CAAD 412/2015-T: IRS Taxation of Securities Capital Gains and Assessment Validity

ARBITRAL DECISION

A – REPORT

1. A..., taxpayer no. ..., and B..., taxpayer no. ..., residents at Rua..., no. ..., ..., ...-..., hereby, in accordance with the provisions of Articles 2 and 10 of Decree-Law no. 10/2011, of 20 January (Legal Regime for Arbitration in Tax Matters, hereinafter referred to only as LRAT), present a REQUEST FOR CONSTITUTION OF AN ARBITRAL TRIBUNAL, aiming at the annulment of the act of assessment of Personal Income Tax (PIT) no. 2015..., relating to the year 2010, in the total amount of €424,016.92, of which €28,571.24 refers to compensatory interest (assessment no. 2015...), as well as the statement of account reconciliation no. 2015... with a balance of €217,083.62 (total amount less the amount of €206,933.30 paid on 28-9-2011), which was assessed on 7-5-2015.

2. The Requesters opted not to appoint an arbitrator, wherefore the Deontological Council of CAAD proceeded to appoint arbitrators Dr. José Pedro Carvalho (president), Dr. José Coutinho Pires and Prof. Doctor Daniel Taborda, which was accepted by the parties – Requesters and Respondent (Tax and Customs Authority, hereinafter TCA).

3. The Arbitral Tribunal was duly constituted in CAAD, on 14-09-2015, to examine and decide the subject matter of the present arbitral proceedings, as recorded in the respective minutes.

4. The parties possess legal personality and capacity and are legitimate.

5. The Tribunal is competent and the request is legitimate, having been submitted on 3-7-2015 and accepted by the Tribunal as a process in the phase of arbitral procedure on the 7th.

6. An Arbitral Order was issued on 20-10-2015 which justified the waiver of the meeting referred to in Article 18 of the LRAT and granted the parties the possibility of submitting written pleadings.

7. The parties submitted written pleadings on 29-10-2015 (Requesters) and on 12-11-2015 (Respondent).

8. Synthetically, the Respondent maintained that the Requesters' pleadings did not raise new arguments to the initial petition, centred on the lack of substantiation and omission of legal formalities in the assessment and on the exclusion from taxation of capital gains arising from the sale of shares.

9. In light of the foregoing, it is important to describe the facts contained in the initial petition (IP).

A1 – OF THE INITIAL PETITION

1. The Requesters, identified above, presented to the Arbitral Tribunal a request for arbitral pronouncement, aiming at the annulment of the act of assessment of PIT no. 2015..., in the amount of €424,016.92, of which €28,571.24 refers to compensatory interest, and of the statement of account reconciliation no. 2015... with a final balance of €217,063.62 (cf. Doc no. 1 attached to the IP).

2. In the first part of the IP, the Requesters invoke the lack of substantiation of the acts of assessment subject to arbitral pronouncement (no. 2015... – PIT – and no. 2015... – compensatory interest), carried out on 1 April 2015. In violation of the provision in Article 77, no. 2 of the General Tax Code (GTC), the acts of assessment carried out do not reference the applicable legal provisions, nor do they contain any explicit reference to another document containing that substantiation, and should therefore be annulled. The Requesters argue that the right to be heard before assessment, provided for in Article 60, no. 1, subparagraph a) of the GTC, was omitted, which also implies the annulment of the acts of assessment.

3. The IP continues with the description of the facts which they consider relevant for the proceedings, namely the sale on 5 July 2010 of all shares representing the capital of the commercial companies C..., SA and D... SA, hereinafter C... and D... respectively, to the company E..., SGPS, SA, for the amount of 2 million euros.

4. It was mentioned by the Requesters in Schedule 8-A that this was a sale of equity stakes in micro and small enterprises, with the companies C... and D... having been identified, whose capital gain would be taxed only at 50%, in accordance with Article 43, no. 3 of the PIT Code. By official communication dated 4 July 2011 from the TCA, the Requesters were notified that "the declared capital gains income is lower than known or the equity stakes sold do not belong to micro or small [enterprises]" (cf. Doc no. 11 attached to the IP).

5. On 28 July 2011, the Requesters made a statement and request in response to the notification mentioned above, in which it was argued that capital gains were excluded from taxation and it was justified that the aforementioned Schedule G was filled in on the basis of the impossibility of the computer system allowing Schedule G1 to be completed, relating to capital gains excluded from taxation, in accordance with Article 10, no. 2, subparagraph a). Without conceding, they argued that the status of micro or small enterprises exempted from taxation half of the capital gains obtained. (cf. Doc no. 12 attached to the IP).

6. The Requesters were notified in August of the PIT assessment note no. 2011..., calculating a tax payable of €206,933.30, of which €188,612.38 relates to the taxation of capital gains. Payment was made on 28 September 2011.

7. On 18 December 2014, the Requesters were notified of the inspection procedure for PIT of 2010 (cf. Doc no. 15, attached to the IP).

8. On 16 February 2015, the Requesters were notified of the draft inspection report and, on 27 March, of the final inspection report (cf. Docs nos. 17 and 2 attached to the IP).

9. According to the reports, the reasons for the inspection relate to the declaration in Schedule 8-A of Schedule G of PIT Form 3 for the tax year 2010, concerning paid transfers of equity stakes in micro or small enterprises, having, under Article 43, no. 3 of the PIT Code, benefited from the 50% taxation exemption. In fact being medium-sized enterprises, the capital gain should have been taxed in its entirety.

10. The correction proposed to PIT of 2010 in the inspection report was €188,512.38.

11. On 13 April 2015, the taxpayers were notified of the additional PIT assessment of €188,512.38 and compensatory interest of €28,571.24. Payment of €217,083.62, in accordance with the statement of account reconciliation included in the same notification, was made on 7 May 2015.

12. On the basis of an extensive review of doctrine and jurisprudence, the Requesters understand that capital gains relating to the year 2010, in the amount of €377,124.76, having been obtained before 27 July 2010, are excluded from taxation.

13. The Requesters also invoke, as already mentioned, that the acts of assessment suffer from the defect of lack of substantiation.

14. They request the annulment of the act of assessment of PIT no. 2015... relating to the year 2010, the amount of which €424,016.92 has already been paid in full, and request restitution of the amount of €217,083.62, paid on 7 May 2015, together with indemnity interest at the legal rate, based on Articles 100 and 43 of the GTC.

AII – OF THE RESPONDENT'S RESPONSE

1. The Respondent argues that there is no defect of lack of substantiation, justifying that "the act is substantiated when, by the reasoning adduced, it is capable of revealing to a normal addressee the reasons of fact and law that determine the decision, enabling him to react effectively through legal means against its harmful nature". Among other arguments, it relies on the fact that the "Requesters understood perfectly the meaning and scope of the assessment on which the present request for arbitral pronouncement is based, as results from the very juridical-argumentative exercise they conduct in their very extensive discourse (...)".

2. Based on doctrine, jurisprudence and the economic and social context in which Law no. 15/2010, of 26 July, was approved, and in particular on the characteristic of annuality of PIT (the taxable event generating the tax relates to 31 December of each year), the Respondent understands that the positive balance of all capital gains and losses on securities obtained in 2010 must be taxed. It acknowledges that this question "constitutes the core of the present dispute".

AIII – OF THE FINAL COUNTER-PLEADINGS

1. The Requesters insist on the arguments invoked in the IP, highlighting the reference to the Judgment of the Supreme Administrative Court no. 5/2015 (Case no. 1292/14-Plenary of the 2nd Section), of 16 September 2015, meanwhile published in the Official Journal 1st series, no. 209, of 26 October, to which we will refer later.

2. The Respondent judges the Requesters' request unfounded, insisting on the thesis that "PIT is characterised by being a direct and periodic tax of an annual nature, being unanimous understanding in Doctrine and Jurisprudence that the taxable event occurs on the date of 31 December of each year, thus understanding the unitary and global character of the taxation of income, notwithstanding the analytical breakdown of the various categories of income according to their source".

B - ISSUES TO BE DECIDED

1. The issues to be decided relate to the alleged lack of substantiation of the acts of assessment, omission of essential formalities and the exclusion from taxation of capital gains on securities obtained before the entry into force of Law no. 15/2010, of 26 July.

C – FACTS FOUND PROVED

The following facts are found to be proved:

1. The challenged assessments relate to a mere arithmetic correction to the taxable base of 2010, due to the omission from the income statement of half of the capital gains obtained from the sale of shares on 5 July 2010, which were held by the Requesters for more than 12 months, given Article 43, no. 6, subparagraph b) of the PIT Code (corresponding to no. 4, in the wording in force in 2010), which provides that "the date of acquisition of shares resulting from the transformation of a limited liability company into a public limited company is the date of acquisition of the quotas from which they originated" (subparagraph a) prescribes a similar regime for capital increase by incorporation of reserves).

2. The amount of €424,016.92 is entirely paid: the amount of €206,933.30 was paid on 28-9-2011 (cf. Doc no. 14 attached to the IP), corresponding to the tax payable calculated in the act of assessment no. 2011... (Doc no. 13), and the amount of €217,083.62 on 7-5-2015 (Doc no. 18), following the statement of account reconciliation (Doc no. 1). Both payments were made within the time limits set in those documents.

3. The capital gains were obtained from the sale of 125,000 shares of company C..., with capital of €125,000, for the amount of €1,100,000 (cf. Doc no. 7 attached to the IP) and the sale of 125,000 shares of company D..., with capital of €125,000, for the amount of €900,000 (Doc no. 8).

4. The Requesters incorporated, as limited liability companies, company C... on 8 May 1997 (cf. Doc no. 3 attached to the IP) and D... on 28 July 2000 (Doc no. 4). Both were transformed into public limited companies on 26 February 2010, through capital increase and the entry of new partners: the two daughters of the Requesters and another commercial company held by them (Doc no. 5 for company C... and Doc no. 6 for company D...).

5. From this restructuring resulted the following distribution of capital:

1. The partners of C... and D... entered into, on 5 July 2010, a contract for the purchase and sale of shares of C... and D... with company E..., SGPS, SA. As regards the Requesters, the following is recorded:

1. As a consequence of these sale operations, the Requesters submitted the PIT Form 3, on 30 May 2011, filling in the respective Schedule G, Schedule 8, the sale and acquisition values, and whose essential content is here reproduced, maintaining the errors shown in that form (€888,861.60 of the value of realization of shares of D... by B..., which contains €2,000 more than the purchase and sale contract, error not identified in the inspection report and which was not alleged by any of the parties), common, moreover, to those of PIT Form 4 submitted by the buyer, E..., SGPS, SA (cf. Docs nos. 9 and 10 attached to the IP):

1. The TCA understood that the amendment to the PIT Code introduced by Law no. 15/2010, of 26 July, is applicable to capital gains from the sale of shares (5 July 2010) before its entry into force (27 July 2010). Therefore it fixed an increase to the taxable base of 2010, subject to the special rate of 20% provided for in no. 4 of Article 72 of the PIT Code (in the wording in force on 31/12/2010). The proposal to PIT of 2010 in the inspection report was €188,512.38, calculated as follows:

Total capital gains: 1,995,200 – 109,076.20 = 1,886,123.80

Capital gains subject to taxation, considering the tax benefit enshrined in Article 72 of the Special Tax Benefits Regime: 1,886,123.80 – 500 = 1,885,623.80

Tax calculated: 20% x 1,885,623.80 = 377,124.76

Tax assessed = 188,612.38

Tax shortfall = 188,512.38

1. The Requesters were notified of the report that concluded the external inspection action for the year 2010, instituted under Service Order OI..., in which it is stated that the taxpayers dispensed with the exercise of the right to be heard, in accordance with Articles 60 of the GTC and 60 of the Regulation of Tax Inspection Procedures (RTIP). In the conclusions of this report (point 6) it states that "in this way, it not having been possible for him in view of the legislative amendment to frame those capital gains within the scope of Schedule G1 (exclusion from taxation of shares held for more than 12 months), the taxpayer opted to declare those capital gains in Schedule G by filling in Schedule 8-A of the same schedule, thus intending to be taxed in accordance with no. 3 of Article 43 of the PIT Code".

2. The Requesters were notified personally. It was recorded in the personal notification certificate, of 6 April 2015, that A... was notified of the "assessment of PIT no. 2015... of 2010, as well as of the assessment of the respective compensatory interest" (...), calculated as a result of the external inspection action for the year 2010 carried out (...) under Service Order OI2014..." and of the means of defence to the notice of charge of the said assessment, to be sent in due course.

3. The assessment in question gave rise to the statement of account reconciliation no. 2015... with a balance of €217,083.62, paid on 7-5-2015, within the time limit for voluntary payment.

D. APPLICABLE LAW

1. The substantiation for the assessment is contained in the final inspection report, complying with the provision in Article 77 of the GTC. Under Article 63, no. 1 of the RTIP, "the tax acts or acts in tax matters resulting from the report may be substantiated in its conclusions (...)". The content of the report is duly substantiated, which, moreover, is apparent from the fact that the Requesters reveal "having understood perfectly the logical and legal process that led to the decision to tax, recognising having perceived the assumptions specifically taken into account by the author of the act and the reasons why the taxed values were reached, denouncing the cognitive and evaluative path traversed ..." (Judgment of the Supreme Administrative Court in case no. 0105/12 of 30-1-2013).

2. As regards the right to be heard, no. 3 of Article 60 of the GTC dispenses with the hearing before assessment, in certain cases, namely if the right to be heard was recognised, before the conclusion of the tax inspection report. Regarding this no. 3, which has an interpretative character, "it is therefore not forbidden to the taxpayer to participate in the formation of the final decision; what proves to be useless and redundant is a second hearing on the same facts and assumptions on which he was already able to pronounce himself previously, when the practice of other acts which then, as already stated, come to be functionally linked to the assessment". (See Daniel Taborda, 2006, The right to be heard in tax procedure, Tax no. 25, p. 158). However, as has already been seen, in the draft of the inspection report the Requesters were invited to exercise the right to be heard, choosing not to do so. The final inspection report reproduced the content of that draft and the tax assessment was made on the basis of this report. Therefore, also here, the allegations of the Requesters do not succeed.

3. As regards the substantive issue, the entry into force of Law no. 15/2010, of 26 July, on 27-7-2010, ended the exclusion from taxation of capital gains obtained from the sale of shares held for more than twelve months, repealing subparagraph a) of no. 2 of Article 10 of the PIT Code, and amended the special rate provided for in Article 72, no. 4 of the CIT Code from 10% to 20%.

4. The essential question is whether all capital gains resulting from the sale of shares held for more than twelve months during the year 2010 should be taxed in the same way, or alternatively in a different way, depending on whether the sale took place on a date before or after 27-7-2010.

5. Confronting the theses adopted by jurisprudence, the point of discord rests on the moment when the taxable event occurs which gives rise to the tax obligation. If it is instantaneous, it occurs at the moment of the sale; if it is complex and of successive formation, at the end of the year, the date on which it is possible to determine the balance, positive or negative, of the capital gains and losses obtained during the tax year.

6. The Judgment of the Supreme Administrative Court no. 5/2015 (Case no. 1292/14-Plenary of the 2nd Section), of 16 September 2015, published in the Official Journal 1st series, no. 209, of 26 October, hereinafter the SAC Judgment, came to standardize the jurisprudence relating to the essential question raised.

7. The SAC Judgment adheres to the thesis which submits that the taxable event relates to the moment when capital gains are realized, being therefore instantaneous and not complex and of successive formation. In the words of the Judgment, "capital gains arise as soon as the amount collected by their owner/transferor exceeds the amount at which he had acquired the asset, that is, as soon as the sale takes place and the inherent gain is achieved. Which means that it is in this gain, obtained at the moment of the sale, that the taxable event generating capital gains resides. And since the gain is measured by the difference between the realization value and the acquisition value of the asset itself, and consequently evaluated in each concrete act of sale, it becomes clear that the capital gain refers to each gain per se".

8. The SAC Judgment distinguishes the positive balance of realized capital gains and losses, which will be taxed, from the taxable event. It argues that "the rule which provides for the necessary aggregation to determine the positive balance between capital gains and losses in view of all the acts of sale that occurred in the year, constitutes a rule on the determination of the taxable base for purposes of PIT, that is, a rule on the determination of collectible income, and not a rule on the incidence, as, moreover, results from the systematic organization of the PIT Code (...)"

9. Note that the standardizing judgments of the SAC "have a special persuasive force, so that the standardizing jurisprudence fixed therein should be respected in subsequent decisions as long as the assumptions that led to it in a given context remain, given its function and the manner in which the appeal for standardization of jurisprudence is configured". Thus, "strong reasons or circumstances must exist to contravene the doctrine standardized by the Supreme, in order to justify the adoption of an understanding divergent from that which came to prevail in the appeal for standardization of jurisprudence in enlarged judgment of the Supreme Administrative Court and with weighing of the opposing theses (among judgments of the SAC, among judgments of the TAC or between judgment of the latter and of the SAC, cf. no. 1 of Article 152 of the Code of Administrative Procedure), which justified its admissibility", only being justified the departure from that jurisprudence, through "the convergence in particular of the following circumstances: i) a significant period of time having elapsed since the standardizing judgment; ii) there being in the meantime a doctrinal debate questioning substantively the standardized jurisprudence; iii) relevant legal arguments being used which have not been discussed in the standardizing judgment; iv) the composition of the Supreme Court having been altered so as to foresee the possibility of the prevailing of a different solution" (Judgment of the Central Administrative Court of the South, of 9-07-2015, issued in case no. 12282/15). This is not the situation that now arises.

10. Thus, the gains constituted by capital gains arising from the paid sale of shares are considered to be obtained at the date of realization (5 July 2010), wherefore the regime introduced by Law no. 15/2010, of 26 July, does not apply. On 5 July 2010, the provision in Article 10, no. 2, subparagraph a) of the PIT Code was in force, therefore the capital gains realized were excluded from taxation, making illegal the assessment that was imposed on them.

11. Besides the annulment of the assessment, the right to indemnity interest is requested. Given that the undue tax debt has been paid due to an error attributable to the TCA's services, the right to indemnity interest subsists (no. 1 of Article 43 of the GTC). This shall be calculated on the amount unduly assessed and paid, with counting from the day following the said payment until the date of issuance of the respective credit note (Articles 43 of the GTC and 61 of the Code of Tax and Customs Procedure).

E. DECISION

In light of the foregoing, the judges composing the collective Arbitral Tribunal agree on:

a) Finding the request for annulment substantiated, annul the act of assessment of PIT relating to the year 2010, no. 2015..., in the amount of €424,016.92, of which €28,571.24 refers to compensatory interest, and of the statement of account reconciliation no. 2015... with a final balance of €217,063.62.

b) Finding the request relating to indemnity interest substantiated, condemn the TCA to refund €217,083.62, which corresponds to the balance of the statement of account reconciliation no. 2015..., paid on 7-5-2015, and to pay the indemnity interest due from the day following that payment, until the date of issuance of the respective credit note.

Value of the Case

In accordance with the provision in Articles 97-A of the Code of Tax and Customs Procedure and 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the case is €217,063.62.

Costs

Under Article 4, no. 4 of the Regulation of Costs in Tax Arbitration Proceedings and Table I, the value of the arbitration fee to be borne entirely by the TCA is fixed at €4,284.

Lisbon, 14 December 2015

The Collective Arbitral Tribunal

José Pedro Carvalho (president)

I voted on the decision with the attached declaration

José Coutinho Pires

I reviewed the position expressed in case no. 340/2014-T of CAAD, in light of the doctrine derived from the judgment of the Plenary of the Section of Tax Litigation of 16-09-2015.

Daniel Taborda - Rapporteur

Declaration of Vote

Saving the utmost respect due, I fundamentally disagree with what was decided in the Judgment of the Plenary of the Section of Tax Litigation of the SAC, of 16-09-2015, in case no. 1292/14, because it seems to me, in the sense of previous decisions in which I intervened, that it empties the provision of Article 43/1 of the CIT Code.

In fact, I have no doubts – nor has the arbitral jurisprudence dissonant from that in which I intervened[1] – regarding the continuous character of the taxable event relating to the taxation of capital gains in PIT, which is a completely different fact from what occurs, for example, in autonomous taxations arising from the realization of certain expenses, and the argument – the only one – on which the fixed jurisprudence rests, resulting from the rule of no. 3 of Article 10, does not seem to me to have the scope given by that jurisprudence, insofar as, from my point of view, it will be, solely, a rule relating to the periodization of tax years, having the same nature, for example, as the rules of Articles 7/1 and 24/4 of the PIT Code, to remain by that Code.

The jurisprudence of the SAC, furthermore, leaves without answer – and no convincing one is foreseen – the question of knowing, in light of what was decided by that Supreme Court, what happens – in the context of taxation of PIT for the year 2010 – to losses resulting from the sale of equity stakes held for less than 12 months[2] suffered before the entry into force of Law no. 15/2010, of 26 July. Do they contribute to the annual balance to which Article 43/1 of the PIT Code alludes? Or not? Will losses – which are not, evidently, subject to taxation – also be an instantaneous taxable event?

On the other hand, the fixed jurisprudence does not address, also, the question of capital gains subject to aggregation (in accordance with Articles 22/3/b) and 72/4 of the PIT Code), taking into account that the option for this only occurs at the end of the year/period[3], nor, either, the expiration of the right to assess PIT on capital gains, in light, equally, of that possibility of aggregation.

Besides these, various other questions of systemic and dogmatic coherence remain without answer, such as knowing what the justification is for a capital gain, being an instantaneous fact, not being taxed, or being less taxed, as a function of the occurrence of a subsequent loss, as well as knowing what the justification is for the relevance of this (subsequent loss) being circumscribed to its occurrence in the same calendar year.

It also seems to me to be unconstitutional, in the first place for violation of the principle of equality, the discrimination between income from capital gains and labour income, arising from the jurisprudence established by the SAC, combined with the jurisprudence of the Constitutional Court. In fact, according to the latter – in the terms analysed in the various decisions on the matter – labour income, although arising from objectively instantaneous facts – such as earning a salary or the payment of a service – is taxed in PIT in light of the law in force on 31 December, while the balance resulting from gains and losses, in accordance with the jurisprudence of the Plenary of the SAC, does not. Saving better judgment, one continues not to discern (also) material ground for such inequality.

Nevertheless, and given the provision in Article 25/2 of the LRAT, one recognises the futility of an arbitral decision dissonant with the Jurisprudence – although unjust – fixed by the Plenary of the SAC.

The arbitrator president,

(José Pedro Carvalho)

[1] See, for example, the decision of the arbitral case 135/2013-T.

[2] Being that the PIT Code does not define losses, unlike what it does with capital gains, those must be understood as losses arising from operations which, generating gains, would constitute capital gains. In light of this understanding – and saving better study no better alternative is discerned – not constituting, until 2010 and in light of Article 10 of the PIT Code, the gains arising from the sale of equity stakes held for less than 12 months capital gains, the losses arising from identical operations should not, saving better opinion, be considered losses.

[3] In fact, and saving better opinion, the declaration of the capital gain relevant for taxation in PIT as an instantaneous fact, operated by the SAC, saving better opinion, conditions the nature (instantaneous or continuous) of the taxable event to a choice subsequent to its occurrence, given that, aggregated in the taxable income in PIT, nothing will distinguish (materially or at the level of the legal framework applicable) the income resulting from the capital gain, from a provision of an isolated service, or from a single rent or salary earned in the year...