Process: 41/2014-T

Date: September 15, 2014

Tax Type: IRS

Source: Original CAAD Decision

Summary

This CAAD arbitration case (41/2014-T) concerns a dispute over Personal Income Tax (IRS) assessment for 2009, where Portuguese resident taxpayers challenged the Tax Authority's refusal to grant tax credit for US state taxes paid in Georgia (USD 8,709). The core legal issue involves whether Portuguese domestic law permits tax credit for US state taxes when the Portugal-USA Double Taxation Convention explicitly covers only federal taxes under Article 2(2)(b)(i). The taxpayers argued that Article 81(1) of the Personal Income Tax Code (PIRC) provides a unilateral rule for international tax credit that applies when a DTC does not cover specific taxes, citing Law 75/93 which extended tax credit beyond conventional scope. They contended that Article 81(2) PIRC, which defers to treaty provisions, only applies to taxes within the DTC's scope, and excluding state taxes would create the double taxation that Portuguese law seeks to prevent. The Tax Authority maintained that only taxes covered by the DTC qualify for credit under Article 24(3)(a). The arbitration followed standard CAAD procedure: request filed January 2014, tribunal constituted March 2014 with arbitrator Jorge Carita, first meeting held where parties waived additional evidence, with decision deadline set for September 2014. The taxpayers also sought compensatory interest under Article 43 of the General Tax Code, arguing the assessment resulted from administrative error.

Full Decision

ARBITRAL DECISION

CAAD: Tax Arbitration

Case no. 41/2014 – T

Subject: PIT - Tax Credit ADT Portugal-USA

REPORT

  1. On 20 January 2014, A and B, hereinafter referred to as Claimants, taxpayers number ... and number ..., residents of Portugal, requested the constitution of an arbitral tribunal and an application for an arbitral award, in accordance with paragraph (a) of article 2(1) and paragraph (a) of article 10(1) of Decree-Law no. 10/2011, of 20 January (Legal Regime for Arbitration in Tax Matters, hereinafter referred to only as LRTM), in which the Tax and Customs Authority (hereinafter referred to as TCA) is the Respondent.

  2. The Claimants are represented, in the present proceedings, by their attorney, Dr. C, and the Respondent is represented by the legal advisors, Dr. D and Dr. E.

  3. The request for constitution of the arbitral tribunal was accepted by the Esteemed President of CAAD and was notified to the Respondent on 21 January 2014.

  4. By means of the request for constitution of the arbitral tribunal and application for arbitral award, the Claimants seek (i) partial annulment of the assessment of Personal Income Tax, no. ..., relating to the year 2009, with all legal consequences; (ii) condemnation of the Respondent to refund to the Claimants the tax wrongfully paid, plus compensatory interest, from the date of payment until full reimbursement, and (iii) payment of compensatory interest for deprivation of the paid amount, in accordance with article 43 of the General Tax Code (GTC).

  5. The Respondent filed its Response, contending for the dismissal of the claims formulated by the Claimants, and consequently, for the Respondent's acquittal regarding all claims against it.

  6. Having verified the formal regularity of the application filed, in accordance with the provisions of paragraph (a) of article 6(2) of the LRTM, and the Claimants not having proceeded to appoint an arbitrator, Dr. Jorge Carita was designated by the President of the Deontological Council of CAAD.

  7. The Arbitrator accepted the designation made, and the arbitral tribunal was constituted on 21 March 2014, at the seat of CAAD, located at Avenida Duque de Loulé, no. 72-A, in Lisbon, as per the deed of constitution of the arbitral tribunal which was drawn up and is attached to the present record.

  8. On 23 March 2014, the first meeting of the arbitral tribunal took place at the seat of CAAD, in accordance with article 18 of the LRTM, and a deed thereof was drawn up, which is likewise attached to the record.

  9. At that meeting, and as stated in the respective deed, the representatives of the Claimants and the Respondent declared that they waived the production of additional evidence and submissions.

  10. The Tribunal, in compliance with the provisions of article 18(2) of the LRTM, set 16 September 2014 for the delivery of the arbitral award, and warned the Claimants that they should proceed to pay the subsequent arbitration fee, in accordance with article 4(3) of the Regulation of Costs in Tax Arbitration Proceedings, and communicate such payment to CAAD by that date.

II. The Claimants' Arguments

  1. On 3 June 2013, the Claimants were notified of the Assessment Notice, contained in document no. ..., which determined a new amount of tax assessed in the value of € 24,268.25, by virtue of an additional assessment of Personal Income Tax (PIT) relating to the year 2009.

  2. The said additional assessment results from the correction of elements of the PIT income statement of 2009, namely the values contained in Annex J earned by the Claimants, A and B.

  3. Such correction is based on income earned by the Claimant in the United States of America (USA) and the respective federal and state tax.

  4. Further, they allege that, in the correction, despite a document proving state tax paid in the State of Georgia – USA, in the amount of 8,709 USD, on income earned in the USA, being submitted and accepted by the Tax and Customs Authority, and the latter having recognized the existence of state tax, this was not considered for purposes of tax credit, as it is not covered by the Double Taxation Convention (DTC) existing between Portugal and the United States of America, which applies only "(…)to federal income taxes levied in accordance with the provisions of the Internal Revenue Code (General Code of Taxes) (excluding social security contributions);", in accordance with sub-paragraph (i) of paragraph (b) of article 2(2) of the DTC.

  5. According to the Claimants, international tax credit is not limited to the conventional regime enclosed in Double Taxation Conventions, since 1994, with the entry into force of Law no. 75/93, of 20 December, Portugal freely and expressly extended the scope of granting of international tax credit to taxes not covered by DTCs, through "unilateral provisions intended to eliminate or mitigate double taxation."

  6. Therefore, and in this manner, the analysis of tax credit cannot be verified solely by the inclusion of a given tax in the bilateral Convention of the respective country, but rather in the combination of the tax legislation in force and the applicable DTCs.

  7. The Claimants understand that, firstly, it should be analyzed whether a given tax is supported by the DTC, and in the event it does not have such support, whether by non-existence of a DTC or because the States have not agreed upon/included the said tax within its scope, the unilateral rule established by the Portuguese State should be applied, "in this case article 81 of the PIRC."

  8. Further, the Claimants allege that, since state tax is not covered by the DTC between Portugal and the USA, the unilateral rule provided for in article 81(1) of the Personal Income Tax Code (PIRC) should be applied, under penalty of the taxpayer being subject to double taxation which the law itself seeks to avoid. For this reason, one cannot promote the application of article 81(2) of the PIRC to state tax, as the article provides that it is only applicable to taxes defined in accordance with the convention.

  9. They further understand that it was the Portuguese and American states that expressly agreed upon the non-application of the assumptions established in the DTC to state tax, and that the failure to fulfill some of the assumptions of the scope of application thereof determines the non-applicability of the DTC and consequent absence of primacy of this over the national rules.

  10. Thus, the claimants conclude that the PIRC determines a rule of application to cases of international double taxation (article 81(1)), which will be disregarded in case of application of a DTC. No DTC being applied, it does not reach the disregarding of that rule by application of article 81(2), whereby the Portuguese state should grant the right of tax credit of state tax paid in the United States of America, in the value of 8,709 USD, that is, € 6,045.40 (six thousand and forty-five euros and forty cents).

  11. Finally, the claimants understand that they are entitled to receive compensatory interest from the Respondent, by virtue of the payment of tax which they made, calculated until the effective reimbursement of the tax, given that the assessed liability impugned suffers from error of the services, in accordance with article 43 of the GTC.

III. The Respondent's Response

  1. The Respondent understands that the rules of legal interpretation, on the one hand, of paragraph (a) of article 24(3) of the DTC, regarding the elimination of double taxation: «…(a) when a resident of Portugal obtains income which, in accordance with the provisions of this convention, may be taxed in the United States (…) Portugal shall allow a deduction from the income tax of such resident of an amount equal to the income tax paid in the United States» and, on the other, of sub-paragraph (i) of paragraph (b) of article 2(2) of the DTC to the effect that: «(1) The present taxes to which this convention applies are:

(…)

(a) In the United States:

(i) Federal income taxes levied in accordance with the Internal Revenue Code (General Code of Taxes) (excluding social security contributions»

permits the conclusion that, for purposes of this DTC, state taxes of the USA are not provided for.

  1. The Respondent agrees with the claimants' reasoning regarding the figure of the «…tax credit is not limited to the conventional regime enclosed in Double Taxation Conventions» and that « …the analysis of tax credit cannot be verified solely by the inclusion of a given tax in the bilateral convention of the respective country, but rather in the combination of tax legislation in force and the applicable DTCs», however, it disagrees with the conclusions which the claimants draw from the combination of the tax legislation in force between Portugal and the applicable DTC, mentioned above.

  2. Its disagreement is supported by Official Letter no. 20 022/00, of 19 May, which establishes that: «Article 80-D of the PIRC provides, when a resident of Portugal obtains income which may be taxed in the other Contracting State, a tax credit intended at the elimination of double taxation, which generally consists of the deduction of tax paid in that State, up to the limit of the fraction of Portuguese tax calculated before the deduction, corresponding to income taxed abroad, being, however, the recourse to these mechanisms subject to the rules of double taxation conventions whenever they exist».

  3. Concluding from this, the Respondent that the article 81 itself limits itself when in article 81(2) it provides that: «(2) – When there is a convention to eliminate double taxation celebrated by Portugal, the deduction to be made in accordance with the preceding number cannot exceed the tax paid abroad as provided by the convention»

  4. Understanding, the Respondent that, in this case we have a DTC celebrated by Portugal, whereby the application of article 81(1) is limited, in the first place by article 81(2) thereof, and in the second place and because this article refers to them, by the very provisions of the DTC.

  5. It further invokes that it is precisely by the application of domestic law that tax credit is limited to tax paid abroad as provided in the convention, as established in article 81(2) of the PIRC, and the verification of the existence of a DTC is apriori to any reasoning, including, in this case, its application or not. Not in any logic of overlapping of the DTC over domestic rules but, rather, because in light of the letter of article 81(2) of the very domestic rule which is article 81 of the PIRC, the DTC is a limiting condition of tax credit itself.

  6. Further, the Respondent defends that, by virtue of our being faced with tax credit, it necessarily follows the analysis of other rules which enclose in themselves a character of speciality compared to article 81(1) of the PIRC, i.e., article 81(2) of that same article. It follows from the general rules of Law, specifically from article 7(3) of the Civil Code that: "general law does not repeal special law, unless the contrary is the unequivocal intention of the legislator."

  7. The respondent sustains its thesis, further on the argument that, in accordance with the provisions of article 11(1) of the GTC which refers to article 9(1) of the Civil Code, to interpret a law is to fix its meaning and the scope with which it should apply, that is, to determine its decisive meanings and scopes. If the literal apprehension of the text is the starting point of all interpretation, it is, however, insufficient, because a task of interconnection of the legal system in which the rule is inserted and of valuation that escapes the literal domain will always be necessary. In this task of interconnection and valuation that accompanies the apprehension of the literal meaning, logical elements intervene, with doctrine pointing to elements of order (1) systematic, (2) historical, and (3) rational or teleological.

  8. It further states that, having regard to all these elements which underlie a correct legal interpretation, one cannot logically conclude as the Claimants do, because if one were to understand as they do, it would suffice that the legislator had not included article 81(2) of the PIRC.

  9. Finally, the Respondent alleges that the right to compensatory interest should not be recognized to the here Claimants, given the legal conformity of the tax act, object of the present arbitral application, it not being therefore possible to consider there to be any error attributable to the services.

IV. Procedural Matters

The Tribunal is competent and is regularly constituted, in accordance with paragraph (a) of article 2(1) and articles 5 and 6, all of the LRTM.

The parties have legal personality and capacity, are shown to be legitimate, and are regularly represented.

There are no nullities, exceptions, or preliminary matters that prevent knowledge of the merits of the application.

V. Factual Matters

With relevance for the decision, the following facts are deemed proven:

A. Within the scope of the analysis of Annex J of the Model 3 Income Statement of PIT for 2009, the Administration Division of the International Relations Service Directorate notified the Claimants, through official letter no. ..., of 30.01.2012, to the effect that: "according to the information contained in our systems, Your Excellency declared, in Annex J of the model 3 income statement(s) of PIT, relating to the year 2009, income earned and tax paid abroad, having consequently benefited from a tax credit for international double taxation. However according to the information collected, the documents delivered do not meet the required requirements, as they are not proof of the amounts of income earned, their nature and tax suffered abroad, issued and/or authenticated by a fiscal authority and representative of the total and final amounts for the aforementioned year, being the document of the employing entity.", and to "send to this Directorate (…) «…valid documents, issued by the fiscal authority of the State of source of the income, proof of the amounts entered in the respective Annex J, as determined in the instructions for completion of this annex"

B. On 23 April 2012, the Claimants submitted to that Service Directorate the following documents:

(a) Statement issued by the Internal Revenue Service regarding the summary of their tax situation for the year 2009;

(b) Statement authenticated by notary, attesting to the tax assessment issued in the USA, as well as the values declared to the State of Georgia.

C. Following the analysis of the PIT income statement presented by the Claimants, relating to the year 2009, the International Relations Service Directorate, through Official Letter no. ..., of 21.12.2012, sent the case to the Finance Directorate of ..., for purposes of correction of the PIT assessment of the year 2009 of the claimants, in the sense of "removing the tax credit for international double taxation previously granted, under article 65(4) of the PIT Code," on the ground of the claimant's submission of "a document from the tax authorities of the USA which is not valid, (…)".

D. Through official letter no. ..., of 14.01.2013, the Claimants were notified of the dispatch of 18.12.2012, issued by the Director of International Relations Services, whereby it was determined that, in light of the inauthenticity of the documents and, consequently, the impossibility of proof of the values contained therein, the tax credit for international double taxation previously granted should be removed, and they exercise, if they wish, within the period of 15 days the right to prior hearing provided in article 60 of the GTC.

E. On 26 January 2013, the Claimants exercised their right to prior hearing, where they set forth the factual reasons supporting their position regarding the proposed corrections, and where they attached a copy of statement authenticated issued by F, LLP, Account Transcript of the Internal Revenue Service relating to 2009, and the USA income statement.

F. In light of the new documents submitted by the Claimants, amendments were made to Annex J of the Model 3 Statement submitted by the Claimants, in the following manner:

(a) The income from dependent work earned in the USA, declared in the amount of € 100,718.99 was corrected to the amount of € 109,455.08;

(b) The tax paid in the USA, declared in the amount of € 25,458.75 was corrected to the amount of € 26,554.90.

G. On 16 May 2013, the Finance Directorate of ... notified the Claimants, through Official Letter no. ..., of 2013.05.09, that "some of the elements contained in the PIT income statement of the year indicated were altered, (…)" on the ground of the information ..., provided by the International Relations Service Directorate, according to which "the taxpayer presented the USA income statement (country where the taxpayer earned income) as well as the final tax assessment. According to the USA income statement, the amount of income earned was 157,681USD, the amount of tax supported was 38,255USD, which according to the exchange rate, published by the Bank of Portugal, at the end of the period of 1.4406, for the year 2009, corresponds to the value of 109,455.08€ of income earned and 26,554.90€ of tax supported, amounts which should be contained in Annex J of the income statement, model 3, of the said year. In the taxpayer's statement, he requests that the amount of 8,709USD which corresponds to state tax be considered, however in accordance with the provisions of article 2(1)(b)(i) of the Convention to avoid double taxation between Portugal and the USA, only federal tax can be considered, since state tax is not covered by the DTC."

H. On 31 May 2013, the claimants were notified of the account adjustment statement for PIT of the year 2009, document no. ..., with a balance due of € 2,573.03 (two thousand five hundred and seventy-three euros and three cents),

I. And, on 3 June 2013, the claimants received the PIT assessment statement of the year 2009, contained in the offset no. ..., in the value of € 24,268.25 (twenty-four thousand two hundred and sixty-eight euros and twenty-five cents).

J. The claimants filed a request for reconsideration on 16 July 2013, recorded with no. ..., at the Finance Service of ..., and processed in the Administration Division of the International Relations Service Directorate, setting forth the factual and legal reasons which they understood to support the request for "acceptance of the state tax credit in the amount of 8,709 USD (eight thousand seven hundred and nine dollars) in accordance with article 81 of the PIRC and correction of the tax calculation and assessment.

K. On 2 September 2013, the claimants were notified, through Official Letter no. ..., of 2013.08.29, of the Finance Directorate of ...., of the draft decision of the request for reconsideration recorded with no. ..., to the effect of its rejection, and, for them to exercise, if they wish, the right to prior hearing, in accordance with article 60 of the GTC.

L. The Claimants exercised the right to prior hearing on 16 September 2013.

M. Through Official Letter no. ..., of 2013.10.08, of the Finance Directorate of ..., the claimants were notified on 22 October 2013, of the final decision of the request for reconsideration, to the effect of its rejection.

VI. Motivation of Factual Matters

For the conviction of the Arbitral Tribunal, regarding the proven facts, the documents attached to the record were relevant, as well as the administrative file, all analyzed and weighed in conjunction with the pleadings, from which results agreement regarding the factual presentation by the Claimants in the application for arbitral award.

VII. Facts Deemed Not Proven

There are no facts deemed not proven, because all facts relevant for the assessment of the application were deemed proven.

VIII. Legal Grounds

The following are the matters to be assessed and decided:

1 – If, the Convention to avoid Double Taxation celebrated between Portugal and the United States of America applies only to federal income taxes levied in accordance with the provisions of the Internal Revenue Code (General Code of Taxes) (excluding social security contributions), in accordance with the provisions of sub-paragraph (i) of paragraph (b) of article 2(1) thereof, will the claimants have the right to tax credit for state tax paid in the Source Country, in accordance with the provisions of article 81(1) of the Personal Income Tax Code.

2 – Whether the Claimants are entitled to compensatory interest.

Let us see:

1 – Regarding the scope of application of the DTC celebrated between Portugal and the United States of America, and article 81(1) of the Personal Income Tax Code (PIRC).

– International double taxation –

Double taxation is a concept used in Tax Law to designate cases of concurrence of rules. This concurrence is characterized by the existence of the same fact being integrated into the provision of two different rules. There is, thus, concurrence of Tax Law rules, when the same fact is integrated into the hypothesis of two distinct material rules, giving rise to the constitution of more than one tax obligation.[1]

This concurrence of rules can occur in different States, embodying, in light of the existence of identity of the tax fact and plurality of subjection rules belonging to different legal-tax systems, the so-called International Double Taxation.

The identity of the tax fact, for its verification, requires that between the two (or more) taxations there exists: identity of the object; identity of the subject; identity of the tax period, and identity of the tax. "With regard to this latter identity, it is said that there is identity of the tax, when, in both systems, the tax has identical substantial nature."[2]

Now, in order to eliminate international double taxation and obviate the negative consequences which it represents for the development of international economic activity, there were placed at the disposal of States two types of instruments, namely:

(i) unilateral measures – internal provisions of States – and;

(ii) bilateral measures – treaties or double taxation conventions.

With regard to unilateral measures, Américo Brás Carlos teaches that "Unilateral mechanisms are, as the very name indicates, internal mechanisms for the elimination of international double taxation adopted by each State, without the necessary correspondence in other systems. These mechanisms can act relatively to the taxable matter earned abroad, exempting it (full or progressive exemption), or in relation to the tax paid there, permitting its deduction from the tax payable in the country of its residence (tax credit, such as article 81 of the PIRC and article 91 of the CIRC)."[3]

As for bilateral measures, we have the so-called Conventions to Eliminate International Double Taxation, which are embodied in "international treaties celebrated between two States – the State of source and the State of residence – through which they regulate between themselves the manner of taxing facts which, by force of the elements of connection used are comprised within the scope of tax application of both States, in a manner to eliminate double taxation."[4], which, it may be said, do not always completely eliminate double taxation, but may always mitigate it.

Let us see:

– Unilateral measures for the elimination of international double taxation in Portugal – Article 81 of the PIRC

Individuals resident in Portugal are taxed, in accordance with article 15(1) of the PIRC, by way of personal income tax, on the totality of their income, including that obtained outside that territory, in accordance with the principle of universality.

"In Portuguese tax law, it is the principle of universality (of totality, of unlimited taxability or of world-wide-income) that governs the taxation of individuals and legal entities. The principle of universality – whose origins date back to the Prussian Law of 24 July 1891 on income tax and the 1913 American income tax – is enshrined among us, as to individuals, in article 1(2) of the PIRC, according to which 'income, whether in money or in kind, is subject to taxation, regardless of the place where it is obtained, the currency and the form in which it is earned'; and also in article 15(1) of the same Code, according to which 'being individuals resident in Portuguese territory, PIT is levied on the totality of their income, including that obtained outside that territory.'"[5]

In this sequence, and as that Author further teaches, "As a rule, legislations that enshrine the principle of universality contain unilateral provisions intended to eliminate or mitigate the double taxation to which it may lead, providing for the granting of a tax credit for international double taxation.

Until the end of 1993, Portuguese legislation restricted tax credit for international double taxation to the circle of countries with which Portugal had celebrated double taxation agreements, thus penalizing international movements of persons and capital to the remainder, as it is scarcely possible for income to bear being taxed twice. In 1994, the scope of tax credit for double taxation was extended.

It was indeed surprising that the Portuguese legislator reiterated the enshrinement of the principle of universality, both as to individuals and legal entities, without extracting therefrom the reflex consequences which a fair weighing of interests entails.

In fact, if the law intended to recognize the movement of internationalization of the Portuguese economy, it should have done so in a broad and rational manner: to tax, on the one hand, the totality of worldwide income, but, on the other hand, to grant automatically and as a matter of right, foreign tax credits, whatever the nature of the taxpayer – individual or legal entity, branch or subsidiary of a Portuguese company.

With regard to individuals – which concerns us here – similar provisions apply. Thus, in the PIRC, in its article 81(1), it provides that holders of the different categories of income, obtained abroad, are entitled to a tax credit for international double taxation, deductible up to the extent of the portion of the PIT levy proportional to those net income, which will correspond to the lesser of the following amounts: (i) income tax paid abroad; (ii) fraction of the PIT levy, calculated before the deduction, corresponding to the income which in the country in question may be taxed, net of the specific deductions provided in the said Code.

In accordance with article 81(2), when there is a convention to eliminate double taxation celebrated by Portugal, that deduction cannot exceed the tax paid abroad, as provided in the convention."[6]

In cases in which the Source State, where the (foreign) income is obtained, can also tax that income, it shall be incumbent upon the State of residence – in the present case – Portugal – to eliminate or mitigate double taxation according to the method of exemption or imputation (or credit) of foreign tax.

The non-existence of a Convention heightens situations of double taxation, by virtue of the Source State being able to more easily arrogate to itself the right to tax the income obtained there.

Indeed, and in order to obviate such situations, in Portugal (and in the case of income obtained by individuals), the elimination or mitigation of double taxation may occur by force of the unilateral regime provided for in article 81(1) of the PIRC.

Now, article 81 of the PIRC, under the heading: "elimination of international double taxation", in its article 81(1), provides the rule regime, according to which: "holders of income of the different categories obtained abroad are entitled to a tax credit for international double taxation deductible up to the extent of the portion of the PIT levy proportional to those net income, considered in accordance with paragraph (b) of article 22(6), which will correspond to the lesser of the following amounts:

(a) Income tax paid abroad;

(b) Fraction of the PIT levy, calculated before the deduction, corresponding to income which in the country in question may be taxed, net of the specific deductions provided in this Code."

And in article 81(2), which will be the exception to that article 81(1), it provides that: "when there is a convention to eliminate international double taxation celebrated by Portugal, the deduction to be made in accordance with the preceding article cannot exceed the tax paid abroad as provided in the convention."

It results thus, from the conjunction of these articles of article 81 of the PIRC, above transcribed, that article 81(1) is a unilateral measure for the elimination or mitigation of international double taxation, of tax paid abroad not provided for in a DTC, and will be the general rule, whereas article 81(2) prescribes situations in which the limits provided may be encompassed without, however, exceeding the deductions provided in the Convention.

According to our understanding, this article 81(2) embodies, in the words of Américo Brás Carlos "(...) the unilateral measures [which] may be applied jointly with bilateral measures resulting from conventions to avoid international double taxation which limit the taxation of the source (or origin) State of the income to a rate lower than the normal. The consequence is that the deduction from the Portuguese tax levy cannot be superior to the tax paid abroad as provided in the convention"[7] – e.g. article 81(2) of the PIRC.

This means that the application of article 81(2) of the PIRC merely applies a limit to the deduction of taxes provided for in the DTC, a limit which cannot be superior to the tax paid abroad, as provided in the convention.

Indeed, the limitation established by article 81 of the PIRC is intended, in particular, to avoid that a taxpayer who could have invoked the convention in the source country, having not done so, come to oblige the Portuguese state to refund its own tax, by force of the taxpayer's omission/negligence.

– Bilateral measures – conventions to avoid international double taxation – scope of application –

With regard to the scope of application of international double taxation treaties, and according to Alberto Xavier, in the work cited, p. 122, "it can be examined from five distinct angles: as to persons, as to taxes, as to territory, as to succession of States, and as to time.

The scope of application of treaties against double taxation, as to persons, is defined according to the criterion of residence and not nationality (…); in the matter of taxes on income and capital – which concerns us here - they apply, in principle, to taxes that have that substantial nature, independently of their designation (nomen iuris), of the person of public law that is its holder, or of the method adopted for its collection. (...) The Contracting States draw up, as a rule, a list of present taxes to which the convention applies, a list which has the character merely declaratory, having no limiting reach.

The indication of taxes covered by the Conventions was, among us, object of three distinct techniques: the conventions proceed to the general definition of the type of tax on income, followed by an enumeration whose exemplificative character results from the use of the expression, namely; (...) other conventions also proceed to the general definition of the characteristics of the taxes to which they apply, but immediately thereafter elaborate a comprehensive list of present taxes included therein, whereby the definition only makes sense for purposes of judging applicability to future taxes (...); finally, the third group of Conventions limits itself to establishing a comprehensive list of present taxes to which the convention applies, dispensing with any generic definition.

(...)."

Now, regarding the matter which concerns us, it is necessary, from the start, to point out that the Government of the Portuguese Republic and the Government of the United States of America, with a view to avoiding double taxation and preventing tax evasion in the matter of income taxes, celebrated, on 12 October 1995, a Convention, published in the Official Journal Series I A no. 236 of 12 October 1995 (Resolution of the Assembly of the Republic no. 39/95, of 12 October), in accordance with which it applies to persons resident of one or both Contracting States (article 1 of the DTC).

Article 2 of the Convention lists the taxes covered by the Convention, which are hereby transcribed:

"(1) The present taxes to which this Convention applies are:

(a) In Portugal:

… … …

(b) In the United States:

(i) Federal income taxes levied in accordance with the provisions of the Internal Revenue Code (General Code of Taxes) (excluding social security contributions); and

(ii) Special tax with respect to income from investments of private foundations, under section 4940 of the Internal Revenue Code, subject to any amendments that may be introduced, without, however, altering its general principles."

By examining the Internal Revenue Code of the USA, we may verify that there are more federal taxes that fall outside the scope of the Portugal/USA DTC, not just the state tax in question in the present proceedings.

From the dichotomy presented by Alberto Xavier regarding the types/groups of enumeration of taxes provided for in the Portugal/USA DTC, it will be pacifically concluded that the DTC in question is found in the third group referred to by that Author, having limited itself to "establishing a comprehensive list of present taxes to which the convention applies, dispensing with any generic definition."

Thus being, and in light of this characteristic, from a reading of article 2 of the DTC, it can be affirmed that the DTC provides only for rules to avoid/mitigate international double taxation, – as far as concerns us – as to federal taxes, leaving outside its scope of provision and application state taxes, here in question.

This is a conclusion that appears to be pacifically accepted by both parties in the present proceedings.

The disagreement is confined to the application or non-application of the unilateral measures provided for in article 81(1) of the PIRC, as a means of elimination of double taxation which falls upon the Claimant, regarding state tax paid by him in the USA, in the value of 8,709 USD.

The final crusade with which we are faced is to know whether, on the one hand, and as the Claimant argues, international tax credit for double taxation is not limited to the regime enclosed in Double Taxation Conventions, "and that the analysis of tax credit cannot be verified solely by the inclusion of a given tax in the bilateral Convention of the respective country, but rather in the combination of tax legislation in force and applicable DTCs, and should first be analyzed whether a given tax is supported by the DTC, and in the event it does not have such support, whether by non-existence of a DTC or because the States have not agreed upon/included the said tax, the unilateral rule established by the Portuguese State should be applied, 'in this case article 81 of the PIRC.'"; or if, on the other hand, as the respondent contends, "the application of article 81(1) is limited in the first place by article 81(2) thereof, and in the second place and because this article refers to them, by the very provisions of the DTC. (...) it is precisely by the application of domestic law that tax credit is limited to tax paid abroad as provided in the convention, as established in article 81(2) of the PIRC, and the verification of the existence of a DTC is apriori to any reasoning, including, in this case, its application or not. Not in any logic of overlapping of the DTC over domestic rules but, rather, because in light of the letter of article 81(2) of the very domestic rule which is article 81 of the PIRC, the DTC is a limiting condition of tax credit itself. And that, by virtue of our being faced with tax credit, it necessarily follows the analysis of other rules which enclose in themselves a character of speciality compared to article 81(1) of the PIRC, i.e., article 81(2) of that same article. It follows from the general rules of Law, specifically from article 7(3) of the Civil Code that: "general law does not repeal special law, unless the contrary is the unequivocal intention of the legislator.'»

Now, Portugal, like other legal systems, apart from the numerous Conventions for the elimination or mitigation of double taxation which it has celebrated with other States, has in its legal system provisions that invoke unilateral measures with the same objective, whereby, before we proceed, it will be prudent to address the question as to the place of international conventions in the hierarchy of sources of Portuguese Law.

On this matter Alberto Xavier clarifies us, in the work cited, p. 117 that: "In Portuguese law there does not exist, (...), an act of transformation of conventional law into internal law. Indeed article 8(2) of the Constitution (which maintained its wording intact, even after subsequent constitutional revisions) provides that the provisions contained in validly celebrated international conventions (and, therefore regularly ratified and approved) are in force in the internal order as soon as published. From this it follows that treaties are immediate sources of law and obligations for their recipients, being able to be invoked as such, before the courts (principle of direct and immediate efficacy); and that to the interpretation of their provisions the rules of hermeneutics applicable to treaties are to be applied, and not those which respect the internal legislation of each Contracting State.

In other words, Portuguese law enshrines a general clause of complete automatic reception of international conventional law, in harmony with the monist view, that is, the clause by which Public International Law acquires relevance in the internal order, independently of any other formality than mere publication. International law thus applies in the Portuguese internal order, by effect of the international commitment of the Portuguese State and applies in its quality of international law, it not being necessary a "transformation" or "order of execution", case by case, that is, coming into force independently of legal conversion (principle of direct or immediate applicability)."

Notwithstanding, the hierarchical superiority of treaties is proclaimed both in the provisions of articles 26 and 27 of the Vienna Convention, as well as in article 8(2) of the Constitution of the Portuguese Republic, whereby "[f]rom this two conclusions flow: (a) that international conventional law is placed in the internal legal order at a hierarchical degree superior to that of law; (b) that, in case of conflict, the treaty is imposed over internal law.

This is the established position of the Constitutional Court.

The supremacy of the treaty over internal law does not, however, result in the repeal of the latter. Indeed, we are not here faced with an abrogative phenomenon, since internal law maintains its full efficacy outside of cases withdrawn from its application by the treaty. It is, rather, a limitation of the efficacy of the law which becomes relatively inapplicable to a certain circle of persons and situations, a limitation which precisely characterizes the institute of derogation."[8], the truth is that this question – regarding the primacy of international law approved and ratified by the Portuguese State – adds nothing to the case at hand, given that, as we have seen, what we have here is a state tax, which is not found in the DTC celebrated between Portugal and the USA, whereby it now falls to us to discern whether the same can have article 81 of the PIRC applied to it and in what terms.

– The concrete case – the question to be decided

It follows from the general rules of Law, specifically from article 7(3) of the Civil Code that: "General law does not repeal special law, unless the contrary is the unequivocal intention of the legislator".

In the concrete case at hand, we have a special rule which is found in the DTC, which, if it is not possible to proceed to its application, by lack of provision or application to a certain tax, it is necessary to resort to the general rule which the legal system of the State of residence provides, so that the elimination or mitigation of double taxation can be applied to the taxpayer (its resident), given the reasons of an economic order already mentioned.

Thus being, and as far as concerns the question at hand, the elimination or mitigation of international double taxation of the tax previously paid by the Claimants in the USA, – state tax, to which the Portugal/USA DTC does not have application, in accordance with article 2 of the Portugal/USA DTC, – should pass through the filter of article 81(1) of the PIRC, as a unilateral measure to prevent that the same income be subject to the same tax twice, precisely because the same is not found provided for as a tax covered in the Portugal/USA DTC.

This means that, firstly, it must be verified whether the tax in question can have the DTC applied to it, and in the case of a negative response and if therefrom does not result the elimination or mitigation of international double taxation, the unilateral rule will have to be applied.

Thus being, having into account that:

  1. The DTC celebrated between Portugal and the USA does not apply to state taxes, (only to federal ones) by lack of provision for the latter in that Convention;

  2. The claimants paid tax abroad, which is proven by the authenticated statement issued by F, LLP; Account Transcript of the Internal Revenue Service relating to 2009; and the USA income statement, accepted by the Respondent for purposes of tax credit;

  3. The claimants declared in Annex J of the Income Statement Mod. 3 PIT the income earned abroad, under the principle of universality;

Given the existence of unilateral measures to eliminate or mitigate international double taxation, a tax credit should be granted under article 81(1) of the PIRC, whereby the Respondent's position in the assessment made is without merit.

In light of the foregoing, the act of assessment of Personal Income Tax, no. ..., relating to the year 2009, is partially null, by violation of the provisions of article 81(1) of the PIRC, by virtue of error as to the assumptions of law, and in consequence, the Respondent must recognize the tax credit to the Claimant in the value of € 6,045.40 (8,709 USD).

2 – Whether the Claimant is entitled to compensatory interest.

The Claimants further petition that the right to compensatory interest be recognized, counted at the legal rate from the date of payment of the tax until the date of its full reimbursement.

Article 43(1) of the GTC and article 61 of the Code of Tax Procedure and Process provide that compensatory interest is due when it is determined in a request for reconsideration or judicial challenge that there was error attributable to the services from which results payment of a tax debt in an amount superior to that legally due.

Error attributable to the administration is considered to occur when the error is not attributable to the taxpayer and is based on erroneous assumptions of fact which are not the responsibility of the taxpayer.

Now, resulting from the tax act impugned the obligation of payment of tax superior to that which would be due, compensatory interest is due in accordance with the legally provided terms, the legislator presuming, in these cases, in which the annulment of the assessment is verified, that there occurred in the sphere of the taxpayer a loss by virtue of having been deprived of the patrimonial sum which he had to hand over to the State by virtue of an illegal assessment. In consequence, the taxpayer is entitled to that compensation, independently of any allegation or proof of loss suffered.

In the present case, it will be unquestionable that, following the establishment of the illegality of the act of assessment, there will be a place for reimbursement of the tax by force of the provisions of article 43(1) of the GTC, and article 100 of the GTC passing, necessarily therethrough the reestablishment of the "situation that would exist if the tax act object of the arbitral award had not been practiced".

In the same manner, it is understood that it will be free from doubt that the illegality of the act is attributable to the Tax Authority, which autonomously practiced it illegally.

As to the concept of "error", it has been understood that only in cases of annulments based on defects respecting the tax legal relationship will there be place to payment of compensatory interest, such right not being recognized in the case of annulments for procedural defects or of form.

Thus being, being faced with a defect of violation of substantive law, which is embodied in error as to the assumptions of law, attributable to the Tax Authority, the claimants are entitled to compensatory interest, in accordance with articles 43(1) of the GTC and 61 of the CPPT, calculated on the sum of € 6,045.40 and counted from the payment of the tax until the full reimbursement of the said amount.

DECISION

In accordance with the foregoing, the following is decided:

(a) To uphold the application for partial declaration of illegality of Personal Income Tax, in the value of € 6,045.40 (six thousand and forty-five euros and forty cents); and

(b) To condemn the Tax and Customs Authority to reimburse the Claimants the amount which they paid, plus compensatory interest, calculated at the legal rate, from the payment of the tax until the full reimbursement.

Value of the Case

The value of the case is fixed at € 6,045.40 in accordance with article 97-A(1)(a) of the CPPT, applicable by force of paragraphs (a) and (b) of article 29(1) of the LRTM and article 3(2) of the Regulation of Costs in Tax Arbitration Proceedings.

Costs

In accordance with article 22(4) of the LRTM, the amount of costs is fixed at € 612.00, in accordance with Table I attached to the RCTP, at the expense of the Tax and Customs Authority.

Notify.

Lisbon, 15 September 2014

The Arbitrator

Jorge Carita

[1] Alberto Xavier, in Tax Law of International Scope, 2nd Edition, Almedina, pp. 30.

[2] Américo Brás Carlos, in Taxes – General Theory, Almedina, p. 236.

[3] Américo Brás Carlos, in Taxes – General Theory, Almedina, pp. 237 and 238.

[4] Idem, p. 240.

[5] Idem, p. 489.

[6] Ibidem p. 494.

[7] Américo Brás Carlos, in Taxes – General Theory, Almedina, p. 239.

[8] Alberto Xavier, in Tax Law of International Scope, 2nd Edition, Almedina, pp. 118.

Frequently Asked Questions

Automatically Created

What is the IRS tax credit under the Portugal-USA Double Taxation Agreement?
The IRS tax credit under the Portugal-USA Double Taxation Agreement operates through the ordinary credit method established in Article 24(3)(a) of the Convention. When a Portuguese tax resident obtains income that may be taxed in the United States according to the Convention, Portugal allows a deduction from the resident's income tax equal to the income tax paid in the US. However, the Convention's scope is explicitly limited to federal income taxes levied under the US Internal Revenue Code, excluding social security contributions and state taxes. The credit is calculated based on the lower of the foreign tax actually paid or the Portuguese tax attributable to that foreign income, preventing over-crediting. This mechanism aims to eliminate juridical double taxation on the same income, ensuring taxpayers are not taxed twice on US-sourced income by both countries.
How does the CAAD arbitration process work for IRS tax credit disputes?
The CAAD (Centro de Arbitragem Administrativa) arbitration process for IRS tax credit disputes follows the Legal Regime for Arbitration in Tax Matters (RJAT). Taxpayers initiate proceedings by filing a request for constitution of an arbitral tribunal under Article 2(1) and Article 10(1) of Decree-Law 10/2011. The CAAD President accepts the request and notifies the Tax Authority, which files a response. If parties don't appoint arbitrators, the President designates one. The tribunal is formally constituted with a deed, followed by a first meeting under Article 18 where parties may present evidence or waive it. The arbitrator sets a deadline for the decision (typically 6 months) and determines arbitration fees per the Regulation of Costs. The process provides an alternative to judicial courts, offering faster resolution of tax disputes with specialized arbitrators experienced in tax law.
Can taxpayers claim compensatory interest on overpaid IRS tax in Portugal?
Yes, taxpayers can claim compensatory interest on overpaid IRS tax in Portugal under Article 43 of the General Tax Code (LGT). Compensatory interest is due when tax collection results from an error attributable to the tax services, calculated from the date of payment until effective reimbursement. The taxpayer must demonstrate that the overpayment resulted from administrative error rather than legitimate legal interpretation or taxpayer mistake. The interest rate is legally established and aims to compensate taxpayers for the financial deprivation caused by wrongful tax collection. In arbitration cases like 41/2014-T, claimants specifically request compensatory interest as part of their relief, arguing the incorrect denial of tax credit constituted service error. This mechanism ensures taxpayers are made whole when the Administration improperly collects tax, recognizing the time value of money and the taxpayer's loss of use of funds.
What are the legal grounds for partial annulment of an IRS tax assessment?
Legal grounds for partial annulment of an IRS tax assessment in Portuguese tax arbitration include: (1) illegality due to violation of substantive tax law, such as incorrect application of tax credit rules under the PIRC or Double Taxation Conventions; (2) error in determining taxable income or calculating tax liability, including improper rejection of deductions or credits; (3) misinterpretation of international tax treaties or domestic law provisions; (4) violation of fundamental procedural guarantees or taxpayer rights; (5) lack of factual basis for assessment corrections; and (6) incorrect legal qualification of income or transactions. In case 41/2014-T, claimants sought partial annulment arguing the Tax Authority erroneously refused to apply Article 81(1) PIRC's unilateral tax credit provision to US state taxes not covered by the DTC. The annulment is 'partial' when challenging only specific elements of the assessment rather than the entire tax liability, allowing courts or arbitrators to correct specific errors while maintaining valid assessment components.
How does the Portugal-USA tax treaty prevent double taxation on personal income?
The Portugal-USA tax treaty prevents double taxation on personal income primarily through the tax credit method established in Article 24(3). When a Portuguese resident earns income taxable in the USA under treaty provisions, Portugal grants a credit against Portuguese IRS equal to the US income tax paid. This 'ordinary credit' method allows the residence country (Portugal) to tax worldwide income while crediting foreign taxes paid, ensuring the same income isn't fully taxed twice. The treaty allocates taxing rights between countries based on income type: some income is taxed exclusively by one country, while other income may be taxed by both with credit relief. Article 2 defines the scope of covered taxes (US federal taxes and Portuguese IRS), establishing the treaty's application boundaries. The treaty follows OECD Model Convention principles, providing certainty and preventing fiscal evasion while eliminating double taxation. However, the Convention's limitation to federal taxes creates interpretive questions about whether Portuguese domestic law (Article 81 PIRC) separately addresses taxes outside treaty scope, as demonstrated in this arbitration case.