to the existing transfer of exploitation contract, the expenses of exploitation of the vineyard are covered by the transferee company and not the taxpayer (Annex 16 fls. 3 to 79).

(…)

Moreover, they relate to a fixed monthly amount of 1,200.00 € plus VAT (at the rate of 23%), in engineering services (January) and cleaning (February to December), however they do not relate to services actually provided by the issuers of the invoices, given that their purpose is to justify monthly payments in favor of a private individual (I…), as evidenced by the email collected from the taxpayer's accounting and self-declarations of the private individual it is demonstrated that this is a simulated operation and VAT is not deductible in accordance with article 19, no. 3 of the CIVA".

x) The Claimant filed a gracious reclamation of the assessments now contested, and filed a hierarchical appeal, having obtained no favorable decision (see administrative file attached by the Respondent).

y) On 28/12/2015 the Claimant paid, in the tax enforcement proceedings instituted against it, the amount of € 117,107.44, corresponding to € 103,202.29 in tax and the remainder in interest and charges (see administrative file attached by the Respondent).

III – 2 – Explanation of the judgment on the proven facts

The facts found as proven result from the tribunal's conviction, based on the critical examination of the documents attached to the case, the inspection report, all of which is reproduced here, and the testimony of the witnesses, who demonstrated knowledge of the facts and testified with apparent impartiality.

III – 3 – Unproven facts

With relevance to the decision on the merits, nothing remained unproven.

IV – LAW

The central issue that the Tribunal should examine and decide concerns the deduction of VAT incurred in certain expenses, regarding which the Claimant understands it has the right to deduct the VAT incurred, with the AT not having the same understanding.

Analyzing.

A) Deduction of VAT borne on expenses incurred with the furnishing of the Palace…

With respect to the acquisition of "Artistic Heritage, furniture and decoration articles" in the amounts of VAT incurred of € 6,492.00 in period 0906T and € 197,928.00 in period 0912T, in the total amount of € 204,420.00, the AT invoked to justify the non-deductibility of the tax, subsection a) of article 20, no. 1 of the CIVA, to the extent that such goods would have been acquired for "purposes unrelated to the activity of the Appellant, and, in this context, were not directly and exclusively allocated to its exercise" – point 45 of the Information from the VAT Services Division that resulted in the dismissal of the hierarchical appeal, insofar as the Appellant's activity was limited to viticulture, not having carried out the real estate rental activity for which it is also registered.

Moreover, the AT invokes the provisions of subsection e) of article 21, no. 1 of the CIVA, to the extent that these would be "luxury goods intended for personal use of the proprietor of the taxpayer and generally for purposes unrelated to the taxpayer," reason why VAT cannot be deducted.[1]

The right to deduction of the tax constitutes one of the main characteristics of this tax, as was established from the outset in article 2 of the First Council Directive no. 67/227/EEC, of 11 April 1967, published in the Official Journal no. L 71. of 14.3.67, in the following terms: "For each transaction, the tax on added value, calculated on the price of the good or service at the rate applicable to the said good or service, shall be payable, subject to the prior deduction of the amount of value added tax which has been borne directly on the cost of the various components constituting the price."

The exercise of the right to deduction supported by operations of acquisition of goods and services from taxpayers is not, however, a free or unconditional right, depending instead on the verification of certain subjective and objective requirements.

Thus, it is first and foremost the condition that the acquirer is himself a taxpayer acting as such, that is, that he acquires goods and services to actually use them in its tax activity. Already on the objective level, the legislator imposes, in particular, that the acquisitions (rectius, expense in question) are not excluded from the right to deduction.

According to the case law of the Court of Justice of the European Union – CJEU - "(…) the right to deduction depends, in the first place, on the existence of a direct and immediate relationship between the goods and services acquired and the entirety of the economic activity developed by the taxpayer, in the sense that, in the absence of such relationship, that right is summarily refused, irrespective of supplementary inquiries. In a second place, it is also necessary that there be a specific relationship between the good or service acquired and those operations which, falling within the overall activity of the same taxpayer, can be classified strictly as taxable operations." (Portugal Telecom SGPS, case no. C-496/11 [2012]).

Within the scope of national law, according to the provisions of article 19 of the CIVA, for calculation of the tax due, taxpayers shall deduct from the tax incurred on the taxable operations they carried out the tax that has been borne on goods or services acquired, imported or used by the taxpayer for the realization of the operations referred to in article 20 of the same CIVA, being a prerequisite of the right to deduction that the goods and services are directly related to the exercise of its activity.

Considering that the goods in question were effectively used in the activity of the Claimant, as between it and F… an amendment to the transfer of exploitation contract was concluded with a view to including access to and use by the transferee of the residential and social part of the palace, including gardens and other non-agricultural exterior areas, for a period of 180 days in each year of the duration of the initial contract. (see document no. 8 attached by the Claimant with its arbitration petition) and, as well, F… began to use in the promotion and sale of its products the image, both exterior and interior, including the furniture of…, according to the Group's strategy of positioning the wines produced at… by F… in the high-end wine market (see testimony of witness D…), it is clear that there is a direct connection between the acquisition of these goods and the activity pursued by the Claimant, even though the same occurred some time after the acquisition of the aforementioned goods.

In fact, the AT itself recognizes in point 88 of the Information supporting the order dismissing the hierarchical appeal the activity carried out by the Claimant when it states: "In this respect, it seems to us to be admissible that the transfer of exploitation of the real estate Fifth of… is covered by CAE 68200 – Rental of real estate, which includes the activities of rental and operation of real estate (own or rented), namely residential and non-residential buildings (includes industrial, commercial spaces and installations, etc.) and land.".

Moreover recognizing in article 82 of its response, that "(…) the right to deduction cannot be restricted by the fact that the activity for which it was registered was carried out later than the deduction made, despite the period between the deduction of VAT borne upstream and the corresponding taxation downstream having been two years, and the deduction of VAT being made in relation to another economic activity.".

With respect to the application of the exclusion of deduction of VAT incurred on the basis of the rule of article 19, no. 7 of the CIVA, in cases where a real property is used simultaneously for business and private purposes, in which case the full deduction of VAT borne on its acquisition and construction could only be made for the part corresponding to economic activity[2], being at issue in the case sub judice the acquisition of movable goods, this exclusion does not apply to the case at hand.

Let us now examine whether the non-deductibility of VAT is justified on the basis of subsection e) of article 20, no. 1 of the CIVA, to the extent that these would be "luxury goods intended for personal use of the proprietor of the taxpayer and generally for purposes unrelated to the taxpayer," reason why VAT cannot be deducted.

The basis for such exclusion of the right to deduction is found in the fact that it relates to VAT borne on inputs with respect to which it is difficult, or even impossible, to control its legitimacy, aiming, by way of exclusion, to prevent the deduction of tax borne on non-essential goods or services to productive activity or easily diverted to private, non-business/professional consumption.

The Community legislator established a fundamental distinction between expenses that have a strictly professional character and those that do not have any connection with the taxpayer's professional activity, expressly excluding sumptuary expenses, with amusement or representation from the right to deduction of VAT. (cf. Cases Commission / France, case 50/87 [1988]; Lennartz, case 97/90 [1991]; Gabalfrisa SL, cases C-110/98 to C-147/98 [2000]).

It is excluded, therefore, from the right to deduction the tax contained in the expenses referred to in no. 1 of article 21 of the CIVA, that is, in expenses that do not have a strictly professional character, such as sumptuary, recreational or representation expenses.

And subsection e) of no. 1 of article 21 of the CIVA establishes the impossibility of deduction of tax with respect to entertainment and luxury expenses, being considered as such those which, by their nature or by their amount, do not constitute normal operating expenses.

This is an express delimitation of the exclusions from the right to deduction that applies generally, irrespective of whether the expenses provided for therein contribute or not to the realization of taxable operations.

Although the Portuguese Republic has opted for the "standstill" clause provided for in article 17, no. 6 of the Sixth Directive, which currently corresponds to article 176 of the Council Directive 2006/112/EC (VAT Directive), with respect to the right to deduction of VAT relating to certain categories of expenses, such as sumptuary expenses, providing that Member States may establish their own regime regarding the exclusion of the right to deduction of VAT, computing that all derogating provisions must be subject to strict interpretation, and provided they define with sufficient precision the nature and purpose of the goods and services for which the right to deduction is excluded, in order to ensure that this faculty will not be used to provide for general exclusions of this regime, the fact is that the national legislator has not specified with precision and necessary objectivity what should be understood by luxury expenses, merely stating that they should be understood as those which by their nature and amount do not constitute "normal operating expenses".

Now, taking into account the amounts spent on the acquisition of these goods by the Claimant (€ 1,509,452.00), the nature of the same and the activity developed by the Claimant of transferring access to and use of the Palace to F… 180 days per year, and subsequently 120 days per year, the question arises whether the expenses in question, with the furnishing of the Palace, configure or not "normal operating expenses", for the purposes of application or not of the exclusion of deduction of VAT incurred, in accordance with article 21, no. 1, subsection e) of the CIVA.

Thus, as mentioned above, the national legislator having not, nor even the Community legislator (merely referring to "expenses that do not have a strictly professional character, such as sumptuary, recreational or representation expenses" – paragraph 1 of article 176 of the VAT Directive) defined this concept, it will be incumbent upon the judge to proceed to an analysis of the specific case, taking into account the amount and nature of the goods acquired by the taxpayer and the activity developed by the latter.

Now, as alleged by the Claimant and proven, its activity - with respect to the transfer of use of the residential and social part of the palace - translates into the exploitation of the property, through its transfer to third-party entities (in particular, to F…), for the most diverse purposes. In fact, F…, by virtue of the conclusion of the first amendment to the transfer of exploitation contract, gained access to and was able to use, in the promotion and sale of its products, the image, both exterior and interior, including the furniture of the Palace, due to the historical and cultural importance of the same and the Group's strategy of positioning the wines produced by this company in the high-end wine market.

For this reason, the Claimant alleges that the furnishing of… can never be considered, on the tax level, as if it were a luxury expense, outside the scope of normal operating expenses, given the ultimate purpose for which it was intended. Moreover, the expenses relating to the acquisition of furniture goods and works of art from the residential and social part of the same not only contribute intrinsically to the services provided by the Claimant, in particular to F…, but should be considered normal operating expenses, for the purposes of the provisions of subsection e) of no. 1 of article 21 of the CIVA.

With respect to the reasoning of this rule, we follow the understanding set forth in the decision of the Northern Central Administrative Court of 16 February 2017 (case no. 01438/09.3BEBRG) that the basis of the exclusion of the right to deduction of VAT provided for in no. 1 of article 21 of the VAT Code is found in the fact that many of the situations provided for in its subsections "relate to VAT borne on 'inputs' with respect to which it is difficult, or even impossible, to control its legitimacy, aiming, by way of exclusion, to prevent the deduction of tax borne on goods or services non-essential to productive activity or easily diverted to private, non-business/professional consumption". In essence, the legislator presumes that this type of expense, in which entertainment or luxury expenses are included, does not have business purposes, but rather private ones and, for this reason, determines the exclusion of deduction of VAT incurred therein.

Having reached this point, it results from the facts found as proven that the expenses with the furnishing of the palace configured normal operating expenses, form part of the Claimant's fixed assets, and there is a direct connection with the activity developed by it and the services provided, in particular to F… . If it is intended to use the residential part of… for meetings with clients, presentations or wine tastings, based on a strategy of introducing wines into the high-end wine market, it should be understood that the expenses incurred by the Claimant with the furnishing of the palace, both by their nature and by their amount, configure normal operating expenses, associated with the services provided by it, whereby the exception determined by the rule of subsection e) of no. 1 of article 21 of the VAT Code should not be applied to the specific case.

It is certain that the utility or reasonableness of such expenses can be questioned from the Claimant's cost-benefit perspective, since it invested € 1,509,452.00 in the acquisition of the palace furnishings, charging for the services provided to F…, of access to and use of the space 180 days per year, and subsequently 120 days, a monthly amount initially of € 5,000.00 and, subsequently, of € 2,250.00. However, this is a matter of management that the AT is not legitimized to weigh – see decision of the Northern Central Administrative Court of 16 February 2017 (case no. 01438/09.3BEBRG).

In this same sense - of admission of deduction of tax incurred with normal operating expenses - it is worth noting the case law of the Court of Justice of the European Union which has considered that "the right to deduction is also admitted in favor of the taxpayer, even in the absence of a direct and immediate nexus between a particular upstream operation and one or more downstream operations with the right to deduction, when the costs of the services in question form part of its general expenses and are, as such, constituent elements of the price of the goods it supplies or of the services it provides. These costs do in fact have a direct and immediate nexus with the entirety of the taxpayer's economic activity" (see decision of 29 October 2009, SKF, C-29/08, Reports, p. I-10413, no. 55 and decisions of 14 September 2017, C-132/16, of 18 July 201, C-124-12 and of 16 February 2012, C-118/11 which cite the first), based on article 176 of Council Directive 2006/112/EC, of 28 November 2006, the basic rule of article 21, no. 1 subsection e) of the VAT Code which establishes that "[t]he Council, acting unanimously on a proposal from the Commission, shall determine which expenses do not confer the right to deduction of VAT. In any case, expenses which do not have a strictly professional character, such as sumptuary, recreational or representation expenses, are excluded from the right to deduction" (emphasis added).

Whereby the Claimant's request for annulment of this correction made by the AT is justified, and the respective VAT should be deductible.

B) VAT incurred on expenses for the residential, social, gardens and other non-agricultural exterior areas of…

With respect to this VAT borne by the Claimant, and contested in the case in the amount of € 65,180.66, the Tribunal considers that the same is not deductible because it was not incurred on expenses directly and exclusively allocated to the exercise of the economic activity of the Claimant, under subsection a) of article 20, no. 1 of the CIVA.

In effect, this rule determines that "[o]nly tax which has been borne on goods or services acquired, imported or used by the taxpayer for the realization of the following operations can be deducted: a) transfers of goods and provision of services subject to tax and not exempt from it (…)", requiring that the goods and services acquired are directly related to the exercise of the taxpayer's activity for the VAT borne to be deducted.

Now, in the case at hand, the services in question for maintenance of the residential, social, gardens and other non-agricultural exterior areas of… have, apparently, mixed use, both for business purposes and for personal purposes (when the managing partner stays when he travels to Portugal), whereby there is no direct and immediate connection between the expenses incurred and the activity developed by the Claimant, which is subject to VAT.

Furthermore, and this point is decisive, we agree with the AT when it argues that these expenses actually had exclusively private purposes, to the extent that F… committed contractually to be solely responsible for all and any expenses arising from the exploitation of the vineyard, in accordance with subsection a) of clause seven of the Transfer of Exploitation Contract.

Thus, it is important to note that (i) the contract concluded between the Claimant and F… is not merely a transfer of exploitation of the agricultural zones of the vineyard, but also a transfer of exploitation of the vineyard activity itself[3]; (ii) subsection a) of clause seven establishes that during the period to which the contract refers, all and any expenses and charges arising from the exploitation and "(…) any other necessary for that purpose" are the exclusive responsibility of F…, and (iii) in the first amendment to this contract, the parties agreed that F… would begin to use the residential, social, gardens and other non-agricultural exterior areas of the Palace "in the context of its activity", that is, in the activity of vineyard exploitation.

In this way, it should be considered that F…, with the conclusion of this first amendment, became solely responsible, also, for the expenses incurred in maintaining the spaces, to which it gained access 180 days per year for meetings with clients, presentations or wine tastings, since these will be expenses equally necessary for the exploitation of the vineyard activity.

For this reason, and taking into account the activity developed by the Claimant, any expenses incurred by it in maintaining these spaces would, necessarily, have private purposes, not admitting the deduction of the respective VAT due to the non-fulfillment of the requirements provided for in subsection a) of article 20, no. 1 of the CIVA, that is, by absence of the relationship with the activity developed by the Claimant, which is subject to VAT.

Reason why this VAT is not deductible, the Claimant's request is rejected.

Of the Right to Compensatory Interest

With respect to the right to compensatory interest, requested by the Claimant, it should be stated that article 24, no. 1, subsection b), of the RJAT provides that the arbitration decision on the merits of the claim to which no appeal or challenge is available binds the Tax Administration from the end of the deadline provided for appeal or challenge, and this must - in the exact terms of the success of the arbitration decision in favor of the taxpayer and until the end of the deadline provided for the execution of the judgments of the tax courts - restore the situation that would have existed if the tax act subject to the arbitration decision had not been carried out, adopting the acts and operations necessary for that purpose.

Such provision is in line with the provisions of article 100 of the General Tax Law, applicable to the case by virtue of the provisions of subsection a) of article 29, no. 1 of the RJAT, in which it is established that "The tax administration is obliged, in the event of partial or total success of reclamations or administrative appeals, or of judicial proceedings in favor of the taxpayer, to immediately and fully restore the situation that would have existed if the illegality had not been committed, including the payment of compensatory interest, in the terms and conditions provided for in the law."

Article 43, no. 1 of the General Tax Law, in turn, provides that "compensatory interest is due when it is determined, in a gracious reclamation or judicial challenge, that there was error attributable to the services which resulted in payment of the tax debt in an amount higher than legally due."

From the analysis of the evidentiary elements in the case, it is possible to conclude that the Respondent had total and full knowledge of the factual elements relevant to proceed with the correct calculation of the tax, not having done so and choosing to maintain the assessments tainted with error regarding the assumptions, and therefore illegal, being, for this reason, obliged to provide compensation.

Accordingly, taking into account the provisions of article 61 of the CPPT and considering that the requirements for the right to compensatory interest are met, that is, verified the existence of error attributable to the services which resulted in payment of the tax debt in an amount higher than legally due, as provided for in no. 1 of article 43 of the General Tax Law, the Claimant is entitled to compensatory interest, at the legal rate, calculated on the amounts that it has already paid, from the date on which payment was made until its full reimbursement.

V – DECISION

As a consequence, this Arbitration Tribunal decides:

• To partially uphold the request for arbitration and declare the partial illegality of the act of dismissal of the Hierarchical Appeal filed by the Claimant, and, consequently, to declare the consequent partial annulment, by defect of violation of law by error in the factual and legal assumptions, of the acts of assessment of VAT and respective compensatory interest relating to the non-deductibility of VAT in the amount of € 204,420.00 and respective compensatory interest calculated, relating to the year 2009, and the restitution of the amount paid of € 103,202.29, plus compensatory interest, at the legal rate, calculated on the amount already paid, from the date on which payment was made until its full reimbursement, and, because insufficient, the proportional inclusion corresponding to the deductible VAT in the tax credit calculated in the periodic VAT return relating to the 4th Quarter of 2013 which was improperly used by the AT to offset the debt resulting from the issuance of the additional VAT assessments.

VI – VALUE OF THE CASE

In accordance with the provisions of articles 306, no. 2 of the CPC, 97-A, no. 1, subsection a), of the Code of Tax Procedure and Process and 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of € 282,433.10 is fixed for the case.

IX – COSTS

In accordance with article 3, no. 3 of the Regulation of Costs in Tax Arbitration Proceedings and attached Table I, the arbitration fee is computed at € 5,202.00, of which 72% is charged to the Respondent and 28% is charged to the Claimant.

Lisbon, 18/04/2018.

The Arbitrators,

(José Baeta de Queiroz)

(Diogo Feio)

(Henrique Nogueira Nunes)

[1] The AT in the Information supporting the order dismissing the Hierarchical Appeal justifies the non-deductibility of VAT in accordance with subsection e) of article 21, no. 1 of the CIVA, not appearing to follow the full reasoning contained in the Inspection Report – point 82 of the aforementioned Information.

[2] As, moreover, the AT recognizes in point 78 of the Information supporting the order dismissing the Hierarchical Appeal.

[3] See in the recitals of the Transfer of Exploitation Contract when it states that "By this present contract the first party A… transfers to the second party F… the exploitation of that activity". (emphasis added).