Non-Resident IRS Taxation in Portugal: Property Income Deductions (CAAD 399/2017-T)

ARBITRAL DECISION

I. REPORT

1. The taxpayer A… (hereinafter referred to as the "Claimant"), with tax identification number…, resident in …, …, Massachusetts, represented by B…, with tax identification number…, resident at Avenue …, no. …, …, …-… Lisbon, in the capacity of Tax Representative, filed, pursuant to the combined provisions of articles 2 and 10 of Decree-Law no. 10/2011, of 20 January, i.e., the Legal Regime for Arbitration in Tax Matters ("LRATM"), a petition for the constitution of an Arbitral Tribunal, in order to declare the dismissal of the Administrative Appeal illegal with a view to annulling the assessment of Personal Income Tax ("PIT") for the fiscal year 2015, with the Tax and Customs Authority ("Respondent" or "TA") being sued.

A) Constitution of the Arbitral Tribunal

1. Pursuant to the provisions of subparagraph a) of paragraph 2 of article 6 and subparagraph b) of paragraph 1 of article 11 of the LRATM, the Deontological Board of the Administrative Arbitration Centre ("CAAD") appointed the undersigned as arbitrator of the sole arbitrator tribunal, who communicated acceptance of the assignment within the applicable time frame, and notified the parties of this appointment on 31 July 2017.

2. Thus, in compliance with the provisions of subparagraph c) of paragraph 1 of article 11 of the LRATM, and by means of communication from the President of the Deontological Board of CAAD, the Sole Arbitral Tribunal was constituted on 31 August 2017.

B) Procedural History

1. In the petition for arbitral pronouncement, the Claimant petitioned for the illegality of the dismissal of the Administrative Appeal with a view to annulling the PIT assessment for fiscal year 2015, as well as, consequently, the annulment of the respective assessment no. 2016/…, and the reimbursement of the tax paid in the amount of Euro 10,771.33.

2. The TA filed a response, petitioning the dismissal of the petition for arbitral pronouncement, on the grounds that there was no defect of violation of law, requesting that the tax act under review, as it does not violate any legal or constitutional provision, be maintained in the legal order.

3. By order of 1 February 2018, the Sole Arbitral Tribunal, pursuant to the provisions of subparagraph c) of article 16 of the LRATM, decided, without opposition from the parties, that it was not necessary to convene the meeting referred to in article 18 of the LRATM, as a result of the simplicity of the questions at issue, as well as considering that it had at its disposal all the necessary elements to make a clear and impartial decision.

4. Both parties were notified to exercise the right of response, and they timely presented additional arguments, which need not be referenced herein as they merely reinforce the positions respectively endorsed in the documents attached at the time of the petition for arbitral pronouncement and the respective Response.

5. This Arbitral Tribunal decided, in accordance with paragraph 2 of article 18 of the LRATM, that oral arguments were not necessary, as the positions of the parties were clearly defined in their respective pleadings, and set as the deadline for the arbitral decision the end of February 2018.

6. The Arbitral Tribunal was duly constituted and is competent to review the questions indicated (article 2, paragraph 1, subparagraph a) of the LRATM); the parties have legal personality and capacity and have full standing (articles 4 and 10, paragraph 2 of the LRATM and article 1 of Order no. 112-A/2011, of 22 March). No nullities occur and no exceptions have been raised, and therefore nothing prevents judgment on the merits.

7. Thus, this case is in a position for a final decision to be rendered.

II. QUESTION TO BE DECIDED

1. The central question to be reviewed and decided as to the merits of the case, as appears from the procedural documents of the parties, is whether, in the case at issue, the deduction of losses ascertained in prior years against real property income (category F) earned by a non-resident would be admissible.

III. DECISION ON THE FACTS AND ITS JUSTIFICATION

1. Upon examination of the documentary evidence produced, this tribunal finds as proven, with relevance to the decision of the case, the following facts:

I. In 2010, the herein Claimant was resident for tax purposes in Portugal, being the owner of real property in national territory.

II. In her capacity as owner, the Claimant enjoyed, in that year, a reimbursement in her favor of Euro 408.30, and in the amount of losses to be carried forward of Euro 61,002.63, relating to expenses incurred in obtaining real property income.

III. The Claimant communicated to the TA, in 2011, that she would alter her tax residence to the United States of America, a residence that was maintained until the year relevant to the present case (2015).

IV. Between the years 2011 to 2013, and 2015, the Claimant earned real property income arising from rental contracts.

V. The Claimant filed, in 2016, the PIT Model 3 Declaration for fiscal year 2015, as a non-resident in national territory, composed solely of Annex F, where income was declared in the amount of Euro 53,902.71.

VI. In fiscal year 2015, the Claimant contends that there were losses to be carried forward in the amount of Euro 27,588.68, of which the amount of Euro 26,954.19 related to losses ascertained in the year 2012, and the remainder (Euro 634.49) related to the carry-forward of losses ascertained in the year 2014.

VII. Having been notified of the aforementioned assessment, and dissatisfied therewith, the Claimant filed an Administrative Appeal in which she advocated for the annulment thereof, on the grounds that the deduction of losses declared due to the carry-forward of losses from prior years was not being considered.

VIII. Upon this Administrative Appeal, the Respondent issued a decision dismissing it, which was notified to the Claimant on 20 April 2017.

IX. The Claimant opted to pay the tax, despite considering it to be illegal.

X. It should further be noted that, as regards the years 2011 and 2013, the Claimant filed a petition for arbitral pronouncement requesting the declaration of illegality of the PIT assessments issued for those fiscal years, which likewise disregarded the deduction of losses from prior years against the real property income earned.

XI. This petition resulted in the Arbitral Decision on Case no. 96/2015-T, which upheld the pretensions of the herein Claimant and, consequently, declared illegal the PIT assessments for fiscal years 2011 and 2013.

XII. In this context, and having regard to the factual framework set out above, the Claimant requested this Arbitral Tribunal to decide on the illegality of the order dismissing the aforementioned Administrative Appeal and, consequently, that the PIT assessment no. 2016/… be declared illegal and the amount of Euro 10,771.33 be reimbursed, corresponding to the value of tax paid on account of the taxation of real property income.

1. The conviction of this tribunal as to the facts found as proven resulted from the documents annexed to the case file and contained in the petition and the unobjected arguments of the parties, as specified in the points of the facts as stated above.

2. There is no factual relevance for the decision of the case found as not proven.

IV. ON THE LAW

A) Legal Framework

1. Given that the legal question to be decided in the present case requires the interpretation of the pertinent legal texts, it is important, first, to enumerate the norms that comprise the relevant legal framework, as of the date of occurrence of the facts.

2. In this sense, in view of the subject matter of the present case, it is necessary to distinguish the treatment that the legislator chose to grant to income earned by residents in Portuguese territory, in contrast to that earned by non-residents.

3. Thus, paragraph 2 of article 15 of the PIT Code provides that "in the case of non-residents, PIT applies solely to income obtained in Portuguese territory," thereby implementing the principle of territoriality or source of income, in contrast to the principle of "worldwide income" applicable to residents.

4. For its part, as regards income earned by residents, provision is made for the option (sometimes the obligation) of its taxation through aggregation.

5. Aggregation, it should be explained, consists of the operation by which the totality of income from the various categories is ascertained, with a view to determining net income, after making the deductions and allowances provided for in the sections following article 22 of the PIT Code.

6. And it is on this net income that the progressive rates will apply, in the case of residents in national territory.

7. By contrast, as regards income earned in Portuguese territory by non-residents, subparagraph a) of paragraph 3 of article 22 of the PIT Code provides that, with the exception of investment income that may be attributable to a permanent establishment in Portuguese territory, aggregation of this income cannot occur.

8. Accordingly, provision is made for the taxation of income earned by non-residents through the application of special or liberatory rates, namely in accordance with article 72 of the PIT Code.

9. In this sense, and having regard to the specific case of real property income, paragraph 5 of article 72 of the PIT Code provides that this shall be taxed at the rate of 28%, it being worth noting that this special rate does not assume a liberatory character, thus presupposing declarative obligations to be fulfilled by non-residents earning this income category.

10. The source deductions resulting therefrom having the nature of payment on account.

11. For its part, as regards the possibility of loss deduction, paragraph 1 of article 55 of the PIT Code provides:

"Without prejudice to the provisions of the following paragraphs, the negative net result ascertained in any income category is deductible from the aggregate net income subject to taxation."

1. Further establishing in its paragraph 2, in relation to the carry-forward of losses from prior years relating to real property income of category F in particular, that:

"The negative net result ascertained in category F may only be carried forward to the five following years to that to which it relates, being deducted from the positive net results of the same category."

1. For the analysis of the question to be decided in the present case, reference should also be made to article 26 of the Convention for the Elimination of Double Taxation ("CDT") concluded between the Portuguese Republic and the United States of America, the paragraph 1 of which presents the following wording:

Non-Discrimination

"1 - Nationals of one Contracting State shall not be subjected in the other Contracting State to any taxation or obligation connected therewith that is different or more burdensome than that to which nationals of that other State are or may be subjected in the same circumstances. This provision shall also apply to persons who are not residents of one or both Contracting States. However, for the purposes of United States taxation, and without prejudice to the provisions of article 25, 'Elimination of Double Taxation', a national of the United States who is not a resident of the United States and a national of Portugal who is not a resident of the United States are not in the same circumstances."

1. It is now necessary to provide a brief exposition of the arguments presented by the parties as to the question to be decided.

B) Arguments of the Parties

1. In the present petition for arbitral pronouncement, the Claimant alleges, in summary, that the PIT assessment that is now sought to be annulled suffers from the following defects:

i) Violation of the principle of taxation of actual income and tax legality, contained in article 103 of the Constitution of the Portuguese Republic (CPR);

ii) Violation of the principle of the primacy of international law over the internal legal order, provided for in paragraph 2 of article 8 of the CPR, through violation of article 26 of the Convention to Avoid Double International Taxation between Portugal and the United States of America (CDT);

iii) Violation of the norms contained in subparagraph a) of paragraph 1 and paragraph 3 of article 22, paragraphs 1 and 2 of article 55, and paragraphs 8 and 9 of article 72, all of the PIT Code; as well as,

iv) Violation of article 8 of the General Tax Law (GTL).

1. As the grounds for these allegations, the Claimant argues that "the method of calculating the net income of category F and the deduction of losses is identical, whether it is resident or non-resident taxpayers" (article 36 of the petition for arbitral pronouncement), and that,

2. There is no provision in internal legislation that excludes the carry-forward of losses in category F against net income of the same category for non-resident taxpayers.

3. For its part, as regards the option for aggregation by non-residents, the Claimant understands that this can only be prohibited in violation of the legal norms referred to, including in violation of the principle of non-discrimination provided for in article 26 of the CDT concluded between Portugal and the United States of America.

4. Nevertheless, regardless of the understanding that may be adopted with respect to the option for aggregation by non-residents, it is to be concluded that the possibility of loss deduction in category F does not depend on aggregation (article 44 of the petition for arbitral pronouncement).

5. For its part, the Respondent, duly notified for this purpose, presented its response in which, in summary, and citing the arguments already presented in the dismissal of the Administrative Appeal, alleged the following:

6. Article 22 of the PIT Code excludes the possibility of aggregation of income earned by non-residents in national territory.

7. Assuming that the real property income earned by the Claimant in 2015 was not, at that time, subject to aggregation, and having regard to the nature of the aggregation operation itself,

8. The Respondent alleges that the deduction operation, particularly the loss deduction provided for in article 55 of the PIT Code (which is not a deduction specific to category F), is "a prior process, antecedent to and conditioned by the possibility of aggregation" (article 35 of the Respondent's Response).

9. Thus, "in the absence of a normative provision enabling the aggregation of income obtained in national territory by non-residents – in the present case, real property income of Category F – all the more so, that prior operation (loss deduction) cannot be performed, since it would always be conditioned upon the prior aggregation of income, only possible for residents" (article 36 of the Respondent's Response).

10. It is, in the understanding of the Respondent, coherent to conclude that the legislator did not intend to apply the loss carry-forward regime provided for in article 55 of the PIT Code, since it opted for isolated and analytical taxation, through the special rates provided for in article 72 of the PIT Code, of income in category F earned by non-resident taxpayers.

11. With respect to the alleged violation of article 26 of the CDT concluded between the Portuguese Republic and the United States of America, it should be noted that the special rate of taxation for real property income earned in national territory by taxpayers residing in the United States of America, being proportional to the amount of income earned, is all the more beneficial compared to the rate applicable to the same income earned by residents in Portugal, the greater the amount in question.

It being further that,

1. The provision in article 26 of the CDT does not preclude the Portuguese State from providing for a regime for the taxation of income earned in national territory by taxpayers residing in the USA different from that applied to its residents.

C) Tribunal's Consideration

1. As a preliminary matter, it should be noted that, in the view of this Arbitral Tribunal, the question to be decided presents two distinct aspects, although they are closely linked:

i) Whether aggregation of real property income earned by non-residents in national territory is admissible, and,

ii) Whether the regime for the deduction of losses ascertained in prior years, provided for category F (real property income), is applicable in the case of non-residents, regardless of whether aggregation is possible or not.

1. In this context, and notwithstanding the argument presented by the Respondent that there is no, in Portugal, "the figure of legal precedent" (article 63 of the Respondent's Response), it is relevant to presently analyze the content of Arbitral Decision no. 96/2015-T, which had as its object the same disputed legal question, as regards the facts occurring in 2011 and 2013.

2. In this respect, and after careful analysis of all the arguments presented, this Decision adopts the doctrine set forth in this matter in Arbitral Decision no. 96/2015-T, in the terms that we shall explain below.

On the possibility of aggregation of income earned by non-residents

1. The PIT Code, approved by Decree-Law no. 442-A/88, of 30 November, introduced a new model of taxation of personal income, in obedience to the constitutional mandate that "Personal income tax shall aim at reducing inequalities and shall be single and progressive, taking into account the needs and income of the household aggregate," established in paragraph 1 of article 104 of the CPR.

2. It was within this context that the determination of taxable income came to be made through aggregation, that is, by the sum of the net income from the various income categories (with some exceptions), after making the specific deductions for each of these categories, as well as the deduction of certain losses, thus arriving at the overall net income.

3. For justification of the creation of the aggregation mechanism, point 3 of the Preamble to the PIT Code provides that "only the unitary perspective allows the distribution of the tax burden according to a rational scheme of progressivity, in consonance with taxpaying capacity."

4. Understandably, this unitary perspective of personal income taxation would only apply to taxpayers resident in national territory, since non-residents would only be taxed on income obtained in this territory, subject to liberatory or special rates, of a proportional nature and without the possibility of aggregation.

5. Indeed, aggregation has as its fundamental objective the taxation of the overall income of taxpayers resident in national territory, through the application of progressive rates, with a view to implementing the principle of taxpaying capacity in personal income taxation.

6. As already set forth in point IV. A) Legal Framework above, the relevant normative provisions of the PIT Code (see paragraph 2 of article 22 and paragraph 5 of article 72) provide, in their wording in force as of the date in question (2015), that real property income earned by non-resident taxpayers in national territory relating to real property situated therein are taxed at the special rate of 28%, without the possibility of aggregation.

7. As already mentioned, it should be noted that the special rate provided for in article 72 is not a liberatory rate, and therefore the Claimant was obliged to comply with her declarative obligations, as she did by submitting the Model 3 Declaration where she properly completed Annex F.

8. In this context, and in order to justify the alleged illegality of the prohibition on the option of aggregation to non-residents, the Claimant invokes the principle of non-discrimination enshrined in article 26 of the CDT concluded between Portugal and the United States of America.

9. It is necessary, in this respect, to provide a brief introduction to the principle of non-discrimination.

10. As advocated by Arbitral Decision no. 96/2015-T, to which reference is made at this point, the principle of non-discrimination is a general corollary of the principle of equality, with respect to the criterion of nationality.

11. Indeed, the CDT itself provides, in its article 26, that the objective element of the provision is to prevent foreigners (non-nationals of one of the States) from being subject, in a given State, to any taxation or corresponding obligation different or more burdensome than those to which nationals of that State are, or may be, subject in the same circumstances.

12. Thus falling, the emphasis of the principle of non-discrimination is founded on the nationality of a given taxpayer, rather than on his or her tax residence, which is considered a legitimate criterion for differentiated tax treatment.

13. It is also worth noting that there is nothing in the case file that allows determination of the nationality of the Claimant.

14. The Claimant further invokes the decision rendered in arbitral case no. 127/2012-T.

However,

1. The question decided there relates to "the taxation of capital gains resulting from the onerous sale of real property rights, carried out by a taxpayer resident in another Member State of the European Union," a situation which is manifestly, neither objectively nor subjectively comparable to that in the present case.

2. It is concluded, therefore, that the assessment does not violate the principle of non-discrimination provided for in the CDT concluded between Portugal and the United States of America, and, consequently,

3. It does not suffer from unconstitutionality due to violation of article 8 of the CPR, which establishes the primacy of international law over the internal order, and the norms contained in the PIT Code are applicable to the specific situation of the Claimant, which we shall interpret.

Thus,

1. For the reasons set out above and, notwithstanding the declarative obligation incumbent on non-resident taxpayers who obtain category F income in Portugal, aggregation of such income earned by a resident of the United States of America is not possible.

Accordingly,

1. This Tribunal agrees, on this particular question, with the argumentation submitted by the Respondent, to the effect of precluding the option of aggregation of real property income earned in Portugal by the herein Claimant.

2. What is now relevant is to take a position on whether article 55 of the PIT Code requires, or does not require, the possibility of aggregation as a criterion for access to the regime for the deduction of losses from prior years.

Deductions of losses against real property income earned by non-residents

1. The Respondent argues that, as aggregation of real property income earned by non-residents is not possible, it "... necessarily results that the deductions operation, particularly the loss deduction, for what is now of interest to us (which is not a deduction specific to Cat. F), and allowance is a prior process, antecedent to and conditioned by the possibility of aggregation,"

2. "Concluding that due to the absence of a normative provision enabling non-residents to aggregate income obtained by them in national territory - in the present case, real property income of Cat. F (real property) -, all the more so, that prior operation (loss deduction) is not capable of being performed, since it would always be conditioned upon the prior aggregation of income (only possible for residents)."

Let us examine this,

1. Citing Arbitral Decision no. 96/2015-T on this question, it is settled that "the historical legislator of the PIT ... did not intend to tax every and any increase, but only net increase."

2. However, and still following the line of thought advocated by this Decision, the determination of net income is not satisfied merely by the contemplation of deductions specific to each income category (assuming relevance, in the present case, to the reference to article 41 of the PIT Code which refers to the possibility of specific deductions to real property income in each year),

3. Since the expenses incurred in obtaining income from a given year may exceed the income itself from that same year.

4. In this sense, arises the necessity of, under penalty of, with taxation, reaching the source producing the income, still being allowed the deduction of losses from prior years which, after all, "are nothing more than the excess over the specific deduction to be considered in the year in which expenses are incurred" (cf. Arbitral Decision no. 96/2015-T, emphasis ours).

5. Indeed, the deduction of losses in category F was, in 2015, contained in paragraph 2 of article 55 of the PIT Code (having maintained its wording at present) and provided as follows: "The negative net result ascertained in category F may only be carried forward to the five following years to that to which it relates, being deducted from the positive net results of the same category."

6. Now, given that losses to be carried forward are nothing more than the accumulation of specific deductions which, in each year, can only be offset against the taxable matter of that same year, to the extent of their amount, and may be offset against the positive taxable matter of subsequent years, within the legally established time limit, this tribunal does not see how the aforementioned principle of net income taxation can be satisfied without taking into account the losses to be carried forward from prior years.

7. On the other hand, and as advocated by the herein Claimant, there is no norm that excludes the possibility of loss deduction by non-resident taxpayers.

8. Having regard to the arguments of the Respondent, if it is true that aggregation operates at a stage subsequent to the subtraction of "deductions and allowances provided for in the following sections" (cf. paragraph 1 of article 22 of the PIT Code), it does not necessarily follow therefrom that, in case aggregation is not possible, it ceases to be possible to benefit from these deductions.

9. Indeed, the only exception of this type is that referring to the deduction of losses in category G (relating to certain moveable capital gains), for residents in national territory, pursuant to paragraph 6 of article 55 of the PIT Code, in the wording in force in the year under analysis, according to which "The negative balance ascertained in a given year, relating to the operations provided for in subparagraphs b), e), f) and g) of paragraph 1 of article 10, may be carried forward to the following two years, against income of the same nature, when the taxpayer opts for aggregation." (emphasis ours).

10. Contrary to the position conveyed by the Respondent regarding the possibility of loss deduction without prior aggregation, legal doctrine has already pronounced on the taxation of income in category F earned by residents, at proportional rates (although these may opt for aggregation), established in paragraph 7 of article 72 of the PIT Code.

11. In this respect, citing Rui Duarte Morais, "It should be noted that, where a special rate (and not a liberatory rate) is at issue, this applies to income determined according to general rules, that is to say, to net income, which means that the taxpayer continues to be admitted to make the specific deductions that the law provides for. He will also retain the right to the carry-forward of losses that he has had, in this category, in prior years."[1] (emphasis ours).

Accordingly,

1. Applying the pertinent provisions of the PIT Code in force as of the date of the facts, including those relating to specific deductions in category F and to loss deduction,

2. And having regard to the fact that there is no rule that expressly excludes their application to income earned by non-residents, nor do they depend on the aggregation of the taxable income, it does not appear to this Tribunal that the intent of the legislator can be interpreted as excluding this deduction,

3. Accordingly, it is concluded that the herein Claimant has the possibility of making the deductions of losses ascertained in the years 2012 and 2014 against the real property income earned in 2015, despite the fact that aggregation of such income is not possible.

V. DECISION

1. Therefore, this Arbitral Tribunal decides:

A) To adjudge the petition for arbitral pronouncement well-founded and, in consequence, to declare illegal the order dismissing the Administrative Appeal with a view to annulling the PIT assessment no. 2016/…, by reference to 2015, as a result of which tax was payable in the amount of € 10,771.33; and, consequently,

B) To order the reimbursement of the amount paid by the Claimant on account of PIT;

C) To order the Respondent, pursuant to article 43, paragraph 1 of the GTL and article 61, paragraphs 2 and 5 of the Code of Tax Procedure and Process ("CTPP"), to pay compensatory interest, at the rate resulting from paragraph 4 of article 43 of the GTL, calculated on the amount paid of € 10,771.33, from the day the aforementioned assessment was paid until the complete reimbursement of the mentioned amount; and,

D) To order the Respondent to pay the costs of the case.

VI. VALUE OF THE CASE

1. The value of the case is set at € 10,771.33, pursuant to article 97-A, paragraph 1, subparagraph a), of the CTPP, applicable by virtue of subparagraphs a) and b) of paragraph 1 of article 29 of the LRATM and paragraph 2 of article 3 of the Regulation of Costs in Tax Arbitration Proceedings ("RCTAP").

VII. COSTS

1. In accordance with the provisions of article 22, paragraph 4 of the LRATM, the value of the arbitration fee is set at € 918.00, pursuant to Table I of the aforementioned Regulation, charged to the Respondent, given the full acceptance of the petition.

Notify.

Lisbon, CAAD, 22 February 2018

The Arbitrator

(Sérgio Santos Pereira)

[1] Cf. MORAIS, Rui Duarte de, "On the PIT," 3rd Edition, Almedina, Coimbra, 2014, pp. 115 et seq.