IRS Capital Gains on Inheritance Partition: Tax Inspection Nullity and Territorial Competence (CAAD 405/2015-T)

ARBITRAL DECISION

The Arbitrators Fernanda Maçãs (Presiding Arbitrator), Catarina Gonçalves and Mariana Vargas, designated by the Ethics Council of the Centre for Administrative Arbitration to form an Arbitral Tribunal, hereby agree:

I. REPORT

1. On 1 July 2015, A… and B…, resident in Rua…, nº…, Building…, Lisbon, holders of Tax Identification Numbers n.º … and … (Claimants), submitted a request for the constitution of an arbitral tribunal, pursuant to the combined provisions of Articles 2 and 10 of Decree-Law n.º 10/2011, of 20 January, which approved the Legal Framework for Arbitration in Tax Matters, with the wording introduced by Article 228 of Law n.º 66-B/2012, of 31 December (hereinafter, briefly designated as RJAT), seeking the declaration of illegality of the act of partial rejection of the gracious appeal with n.º …-2012-…and the consequent IRS assessment with n.º 2011 … and corresponding account settlement with n.º 2011…, relating to the year 2007, in the amount of € 470,605.40.

2. In support of their request, the Claimants allege, in summary, that:

A. Lack of notification of the beginning of the inspection procedure

a. They were not duly notified of the beginning of the inspection procedure.

b. The inspection procedure had external and not internal nature, as the Tax Authority (AT) claims, inasmuch as it was not a procedure carried out exclusively within the services of the tax administration, through formal coherence analysis of documents.

c. The omission of this formality renders the entire inspection procedure null and vitiates the entire procedure with a defect of form.

B. Territorial incompetence and the impossibility of conferring retroactive effects to the ratification of inspection acts

a. The tax inspection was carried out by the Finance Directorate of …; however, the Claimants are – and were at the date of the disputed facts – tax residents in Lisbon, so the competent body for the performance of inspection acts is the Finance Directorate of Lisbon, and not the Finance Directorate of….

b. The Finance Directorate of Lisbon sought to remedy such irregularity by ratifying the inspection acts with retroactive effects, pursuant to Article 137, n.º 3, of the Administrative Procedure Code ("CPA").

c. However, pursuant to Article 137, n.º 4, of the CPA, in the wording at the date of the facts, the ratification, reform and conversion have retroactive effect to the date of the acts to which they relate, provided that there has been no change to the legal regime, which did not occur given that, in particular, Article 16 of the RCPIT, relating to material and territorial competence for inspection acts, underwent legislative amendment.

d. Since the remedying of the inspection acts performed cannot have retroactive effects, the acts performed by the Finance Directorate of… cannot be utilized, and the assessment act is vitiated by a defect of incompetence.

C. Defect of violation of law (erroneous characterization and quantification of income)

a. The partition has merely declarative effect, constituting no constitutive effect of rights for the taxpayers, not configuring a transfer to the individual patrimony of the Claimants of assets assigned to their business activity.

b. Being an act subject to Stamp Tax, it cannot, concurrently, be subject to IRS, inasmuch as it falls within the negative delimitation of tax scope provided in Article 12 of the IRS Code, even if there were a patrimonial increase.

c. The concept of capital gains, for the purposes of Article 3, n.º 2, letter c), of the IRS Code, refers to the definition of capital gains contained in Article 43 of the CIT Code; in the case of sale of a commercial establishment created from scratch by a merchant's activity, where no acquisition value exists, one would be facing a non-taxable capital gain.

d. Even if not understood thus, the sale would be taxed under IRS, Category G, as capital gains, from the onerous transfer of partnership interests, pursuant to Article 10, n.º 1, letter b), of the respective Code, the gain subject to IRS being constituted by the difference between the realization value and the acquisition value, net of the portion qualified as capital income, if applicable.

e. The acquisition value of the partnership interests should be the value that was considered for purposes of Stamp Tax assessment, pursuant to Article 45 of the IRS Code.

f. There was no assignment to a purpose different from the establishment, by way of the partition, all the more so since the establishment did not cease its activity, having been sold for the exercise of the activity it had been developing.

g. The transfer to the private patrimony of the heirs of assets assigned to the active assets of the business activity would presuppose that, after the termination of the undivided estate, business continuity had been given in the personal sphere of the Claimants, which did not occur, since the partition coincided temporally with the purchase and sale agreement and was effected through the allocation of one-third undivided interest of the establishment to each of the heirs.

h. Pursuant to Article 12, n.º 6, of the IRS Code, in the wording in force at the date, "IRS does not apply to patrimonial increases subject to tax on successions and donations, nor to those expressly provided for in a norm of negative delimitation of tax scope of this tax." With the abolition of the Tax on Successions and Donations, those patrimonial increases became taxable under Stamp Tax.

i. Should this not be understood thus, it would always be understood that the commercial activity was exercised from the date of the death of the author of the inheritance until the date of sale by an irregular company, whose partners were the three heirs, among them the herein Claimants, and which existed as such before third parties, and the existence of a common activity cannot be denied, developed within the commercial establishment, aimed at obtaining profit.

j. Situation in which the sale of the establishment would be taxed under IRS, Category G, as capital gains, from the onerous transfer of partnership interests, pursuant to Article 10, n.º 1, letter b), of the IRS Code, the gain subject to tax being constituted by the difference between the realization value and the acquisition value, net of the portion qualified as capital income, if applicable.

k. Now the realization value corresponds to the value of the Claimant husband's quota-share in the sale value; as for the acquisition value of the respective partnership interests, what matters is the value that was considered for purposes of Stamp Tax assessment (Article 45 of the IRS Code), which coincides with the realization value, there being no value to be determined that can be taxed under IRS.

l. It is thus unequivocal that the assessment act is vitiated by violation of law due to error regarding the legal presuppositions, as results from all the above.

1. On 3 July 2015, the request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority (AT).

2. The Claimant did not proceed with the appointment of an arbitrator, so, pursuant to Article 6, n.º 2, letter a), and Article 11, n.º 1, letter b) of the RJAT, the President of the Ethics Council designated the undersigned as arbitrators of the collective arbitral tribunal, who communicated their acceptance of the designation within the deadline.

3. On 27 August 2015, the parties were notified of the designation of the arbitrators, having raised no objection.

4. In accordance with Article 11, n.º 11, letter c) of the RJAT, the collective arbitral tribunal was constituted on 11 September 2015.

5. On 12 October 2015, the Respondent, duly notified for such purpose, presented her response and defended herself by objection, invoking, in summary:

a) The inspection procedure is internal in nature and, therefore, is not subject to the prior notification to which Article 40 of the RCPIT alludes.

b) Being an inspection action of internal character, given its object and the place where it occurred, its commencement did not have to be notified to the Respondents, nor, consequently, did such omission of this formality occur, as it is not legally prescribed for internal inspection procedures.

c) It was the Finance Directorate of Lisbon that was competent, pursuant to the combined provisions of Article 65, n.º 5, of the IRS Code and Article 16 of the RCPIT, for the inspection action, in the context of IRS, given the tax domicile of the Claimants in the Finance Service of Lisbon….

d) However, the acts performed throughout the inspection procedure, in particular, the order of the Chief of the Tax Inspection Division of the Finance Directorate of…, issued on 05/12/2011, were subject to ratification – order of 21/08/2014 of the Director of Finances of Lisbon, thus remedying the irregularity arising from territorial incompetence.

e) As to the alleged error in the characterization and quantification of income, what is being taxed to the Claimants is not the transmission of property of the inheritance assets to the heirs, since that transmission occurred on the date of death (Article 2031 of the Civil Code) and was taxed under Stamp Tax.

f) But rather under "(…) capital gains determined in the context of business activities generating business and professional income (…) namely those resulting from the transfer to the private patrimony of businesspersons of any assets assigned to the active assets of the company (…)" (cf. Article 3, n.º 2, letter c), of the CIRC).

g) As is read in the reasoning of the disputed act "with the cessation of the activity of the undivided estate and the partition of the assets of the commercial establishment (stock, fixed assets and pharmacy license) by the heirs, there was a transfer to the private patrimony of the heirs of assets assigned to the active assets of the business activity, which is subject to the determination of capital gains in the context of the activity generating business income" (fls. 411 of the case file).

h) The taxation that is at issue here is, therefore, that of the capital gains resulting from the transfer to the private patrimony of businesspersons, that is, to the private patrimony of the co-owners of the company (the pharmacy establishment "Diana") of assets assigned to the active assets of the company.

i) Contrary to what the Claimants contend, the taxation/correction at issue is not originated by the partition deed of the assets of the undivided estate, but rather by the cessation of its activity, which occurred because the undivided estate was partitioned (cf. Article 114, n.º 1, letter d), of the IRS Code).

1. On 1 December 2015, the meeting referred to in Article 18 of the RJAT was held, where the witnesses presented by the Claimants were examined.

2. A period having been granted for the presentation of written arguments, these were presented by the parties, pronouncing themselves on the evidence produced and reiterating and developing their respective legal positions.

3. The date of 10 March 2016 was fixed for the issuance of the final decision.

II. PROCEDURAL CLEARANCE

11.1. The Arbitral Tribunal is materially competent and is regularly constituted, pursuant to Articles 2, n.º 1, letter a), 5 and 6, n.º 1, of the RJAT.

11.2. The parties have legal personality and capacity, are legitimate and are legally represented, pursuant to Articles 4 and 10 of the RJAT and Article 1 of Regulation n.º 112-A/2011, of 22 March.

11.3. The proceedings do not suffer from any nullities.

Accordingly, there is no obstacle to the appreciation of the merits of the case.

III. MERITS

A. FACTUAL MATTERS

A.1. Facts deemed proven

With relevance to the appreciation and decision of the issues raised, preliminary and substantive, the following facts are established and proven:

a. The Claimants are husband and wife, with the Claimant husband (A…) being an heir of C….

b. C… exercised the activity of "Retail sale of pharmaceutical products," operating the commercial pharmacy establishment called "D…".

c. On 6 January 2007, the death of C… occurred, on which date the Claimant acquired the right to a quota-share of the inheritance, jointly and in equal proportion with his two brothers.

d. On 26 June 2007, the free transfer resulting from the death, including that of the pharmacy commercial establishment "D…" in …, to which a value of € 3,515,000.00 was assigned, was reported.

e. Due to the beneficiaries being descendants of the author of the inheritance, the exemption provided in Article 6, letter e), of the Stamp Tax Code was applied.

f. After the death, the co-heirs continued the operation of the aforementioned commercial establishment, having exercised such activity within the undivided estate "C… Heirs," Tax Number….

g. On 5 November 2007, the activity of the undivided estate ceased.

h. On 6 November 2007, two deeds were simultaneously executed: a partition deed and a purchase and sale deed.

i. In the partition deed, the commercial establishment was allocated in the proportion of one-third undivided to each of the three heirs (€ 1,171,666.67).

j. In the purchase and sale deed, each of the heirs sold his respective quota-share to the company "E… Lda", holder of Tax Identification Number…, for the global price of € 3,515,000.00.

k. With Model Form 3/IRS declaration, relating to the year 2007, relating to the Claimants, the following were presented: Annexes C, I and D. Annex I of the IES was also presented.

l. On 2 August 2008, the Claimant was notified by the AT to present the supporting documents of his personal situation, namely through the delivery of a duplicate of the IRS declaration and proof of the deductions to the tax withheld.

m. In September 2008, the Claimants were notified of the IRS assessment demonstration with n.º 2008…, through the collection document n.º 2008…, which was subject to a gracious appeal.

n. On 20 January 2009, the Claimant was notified, in Process …-2008/…of the partial approval of the gracious appeal filed.

o. On 13/08/2010, the Tax Inspection Services of the Finance Directorate of… issued service order nº OI2010… for an internal, partial inspection procedure, relating to IRS for 2007, to the Claimants.

p. On 04/11/2011, the Tax Inspection Services of the Finance Directorate of… issued DI 2011… relating to the undivided estate C… Heirs, Tax Number….

q. In December 2011, as a result of this tax inspection, the Claimants were notified of the additional assessment document n.º 2011 … and compensation n.º 2011…, from which resulted an amount due of € 536,773.80 (corresponding to taxes owed and compensatory interest).

r. Disagreeing with the assessment, the Claimants filed, on 10 February 2012, a gracious appeal, and on 17 December 2013, proceeded to pay the tax (in the amount of € 470,605.40) under the Exceptional Regime for Regularization of Tax Debts and Social Security, approved by Decree-Law n.º 151-A/2013, thus benefiting from exemption from payment of the respective compensatory interest.

s. On 21/08/2014, a ratification-remedy order was issued by the Director of Finances of Lisbon.

t. On 9 December 2014, the Claimant husband was notified, by Order n.º …, of 5 December, of the draft decision of partial approval of the gracious appeal with n.º …-2012-…which was, on 2 April 2015, partially approved.

u. The inspection procedure to the Claimants was based, among others, on documentation obtained within the scope of the external inspection order (DI) nº DI2011… to the Undivided Estate.

A.2. Facts deemed not proven

There are no other facts with relevance to the appreciation of the merits of the case that have not been proven.

A.3. Reasoning of the factual matters proven and not proven

With respect to factual matters, the Tribunal need not pronounce itself on all that was alleged by the parties; rather, it falls upon it the duty to select the facts that matter for the decision and to distinguish the proven from the unproven matter (cf. Article 123, n.º 2, of the CPPT and Article 607, n.º 3 of the CPC, applicable by virtue of Article 29, n.º 1, letters a) and e), of the RJAT).

In this manner, the pertinent facts for the judgment of the case are chosen and selected based on their legal relevance, which is established with regard to the various plausible solutions of the legal question(s) (cf. former Article 511, n.º 1, of the CPC, corresponding to the current Article 596, applicable by virtue of Article 29, n.º 1, letter e), of the RJAT).

Thus, taking into account the positions assumed by the parties, in light of Article 110/7 of the CPPT, the documentary evidence and the case file joined to the proceedings, combined with the testimonial evidence produced, the above-listed facts were deemed proven, with relevance to the decision.

B. LAW

B.1 Order of appreciation of the defects

In accordance with Article 124, n.º 1, of the CPPT, applicable subsidiarily to the tax arbitral process, pursuant to Article 29, n.º 1, letter a), of the RJAT, where there are no defects that lead to the declaration of non-existence or nullity of the disputed act, the tribunal should appreciate the defects invoked that determine its voidability.

In the situation under analysis, the Claimants invoke defects of the tax inspection procedure, which, in their understanding, determine the nullity of that procedure, as well as that of the subsequent additional IRS assessment for the year 2007.

Let us examine this.

1. Of the defects of the tax inspection procedure

a. Lack of prior notification

The Claimants allege that, although the tax inspection services of the Finance Directorate of … classified the inspection procedure as being an "internal inspection procedure (…) authorized by Service Order n.º OI2010…, issued by the Finance Directorate of…," of partial/univocal scope – IRS, pursuant to Article 14, n.º 1, letter b), of the Complementary Regime of Tax Inspection Procedure (RCPIT), this procedure was not merely "internal," as elements were gathered from the accounting of the undivided estate of which the Claimant husband was head of household, covered by the external inspection order n.º DI2011…. In this manner, the beginning of the procedure should have been previously notified to the Claimant husband (and not to both, as is stated in the order addressed to them by the said service of the AT – cf. Article 39, letter c), of the RCPIT), with a minimum advance of five days, as required by Article 49, n.º 1, of the RCPIT, and one should not be in a situation where, pursuant to Article 50 of the same statute, prior notification of the beginning of the inspection procedure could be waived. However, the Claimants only learned that the said procedure was underway when they were notified of the draft report of the tax inspection services (RIT), on 10/11/2011. In the petition in which they exercised the right to prior hearing on the draft report, the Claimants argued before the AT the lack of prior notification, as well as other procedural irregularities, among which the lack of knowledge of the content of the service order that gave rise to it and of which they should have been notified at the beginning of the inspection, pursuant to Article 51 of the RCPIT.

As to purposes, the tax inspection procedure is classified into (a) verification and confirmation procedure, aimed at confirming compliance with the taxpayer's obligations and other tax-obligated parties, and (b) information procedure, aimed at complying with the legal duties of information or opinion of which the tax inspection is legally charged (Article 12, n.º 1, of the RCPIT).

As to the place of performance of the inspection, the inspection procedure may be classified as internal or external, depending on whether the acts that comprise it are performed in the organic dependencies and services of the AT or in installations or dependencies of the taxpayers and other tax-obligated parties, of third parties with whom these maintain economic relations, or in any other place to which the AT has access (cf. Article 13, letters a) and b), of the RCPIT, respectively).

According to Joaquim Freitas da Rocha and João Damião Caldeira[1], "The internal procedure is a type of cadastral inspection, carried out within the inspection services themselves, using elements declared by the taxpayers, and encompasses activities of mere verification in which the Administration merely verifies compliance by the taxpayers of their declaratory duties (…) is particularly limited to confronting through the crossing of information available in its databases, whether the taxpayer complied with or not its duties and whether the elements declared coincide with the elements provided by the declarations filed by other tax-obligated parties with whom the taxpayer maintains or maintained relations (…) it is an activity of formal verification to check the accuracy of what the taxpayer formally declared."; on the other hand, "The procedure will be external when the inspection acts are performed, in whole or in part, in the installations or dependencies of the taxpayers or other tax-obligated parties, of third parties with whom they maintain economic relations or in any other place to which the administration has access. In this activity, already of an investigatory nature, it aims to verify the accuracy of the values declared based on the elements that appear in their accounting and documents, whether or not any omission of values occurs and whether the declared values agree with the standards of tax scope applicable to their activity. Whenever the inspection procedure aims at the analysis or verification of accounting, record books or other documents related to the activity of the inspected taxpayer, the inspection procedure must always be classified as being external in nature and is carried out, as a rule, in the installations or dependencies where those elements are or should be located" (emphasis ours).

Now, in the situation at hand, the inspection procedure opened in the name of the Claimant, through service order n.º OI2010…, issued by order of the Chief of the Tax Inspection Division of the Finance Directorate of… on 13/08/2010 (Annex 13 of the RIT), will have been initially conceived as an internal procedure, aimed at verifying compliance with the declaratory operations of the Claimant husband, both in his capacity as head of household of the undivided estate and individually, based on Model Form 3 of IRS presented for the year 2007 (in particular Annexes C and I, relating to the undivided estate and Annex D, filed by him in his capacity as heir), by comparison with documents in the possession of the AT, namely the declaration of cessation of activity of the undivided estate, on 5/11/2007, and the partition and purchase and sale deeds, executed on 6/11/2007, but was subsequently complemented by the external inspection order n.º DI2011…, of the Chief of the Tax Inspection Division of the Finance Directorate of…, dated 4/11/2011, which aimed at gathering elements from the accounting of the undivided estate.

The gathering of the said elements did not aim solely at verifying compliance, by the Claimants, with their declaratory obligations, but also, as results from the RIT, at correcting the "taxpayer's own income," based on those accounting elements, through the imputation, pursuant to Article 19 of the IRS Code, of the "taxable profit of the undivided estate (determined in Annex C of the IRS declaration filed by the taxpayer in his capacity as administrator) and, consequently added to the total profit imputed to the co-owners (determined in Annex I of the IRS declaration filed by the taxpayer in his capacity as administrator" (p. 7 of the RIT). Nor can it be said that the inspection acts to the accounting of the undivided estate are of the nature of preparatory acts of the inspection procedure to the impugning taxpayers, to which Article 44, n.º 2, of the RCPIT refers, since those took place on a date subsequent to its opening.

Accordingly, there is no doubt that the tax inspection procedure from which resulted the additional IRS assessment for the year 2007 now disputed, having been based on information gathered from the accounting of the undivided estate, apt to support corrections to the taxable matter, must be classified as an external procedure, notwithstanding the Respondent's classification of it as an internal procedure, because it took place in the services of the AT.

However, this does not necessarily result in the nullity of the procedure, due to omission of prior notification of its beginning to the taxpayer or due to lack of credentialing of the officials involved therein.

In effect, as has been decided by case law, "while it is true that Article 49, n.º 1, of the RCPIT applies in the tax context the principle of communication provided in Article 55 of the CPA, it should not be overlooked that, in light of this norm, the lack of communication of the beginning of an ex officio procedure does not generate invalidity if, notwithstanding the same, it is demonstrated that the interested party had knowledge of the procedure (and of its respective object) in time to intervene therein (…) 'if, notwithstanding the lack of communication of the procedure «… it is demonstrated that the interested party had knowledge of the procedure in time to be able to intervene therein – and if there is a right to hearing, the interest in question could be satisfied from the outset, despite the lack of communication" – cf. the Decision of the Supreme Administrative Court, of 5/11/2014, Process n.º 0914/13, available at http://www.dgsi.pt.

Having the Claimants been notified of the draft RIT, through order n.º … of the Finance Directorate of…, of 9/11/2011, in consequence of which the Claimant husband exercised the right of hearing, by petition filed on 21/11/2011, it is concluded, in accordance with the Decision of the SAC, cited above, that "(…) considering that the final act of the inspection procedure is reconducted to its final report, the eventual lack of notification to which Article 49, n.º 1, of the cited RCPIT alludes, will always necessarily be degraded into mere irregularity, without invalidating effects, provided that the interested party is given the legal possibility to exercise his right of hearing, either during the procedure or at the end of the procedure when drafting the final report. That is, the alleged violation of law would always necessarily be degraded into mere irregularity, without invalidating effects of the assessment act".

The invoked nullity of the inspection procedure does not succeed, for the reasons indicated.

b. Territorial incompetence for the inspection procedure. Remedy by the competent body

The Claimants further invoke the territorial incompetence of the Finance Directorate of…, in light of Article 16 of the RCPIT, in the wording in force at the date of the inspection procedure, as well as the impossibility of remedying that irregularity, which could not have retroactive effects, pursuant to Article 137, n.º 4, of the (former) Administrative Procedure Code (CPA), given the change in the legislative framework that occurred between the date of its beginning and the date of the attempt to remedy it by the body that would be territorially competent.

According to the petition (point 85 of the p. i.), such fact "vitiates the assessment act with a defect of incompetence, which determines its voidability, pursuant to Article 163 of the CPA (…)".

Let us examine whether they are right.

The wording of Article 16 of the RCPIT, in force both at the date of the beginning of the inspection procedure (13/08/2010) and at the date of the conclusion of the RIT (09/11/2011), was as follows:

"Article 16 - Material and territorial competence

1 - The following services of the General Tax Authority are competent for the performance of tax inspection acts, pursuant to law:

a) The tax inspection service directorates that, pursuant to the organizational structure of the General Tax Authority, integrate the operational area of tax inspection, with respect to taxpayers and other tax-obligated parties to be inspected by the central services;

b) The regional peripheral services, with respect to taxpayers and other tax-obligated parties with tax domicile or seat in its territorial area;

c) The local peripheral services, with respect to taxpayers and other tax-obligated parties with tax domicile or seat in its territorial area.

2 - Taxpayers designated by the director-general of Taxes are directly inspected by the central services, as well as those listed in an order published in the Official Journal."

At the date of the ratification of the acts of the inspection procedure (by order of the Director of Finances of Lisbon, of 18/08/2014), the wording introduced to that norm of the RCPIT by Decree-Law n.º 6/2013, of 17/01, is as follows:

"Article 16 - Material and territorial competence

1 - The following services of the Tax and Customs Authority are competent for the performance of tax inspection acts, pursuant to law:

a) The Unit of Large Taxpayers, with respect to taxpayers that, according to defined criteria, are considered as large taxpayers;

b) The tax inspection service directorates that, pursuant to the organizational structure of the Tax and Customs Authority, integrate the operational area of tax inspection, with respect to taxpayers and other tax-obligated parties to be inspected by the central services;

c) The decentralized organizational units, with respect to taxpayers and other tax-obligated parties with tax domicile or seat in its territorial area.

2 - Without prejudice to the competences of the Unit of Large Taxpayers, taxpayers designated by the director-general of the Tax and Customs Authority are directly inspected by the central services."

The remedy of the defect of incompetence operates by ratification, a secondary act through which the competent body performs a new administrative act with the same decisory content of a prior voidable act, due to a defect of relative incompetence or other formal and procedural invalidity, rendering it valid.

Articles 137, n.º 3 and 4, of the CPA of 1991, in force at the date of the decision on the gracious appeal, provided:

"Article 137 - Ratification, reform and conversion

1 - (…).

2 - (…).

3 - In case of incompetence, the power to ratify the act falls to the body competent for its performance.

4 - Provided that there has been no change to the legal regime, the ratification, reform and conversion have retroactive effect to the date of the acts to which they relate."

The prohibition of retroactivity of the remedy, in case of change of the legal regime, stems from the principle "tempus regit actum," since, 'as an emanation of the principle of legality to which all administrative activity is subject, administrative acts must be governed by the norms that are in force at the date of their performance (…). This principle means, therefore, that, as a rule, the legality of an administrative act must be assessed by the factual and legal situation existing at the date of its issuance' - (cf. Opinion n.º 42/2010, of the Consultative Council of the PGR, available at http://www.ministeriopublico.pt).

It is necessary, therefore, to ascertain whether the change introduced to the wording of Article 16 of the RCPIT constitutes a significant "change to the legal regime," so as to prevent the retroactive effectiveness of the ratification of the inspection procedure.

Decree-Law n.º 6/2013, of 17/01, was issued to allow the proper functioning of the Unit of Large Taxpayers (UGC), a central service of the AT, created by Decree-Law n.º 118/2011, of 15/12, by the merger of the General Tax Authority (DGCI), the General Directorate of Customs and Special Consumption Taxes (DGAIEC) and the General Directorate of IT and Support for Tax and Customs Services (DGITA).

The AT is structured in nuclear units integrated in its central services - service directorates - and in decentralized services - finance directorates and customs, at the regional level, and finance services and customs delegations and posts, at the local level - (cf. Articles 1, letters a) and b) and 35 of Regulation n.º 320-A/2011, of 30/12, amended by Regulation n.º 337/2013, of 20/11).

Finance directorates are assigned the competences set forth in Article 36 of the cited Regulation n.º 320-A/2011, of 30/12, among which are those of "i) Ensure activities related to tax inspection, developing procedures for investigation of tax irregularities, prevention and combating tax fraud and evasion that are entrusted to them." These competences are in all respects identical to those that were assigned to the finance directorates by letter i) of Article 28 of Regulation n.º 348/2007, of 30/03, issued in execution of Decree-Law n.º 81/2007, of 29/03, which defined the mission, attributions and type of internal organization of the DGCI, according to which it fell to those decentralized/peripheral regional services "i) Ensure activities related to tax inspection, developing procedures for investigation of tax irregularities, prevention and combating tax fraud and evasion that are entrusted to them".

Since the competences of the finance directorates, as peripheral regional services of the DGCI, at the date of the conclusion of the inspection procedure, are in all respects identical to those assigned to them, as decentralized services of the AT, which succeeded the DGCI, it is concluded that the legislative change introduced to Article 16 of the RCPIT by Decree-Law n.º 6/2013, of 17/01, is not substantial, and it cannot be considered that there has been a change to the legal regime of the inspection competences of the finance directorates, preventing the validity of the ratification of the acts produced on a date prior to its entry into force, all the more so that, at the date of ratification, there had been no change in fact in the tax situation that was the object of the RIT.

2. Of the merits of the disputed assessment. Of the defect of violation of law, due to error regarding the legal presuppositions.

The additional IRS assessment for the year 2007, issued in the name of the Claimants and object of the present proceedings, is based on the imputation of capital gains income determined by the cessation of the activity of the undivided estate and subsequent sale of the commercial establishment, as stated in the RIT, in the part that is transcribed:

"(…) with the cessation of the activity of the undivided estate and the partition of the assets of the commercial establishment (stock, fixed assets and pharmacy license) by the heirs, there was a transfer to the private patrimony of the heirs of assets assigned to the active assets of the business activity (…) the said transfer of assets from the business sphere to the private sphere of the co-owners is subject to the determination of capital gains within the activity generating business income (cat. B), as determined by letter c) of n.º 2 of Article 3 of the IRS Code." – p. 3.

"As to the realization value, letter c) of n.º 3 of Article 43 of the CIT Code (wording at the date) provides that it is considered 'in the case of assets permanently assigned to purposes other than the activity exercised, its market value' (…)".

"However, in the case at hand, it is found that the value attributed by the co-owners to the commercial establishment (which corresponds to the said 'realization value') is a suitable market value since, on the same date, the heirs proceeded to alienate their respective one-third undivided interests of the assets that comprised the individual establishment to a third party, for the same total price of € 3,515,000.00, as per the purchase and sale deed (Annex 8)" – p. 4.

(…) "regarding the pharmacy license (which certainly represents a large portion of the value of the commercial establishment) (…) we are faced with a transmission of the license by the first owning entity, which always generates capital gains, since, at this stage, there is no record of any acquisition value. The license was not acquired; it was registered by the entity itself. Therefore, the realization value represents in its entirety a taxable value".

(…) "based on the fixed assets records (Annex 10), gathered from the accounting of the undivided estate, the acquisition values net updated based on the coefficients approved by Regulation n.º 768/2007, of 09/07 (…)" – p. 5.

(…) "with both the realization value and the acquisition value determined, we are in a position to determine the gain subject to IRS, which, pursuant to n.º 2 of Article 43 of the CIT Code, combined with letter c) of n.º 2 of Article 3 of the IRS Code (wordings at the date), results from the difference between those two values: Gain subject to IRS = Realization Value – Acquisition Value".

"Therefore, in the case at hand, we are faced with a capital gain or gain subject to IRS in the amount of € 3,361,467.18 (€ 3,515,000.00 - € 153,532.82)" – p. 6.

(…) "Regarding the taxpayer's own income, the corresponding one-third quota-share of the said correction to the profit of the undivided estate should be added to the net income imputed to him (declared by him in Annex D of the IRS declaration) (…)" – p. 7.

Let us examine whether the Tax Authority is right.

The AT states in its Response that "What is being taxed to the Rs. is not the transmission of property of the inheritance assets to the heirs, since that transmission occurred on the date of death (cf. Article 2031 of the Civil Code) and was taxed under Stamp Tax."

In fact, with the opening of the inheritance, there occurred the free transfer to the heirs, among whom the Claimant husband, a transfer subject to Stamp Tax, although exempt from it, given the degree of kinship (cf. Articles 1, n.º 1 and 3, letter d), 2, n.º 2, letter a) and 6, letter e), all of the Stamp Tax Code and item 1.2 of the TGIS attached thereto), in which the commercial establishment, as a universality, including therefore its tangible and intangible assets, namely the license, was attributed a value of € 3,515,000.00, which would serve as a basis for the assessment of Stamp Tax and which was not contested or corrected by the AT (cf. the Stamp Tax assessment, copy attached to the p. i.).

The AT further states that what is being taxed are the "(…) capital gains determined in the context of business activities generating business and professional income (…) namely those resulting from the transfer to the private patrimony of businesspersons of any assets assigned to the active assets of the company (…)" (cf. letter c) of n.º 2 of Article 3 of the CIT Code).

The argument of the AT is, however, based on error in the factual and legal presuppositions.

In effect, strictly speaking, and pursuant to the matter deemed proven in the Report of the IT, what was the subject of correction was the net income determined for the commercial establishment (pharmacy) in the fiscal year corresponding to the cessation of its activity in the legal situation of undivided estate and co-ownership for purposes of imputation of income to the respective co-owners (Article 19 of the CIT Code), determined by the partition. The determination of such income is naturally unrelated to subsequent facts, whether the partition itself or the subsequent alienation of the quota-shares allocated therein to the heirs to a third entity.

There is, however, a need to assess whether the income in question should be characterized as business and professional income (Category B), as the AT seeks, pursuant to the said letter c) of n.º 2 of Article 3 of the CIT Code. It is anticipated that yes, given the preponderant character of Category B and the fact that a cessation of activity determined by a fact equivalent to an onerous alienation (the partition) of assets assigned to the exercise of a business activity.

In effect, according to the said legal provision, income of Category B includes "Capital gains determined in the context of activities generating business and professional income, defined pursuant to Article 43 of the CIT Code, namely those resulting from the transfer to the private patrimony of businesspersons of any assets assigned to the active assets of the company and, as well, other gains or losses that, not being in those conditions, result from the operations referred to in n.º 1 of Article 10, when attributable to activities generating business and professional income".

The fact that the cessation of the activity of the undivided estate occurs by partition of the inheritance assets, which includes the commercial establishment, is only relevant, in this case, for determining the "realization value," that is, the value at which the transmission of assets assigned to the active assets of the business activity to the heirs took place. Recall that what is at issue is the result imputed to the heirs, therefore, necessarily, a result determined while still in the undivided estate.

It is true that, the partition, as the Claimants emphasize, has merely declarative effect, retroacting to the date of death, with a value of € 3,515,000.00 having been attributed to the commercial establishment on that date. However, while the commercial establishment integrated in the undivided estate thus remained, it was annually subject to declaration for purposes of determining its collectible income in IRS and such collectible income was imputed to the heirs in proportion to their hereditary quotas pursuant to the co-ownership regime provided for in Article 19 of the CIT Code. In this case, the civil effect of the partition has no translation or tax effect, because what is at issue is solely to determine the result of that same commercial establishment at the date of the cessation of its activity.

Now, the "sale value" of the commercial establishment, taking as such the value at which the heirs valued it at the date of the partition, was € 3,515,000.00, the AT having not questioned that value, indeed considering it consistent with market value (Article 29, n.º 3, of the IRS Code).

The question to be decided has to do, exclusively, therefore, with the value that should be considered as the acquisition value of the alienated assets.

And it is precisely here that the AT's argument fails.

In seeking to correct the "acquisition value" to the value of the stock that appeared on the commercial establishment's inventory at the date of the partition, the AT performed an unwarranted act because, in this context, it has no legal basis for performing. In truth, if any correction were to be made, it would have to have been made to the value attributed to the commercial establishment for purposes of taxation under Stamp Tax. Having failed to do so, the negative delimitation of tax scope expressly provided in Article 12, n.º 6, of the IRS Code irreversibly operated, in the following terms: IRS does not apply to patrimonial increases from free transfers subject to Stamp Tax, nor to those expressly provided for in a norm of negative delimitation of tax scope of this tax.

In these circumstances, the acquisition value to be considered, excepting any eventual difference between "initial" and "final" stock, which is not even mentioned in the Report of the IT, should be the value attributed to the commercial establishment for purposes of Stamp Tax, that is, € 3,515,000.00.

And it was still the same value of € 3,515,000.00, the total value equivalent to the onerous alienation that, by act of partition, determined the cessation of the activity of the commercial establishment in the situation of undivided estate.

Now, resulting proven that there exists no difference between the sale value and the acquisition value, of € 3,515,000.00, there is no taxable matter for the determination of any taxable result within Category B, with respect to the alienation of the assets assigned to the exercise of the business activity developed in the commercial establishment (pharmacy) in the situation of undivided estate.

Accordingly, it must be concluded that the Tax Authority's claim regarding the determination of income to be imputed to the Claimants is not supported, either by the reality of the factually proven facts or by the applicable law.

Furthermore, giving relevance to the correction effected by the AT regarding the cessation of activity would imply taxing by another means the transmission, whose quantitative aspect was not contested in the proper forum, to the heirs, exempt as already mentioned, which would call into question the entire coherence of the tax system.

For all the foregoing, it is concluded that the Claimants are, in this manner, right.

3. Of the right to compensatory interest

Regarding the request for payment of compensatory interest formulated by the Claimants, it will be stated, first of all, that the tax arbitral process was designed as an alternative means to the judicial review process (cf. the legislative authorization granted to the Government by Article 124, n.º 2 (first part) of Law n.º 3-B/2010, of 28 April – State Budget Law for 2010).

Accordingly, although Article 2, n.º 1, letter a), of the RJAT uses the expression "declaration of illegality" to delimit the competence of the arbitral tribunals that function alongside CAAD, it should be understood that this competence includes the powers that in the judicial review process are assigned to tax tribunals, such as that to appreciate the error attributable to the services, as a source of the obligation to indemnify.

One of the presuppositions of the duty to indemnify through the payment of compensatory interest, pursuant to Article 43, n.º 1, of the General Tax Law (LGT), is that the annulment, in gracious appeal or judicial review, of the assessment act from which resulted payment of the tax debt in an amount greater than legally due, be due to error, of fact or of law, of the AT.

The error attributable to the services may consist of error regarding the factual presuppositions, or error regarding the legal presuppositions, the latter occurring when "in the performance of the act, an erroneous interpretation or application of legal norms has been made, such as the norms of objective and subjective tax scope (…)"[2] and "is demonstrated when they proceed to gracious appeal or judicial review of that same assessment and the error is not attributable to the taxpayer"[3].

Concluding that the AT erred in the issuance of the IRS assessment for the year 2007, for the reasons pointed out above, the right of the Claimants to compensatory interest must be recognized, pursuant to Article 43, n.º 1, of the LGT.

Accordingly, by virtue of the provision established in Article 61 of the CPPT, verified the existence of error attributable to the services of the Tax Administration, from which resulted payment of the tax debt in an amount greater than legally due (see Article 43/1 of the LGT), the Claimant has the right to compensatory interest at the legal rate, calculated on the value of € 470,605.40, which will be counted from the date of payment of that amount, until full reimbursement of that same amount.

C. DECISION

For these reasons, this Arbitral Tribunal decides to find the arbitral claim well-founded and, consequently:

a) Partially annul the act of rejection of the gracious appeal n.º …-2012-…and the consequent IRS assessment with n.º 2011 … and corresponding account settlement with n.º 2011…, relating to the year 2007, in the amount of € 470,605.40;

b) Condemn the Respondent to reimburse the tax improperly paid, increased by compensatory interest, at the legal rate in force, counted from the date of payment, until full reimbursement of the mentioned amount.

D. VALUE OF THE PROCESS

The value of the process is fixed at € 470,605.40, pursuant to Article 97-A, n.º 1, a), of the Code of Tax Procedure and Process, applicable by virtue of letters a) and b) of Article 29, n.º 1, of the RJAT and n.º 2 of Article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

E. COSTS

The amount of the arbitration fee is fixed at € 7,344.00, pursuant to Table I of the Regulation of Costs of Tax Arbitration Proceedings, to be paid by the Respondent, since the claim was entirely well-founded, pursuant to Articles 12, n.º 2, and 22, n.º 4, both of the RJAT, and Article 4, n.º 4, of the cited Regulation.

Lisbon, 4 March 2016.

The Presiding Arbitrator

(Fernanda Maçãs)

The Arbitrator Member

(Catarina Gonçalves)

The Arbitrator Member

(Mariana Vargas)

[1] Cf. the cited authors, in "Complementary Tax Inspection Procedure Regime (RCPIT) – Annotated and Commented", Coimbra Editora, 1st Edition, May 2013, pp. 81 et seq.

[2] SOUSA, Jorge Lopes de, "Code of Tax Procedure and Process – annotated and commented", II Volume, Áreas Editora, 6th Edition, 2011, p. 115.

[3] CAMPOS, Diogo Leite de, RODRIGUES, Benjamim Silva, SOUSA, Jorge Lopes de, "General Tax Law – Annotated and Commented", Encontro da Escrita, 4th Edition, p. 342.