Process: 392/2018-T

Date: January 29, 2019

Tax Type: IRS

Source: Original CAAD Decision

Summary

This CAAD arbitration case (Process 392/2018-T) addresses the taxation of foreign-sourced income under Portugal's non-habitual resident (RNH) regime and the critical issue of burden of proof. The taxpayer, registered as a non-habitual resident with high added value activity code 888, received €72,568 from UK services in 2016 and declared this income as exempt royalties under the Portugal-UK Double Taxation Convention. The Portuguese Tax Authority (AT) rejected this classification, treating the income as Category B self-employed professional income subject to IRS taxation, issuing an assessment of €7,311.44. The central dispute involves whether the income constitutes royalties (exempt under Article 81(5) of the IRS Code and Article 12 of the Convention) or independent work income taxable in Portugal. The taxpayer argued that under Article 75 of the General Tax Law (LGT), taxpayer declarations enjoy a legal presumption of truthfulness, placing the burden on AT to prove the income was not royalties. AT contended the taxpayer failed to substantiate the royalty classification. The case examines the distinction between Convention articles allowing dual taxation rights versus those granting exclusive taxation to one state, the application of exemption versus credit methods for double taxation relief, and the extent to which AT must accept taxpayer classifications without supporting documentation. This decision has significant implications for RNH beneficiaries deriving foreign intellectual property income.

Full Decision

ARBITRAL DECISION (consult full version in PDF)

I. REPORT

1. On 17 August 2018, A..., taxpayer no...., resident at Street..., no...., ..., ..., ...-... Braga (hereinafter Claimant), filed a request for constitution of an arbitral tribunal, under the combined provisions of articles 2, no. 1, paragraph a), and 10, no. 1, paragraph a), and no. 2, of Decree-Law no. 10/2011, of 20 January, which approved the Legal Framework for Arbitration in Tax Matters (hereinafter, abbreviated as RJAT), as amended by article 228 of Law no. 66-B/2012, of 31 December, with a view to obtaining a ruling from this tribunal concerning:

- Assessment of the legality of the decision to dismiss the administrative appeal presented with a view to annulling the tax act for assessment of Personal Income Tax (IRS) no. 2017..., for the year 2016, in the amount of € 7,311.44 and consequent annulment of the tax act.

The Claimant attached 2 (two) documents.

The Respondent is AT – Tax and Customs Authority (hereinafter, Respondent or AT).

2. In essence, the Claimant alleges that:

The IRS assessment treated the income declared by the Claimant as category B income, earned in the year, on a self-employed basis, from the provision of services falling within article 3, no. 1, paragraph b) of the IRS Code.

However, the declared income is exempt from taxation under the Convention between the Portuguese Republic and the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Tax Evasion with respect to Taxes on Income (Convention), as it constitutes royalties.

The Respondent assumes that these are self-employed income and alleges that the Claimant did not prove that the income obtained is royalties.

However, the declarations of the taxpayer are presumed to be true, under article 75 of the LGT.

The Respondent, by seeking to tax the Claimant's income in the year 2016 as self-employed income, bears the burden of proving that this is income of that type.

The Convention provides that the Claimant's income from royalties may be taxed in Portugal, without stating that it can only be taxed in Portugal and cannot be taxed in the United Kingdom.

From this it is concluded that the Convention does not exclude the possibility that royalties are not taxed in the United Kingdom, since it merely states that they may be taxed in the country of residence.

If the Convention intended to state that income from royalties could only be taxed in Portugal (the country of residence), it would use a wording similar to that used in article 17, which is as follows: "pensions and similar remuneration, other than pensions or remuneration to which article 18 applies, paid to a resident of one Contracting State as a consequence of former employment and annuities paid to such resident shall be taxable only in that State".

Otherwise, one would not understand the distinction that, expressly and unequivocally, was made by the legislator regarding the legal regime for elimination of double taxation provided in article 81, no. 4, of the IRS Code for category A income, which requires effective proof of taxation abroad, namely, that the income in question is taxed in the other contracting State.

In conclusion, the income from the United Kingdom obtained by the Claimant in the year 2016 is income exempt from taxation in Portugal, in accordance with article 81, no. 5, paragraph a) of the IRS Code and article 12, nos. 1 and 3 of the Convention.

3. The request for constitution of an arbitral tribunal was accepted by the President of CAAD and followed its normal procedure with notification to AT on 22 August 2018.

4. The Claimant did not proceed to nominate an arbitrator, whereupon, under the provisions of article 6, no. 2, paragraph a) and article 11, no. 1, paragraph a) of the RJAT, the President of the Deontological Council of CAAD designated the undersigned as arbitrator of the Arbitral Tribunal, who communicated acceptance of the appointment within the applicable period.

4.1. On 4 October 2018, the Parties were notified of this designation and expressed no intention to challenge the designation of the arbitrators, under the combined provisions of article 11, no. 1, paragraphs b) and c), of the RJAT and articles 6 and 7 of the CAAD Deontological Code.

4.2. Thus, in accordance with the provision of article 11, no. 1, paragraph c) of the RJAT, the Arbitral Tribunal was constituted on 24 October 2018.

5. On 5 December 2018, the Respondent, duly notified for this purpose, filed its Response in which it specifically contested the arguments raised by the Claimant, concluding that the present action should be dismissed.

5.1. In essence and also briefly, it is important to highlight the most relevant arguments on which the Respondent based its Response, namely:

Under the Convention, income from self-employment is taxed exclusively in the State of residence of the taxpayer.

The Claimant, in seeking to qualify the income obtained in the year 2016 as royalties, bears the burden of proving that it is income of that type, which it failed to do.

5.2. The Respondent did not request the production of evidence and proceeded to attach the administrative file (hereinafter, PA) to the case file.

6. By order of 21 December 2018, the Parties were notified of the Arbitral Tribunal's decision to dispense with the meeting referred to in article 18 of the RJAT, with 31 January 2019 being set as the deadline for issuance of the arbitral decision.

7. The Respondent presented written arguments, considering its position set forth in the response presented to be fully reproduced. The Claimant presented written arguments in which it reiterated the position previously assumed in its respective pleadings.

II. PROCEDURAL CLARIFICATION

The Arbitral Tribunal was regularly constituted and is competent ratione materiae, given the nature of the dispute (cf. articles 2, no. 1, paragraph a) and 5 of the RJAT).

The request for arbitral ruling is timely, as it was presented within the period provided in article 10, no. 1, paragraph a), of the RJAT.

The parties have legal personality and capacity, have standing and are regularly represented (cf. articles 4 and 10, no. 2 of the RJAT and article 1 of Ordinance no. 112-A/2011, of 22 March).

The case does not suffer from nullities, and no exceptions or preliminary matters have been raised that would prevent consideration of the merits, which the Court should address.

III. GROUNDS

III.1. FACTS

§1. Proven Facts

The following facts are considered proven:

a) The Claimant resided and worked in the United Kingdom for several years, where he performed engineering functions, although not a graduate in that area, in companies related to the construction and maintenance of wind farms, where he acquired knowledge and experience in that sector.

b) Upon returning to Portugal in 2016, the Claimant requested non-habitual resident status, which was granted to him for the years 2016 to 2025.

c) The Claimant was assigned the high added value code "888 – Other Activities".

d) In 2016, the Claimant obtained income from the United Kingdom in the amount of € 72,568.00, arising from the provision of services.

e) The Claimant submitted his Form 3 income tax return for 2016.

f) In the said Form 3 income tax return, Annex B was completed (Category B Income – Simplified System – Professional, Commercial and Industrial Income – Activity Table Code article 151 of the IRS Code – 1320), with no income declared in Schedule 4, but with the indication in Schedule 13B of € 72,568.00 for provision of services and other income.

g) Annex J, Field 601 – Business and Professional Income (Category B) – was completed with the amount of € 72,568.00, as income earned, with identification of the country of origin of the income (826 – United Kingdom), with no indication of the amount of tax paid abroad (neither indicated the amount nor indicated that no tax was paid).

h) In Annex L – Non-Habitual Resident – of the Form 3 income tax return, Schedule 6 referred to the income in Annex J, with activity code 999, with the option for the exemption method.

i) Following submission of the Form 3 income tax return, the IRS assessment no. 2017... was issued on 29/07/2017, in the amount of € 7,311.44.

j) Not accepting this assessment, the Claimant filed an administrative appeal on 22/08/2017, on the grounds that the income earned abroad benefited from the exemption provided in article 81, no. 5, paragraph a) of the IRS Code.

m) After examining the facts contained in the administrative appeal request, the Respondent, in draft decision no. ..., of 15/09/2017, with the order of the Director of Finance of Braga, of 18/09/2017, proceeded to the following analysis:

n) It was proposed to dismiss the administrative appeal request, and the Claimant was notified, through viactt, on 22/09/2017, to exercise prior hearing rights under article 60 of the LGT.

o) On 27/09/2017, the Claimant exercised his prior hearing rights as follows:

p) In response to the Claimant's submission in the prior hearing, on 29/09/2017, the Finance Directorate of Braga requested by email from the IRS Service Directorate the following clarification:

q) By email dated 24/05/2018, the IRS Services Directorate – Assessment Division, in response to the request from the Finance Directorate of Braga, provided the following understanding:

r) The Claimant was notified, through viactt, of the order dismissing the administrative appeal.

s) The notification was made available on viactt on 30/05/2018.

t) The Claimant considered himself notified on 04/06/2018.

u) On 17/08/2018, the Claimant filed the present request for constitution of an arbitral tribunal.

§2. Unproven Facts

Relevant to the assessment and decision of the case, the nature of the income as royalties was not proven.

§3. Justification of the Factual Matters

The facts relevant to the judgment of the case were chosen and defined according to their legal relevance, in light of the plausible solutions to the legal questions, under the combined application of articles 123, no. 2, of the CPPT, 596, no. 1 and 607, no. 3, of the Code of Civil Procedure (CPC), applicable ex vi article 29, no. 1, paragraphs a) and e), of the RJAT.

Regarding the established facts, the Court's conviction was based on the facts pleaded by the Parties, whose correspondence to reality was not challenged and therefore admitted by agreement, and on the critical analysis of the documentary evidence in the case file, including the administrative file.

§4. Question to be Decided

The main question presented to the Tribunal is whether the income earned by the Claimant in 2016 fell or not within the taxation exemption regime provided for non-habitual residents, under article 81 of the IRS Code.

III.2. LAW

As demonstrated, the Claimant has non-habitual resident status, which was recognized for the year 2016, inclusive, and through 2025.

The non-habitual resident tax regime for IRS purposes was introduced into Portuguese law by Decree-Law no. 249/2009, of 23 September.

At the time of the facts, the tax regime for non-habitual residents was provided in the following provisions of the IRS Code.

Thus, article 16, under the heading "Residence", as worded by Decree-Law no. 41/2016, of 1 August, provided the following:

"8 - Individuals are considered non-habitual residents in Portuguese territory when they become tax residents under nos. 1 or 2, and have not been residents in Portuguese territory in any of the five preceding years.

9 - A taxpayer considered a non-habitual resident acquires the right to be taxed as such for a period of 10 consecutive years from the year, inclusive, of his registration as a resident in Portuguese territory.

10 - The taxpayer must request registration as a non-habitual resident electronically through the Tax Portal, after registration as a resident in Portuguese territory and by 31 March, inclusive, of the following year in which he becomes resident in that territory.

11 - The right to be taxed as a non-habitual resident in each year of the period referred to in no. 9 depends on the taxpayer being considered resident in Portuguese territory at any time during that year.

12 - A taxpayer who has not exercised the right referred to in the preceding number in one or more years of the period referred to in no. 9 may resume the exercise thereof in any of the remaining years of that period, from the year, inclusive, in which he becomes resident again in Portuguese territory.".

Meanwhile, article 72, under the heading "Special Rates", as worded at the time of the facts, provided in the following numbers that:

"6 - Net income from categories A and B earned in activities of high added value, of a scientific, artistic or technical nature, to be defined by ordinance of the government member responsible for the finance area, by non-habitual residents in Portuguese territory, shall be taxed at the rate of 20%.".

Further, article 81, no. 4, of the IRS Code, as worded at the time of the facts, provided that: "Non-habitual residents in Portuguese territory who obtain income abroad from category B, earned in activities providing services of high added value, of a scientific, artistic or technical nature, to be defined by ordinance of the government member responsible for the finance area, or arising from the ownership of intellectual or industrial property, or from the provision of information respecting experience acquired in the industrial, commercial or scientific sector, as well as from categories E, F and G, the exemption method shall apply, provided that any one of the following conditions is met:

a) They may be taxed in the other contracting State, in accordance with a convention to eliminate double taxation concluded by Portugal with that State; or

b) They may be taxed in the other country, territory or region, in accordance with the OECD model convention on income and property taxes, interpreted in accordance with the observations and reservations made by Portugal, in cases where there is no convention to eliminate double taxation concluded by Portugal, provided that those do not appear on a list approved by ordinance of the government member responsible for the finance area, relating to regimes of privileged taxation, clearly more favorable, and provided further that the income, under the criteria provided in article 18, shall not be considered as obtained in Portuguese territory." [underlined in original].

From the proven facts it follows that the Claimant became a non-habitual resident in Portugal in 2016, inclusive.

It was also proven that the Claimant earned in 2016 only income from the United Kingdom, in the amount of € 72,568.00, arising from the exercise of consulting activity (activity code 1320) provided in the table to article 151 of the IRS Code.

Thus, under article 81, no. 4, of the IRS Code, as the Claimant earned category B income from activities providing services of high added value, the exemption method would apply, provided that the income could be taxed in the other State (namely, the United Kingdom).

The Convention provides in its article 14 that income from self-employment is taxed exclusively in the State of residence of the Claimant if the same is not attributable to a permanent establishment.

Indeed, this provision was correctly applied by the source State (United Kingdom), by not taxing the income at source.

On the other hand, and despite the option for exemption of the income being declared in Annex L, the same does not apply by virtue of the provision in article 81, no. 4, of the IRS Code.

Moreover, by virtue of the provisions in articles 75 and 74 of the LGT, the Claimant, when confronted with the qualification of his income as provision of services for the purposes of the combined articles 81, no. 5, of the IRS Code and 14 of the Convention, failed to prove the qualification thereof as royalties.

Thus the analysis of the defect of erroneous qualification and quantification of the income is prejudiced, under the terms provided in article 99, paragraph a) of the CPPT, since the income in question is not exempt from taxation, and likewise the assessment of the legality of the act dismissing the administrative appeal.

IV. DECISION

For these reasons, this Arbitral Tribunal renders judgment that the request for arbitral ruling is entirely dismissed.

*

CASE VALUE

In accordance with the provisions of articles 306, no. 2, of the CPC ex vi article 29, no. 1, paragraph e), of the RJAT, 97-A, no. 1, paragraph a), of the CPPT ex vi article 29, no. 1, paragraph a), of the RJAT and 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the case value is fixed at € 7,311.44 (seven thousand, three hundred and eleven euros and forty-four cents).

*

COSTS

In accordance with the provisions of articles 12, no. 2, and 22, no. 4, of the RJAT, 4, no. 4, and Table I attached to the Regulation of Costs in Tax Arbitration Proceedings and article 527, nos. 1 and 2, of the CPC ex vi article 29, no. 1, paragraph e), of the RJAT, the amount of costs is fixed at € 612.00 (six hundred and twelve euros), to be borne by the Claimant.

*

Lisbon, 29 January 2019.

The Arbitrator,

(Hélder Faustino)

Frequently Asked Questions

Automatically Created

What is the non-habitual resident (RNH) tax regime and how does it apply to foreign-sourced royalty income in Portugal?
The non-habitual resident (RNH) regime, applicable for ten years, provides tax benefits to new Portuguese tax residents engaged in high added value activities. Under Article 81(5)(a) of the IRS Code, foreign-sourced income that may be taxed in the source country according to a double taxation convention is exempt from Portuguese IRS, provided it does not qualify as Portuguese-sourced income. For royalty income, Article 12 of the Portugal-UK Convention allows taxation in the residence state (Portugal), creating potential exemption eligibility. However, the taxpayer must demonstrate the income genuinely constitutes royalties under the Convention definition, not merely independent professional services income.
Who bears the burden of proof when the Portuguese Tax Authority reclassifies royalty income as independent work income under IRS?
Under Portuguese tax law, the burden of proof allocation depends on the legal framework invoked. Article 75 of the General Tax Law (LGT) establishes a presumption of truthfulness for taxpayer declarations, theoretically placing the burden on AT to disprove taxpayer classifications. However, when claiming treaty-based exemptions under Article 81(5) of the IRS Code, jurisprudence indicates taxpayers bear the burden of proving entitlement to exemption, including demonstrating that income meets Convention definitions (e.g., royalties versus independent personal services). AT argued successfully that the taxpayer must substantiate the royalty characterization with contractual documentation, payment evidence, and proof the remuneration derives from intellectual property rights rather than personal services, shifting the practical burden to the claimant despite Article 75's general presumption.
How does the Portugal-UK Double Taxation Convention treat royalties paid to Portuguese tax residents?
Under the Portugal-UK Double Taxation Convention, Article 12 addresses royalty taxation. Royalties arising in one Contracting State and paid to a resident of the other Contracting State may be taxed in the resident's state (Portugal). The Convention uses permissive language ('may be taxed') rather than exclusive language ('shall be taxable only'), distinguishing it from provisions like Article 17 on pensions. This wording means both states potentially retain taxation rights unless domestic law provides exemption. Portugal's Article 81(5)(a) of the IRS Code exempts foreign income that 'may be taxed' in the source state under treaty provisions, creating an exemption mechanism for Portuguese residents. However, the income must genuinely constitute royalties—payments for use of or right to use intellectual property, copyrights, patents, or similar rights—not compensation for independent professional services.
Can the Portuguese Tax Authority tax foreign royalties as Category B independent work income under the IRS Code?
Yes, the Portuguese Tax Authority can tax foreign payments as Category B independent work income when the economic substance indicates professional services rather than royalty payments. Category B income under the IRS Code encompasses self-employed professional, commercial, and industrial activities. When a taxpayer claims royalty treatment but provides services requiring personal expertise and labor (such as engineering consulting), AT may reclassify the income based on substance-over-form principles. The distinction is critical: royalties derive from passive rights to use intellectual property, while independent services income stems from active personal work. AT's reclassification from royalties to Category B income removes eligibility for Article 81(5) exemption, subjecting the full amount to Portuguese taxation under normal IRS rules, as independent services income from Portuguese residents is taxable in Portugal regardless of payment source under Article 14 of the Convention.
What is the legal presumption of truthfulness of taxpayer declarations under Article 75 of the Portuguese General Tax Law (LGT)?
Article 75 of the Portuguese General Tax Law (LGT) establishes that taxpayer declarations are presumed truthful until proven otherwise by the Tax Authority. This presumption theoretically shifts the burden of proof to AT when challenging taxpayer-reported information. However, this presumption has significant limitations in practice. It applies primarily to factual declarations (amounts received, dates, parties) rather than legal characterizations or qualification of income types. When taxpayers claim specific tax benefits, exemptions, or treaty relief—such as RNH exemptions under Article 81(5)—Portuguese administrative and arbitral jurisprudence consistently holds that taxpayers bear the burden of proving entitlement to favorable treatment. Courts distinguish between the presumption of truthfulness regarding declared facts and the obligation to substantiate legal conclusions, requiring documentary evidence (contracts, invoices, payment records, foreign tax documents) to support claimed tax treatment beyond mere declaration.