Process: 42/2017-T

Date: June 27, 2017

Tax Type: IRS

Source: Original CAAD Decision

Summary

This CAAD arbitration case (Process 42/2017-T) addresses the scope of deductible expenses under Article 41 of the Portuguese Personal Income Tax Code (CIRS) for Category F rental income. The dispute centers on whether property maintenance and conservation expenses must be proportionally allocated based on actual rental days or fully deducted regardless of occupancy periods. The applicant, a non-resident individual operating rental property activity, challenged additional IRS assessments for 2012-2014. The property was rented for only 66, 95, and 121 days respectively in those years. The Tax Authority applied a proportionality coefficient, limiting deductions to periods when the property was actually leased, arguing that expenses should correspond to the income-generating period. The applicant contested this on multiple grounds: lack of proper reasoning in the Tax Inspection Report, post hoc reasoning in the Gracious Complaint dismissal, and legal error in interpreting Article 41 CIRS. The applicant argued that Article 41 allows deduction of all maintenance and conservation expenses with direct causality to the property's income-producing capacity, regardless of occupancy rates. The Tax Authority defended its proportional method, invoking constitutional principles of equality (Article 13 CRP) and tax capacity (Article 104 CRP), arguing that full deductions for minimally-rented properties would discriminate against year-round landlords. The case raises fundamental questions about interpreting maintenance and conservation expenses: whether these concepts should be understood strictly (tied to actual rental periods) or broadly (encompassing all expenses maintaining rental capacity). This interpretation significantly impacts how non-resident landlords and occasional rental operators calculate taxable Category F income.

Full Decision

ARBITRAL DECISION

The request for constitution of the arbitral tribunal was accepted by the Illustrious President of CAAD and notified to the Tax and Customs Authority on 20-01-2017. Under the terms set forth in subsection (a) of paragraph 2 of article 6 and subsection (b) of paragraph 1 of article 11 of Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012, of 31 December, the Deontological Council appointed the undersigned as arbitrator of the single arbitral tribunal, who communicated acceptance of the appointment within the applicable period, and notified the parties of this appointment on 06-03-2017. Thus, in accordance with the provisions set forth in subsection (c) of paragraph 1 of article 11 of Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012, of 31 December, the arbitral tribunal was constituted on 22-03-2017, followed by the regular procedure.

I – REPORT

1- On 13-01-2017, the company "A…", NIPC…, filed a request for constitution of a single arbitral tribunal, under the terms of the combined provisions of articles 2 and 10 of Decree-Law no. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as LFATM), with the Tax and Customs Authority as the Respondent.

2- Seeking the declaration of illegality of the tax acts relating to additional assessments of Corporate Income Tax ("CIT") for the years 2012, 2013 and 2014, as well as the declaration of illegality of the act dismissing the Gracious Complaint that it presented with a view to the declaration of illegality and annulment of the said tax assessments.

3- The Applicant specifically invokes:

- Existence of lack of reasoning in the Tax Inspection Report.

- Existence of post hoc reasoning in the Dismissal of the Gracious Complaint.

- Existence of error of law in the corrections made, and consequently, in the assessments issued, that is, a defect of violation of law, in particular article 41 of the Personal Income Tax Code, in the wording at the time of the facts.

Indeed, according to the Applicant:

4- In accordance with the wording of article 41 of the Personal Income Tax Code, "from the gross income referred to in article 8, maintenance and conservation expenses (...) are deducted". Nevertheless, such indeterminate concepts should not be interpreted in the sense of treating them as a factor of rigidity capable of questioning the rationality that should characterize the income of Category F of Personal Income Tax.

5- The expenses recorded in the years referred to are of direct causality with respect to the real property, in the economic sense thereof, that is, that of producing income, and the same, logically and necessarily, should be considered as maintenance and/or conservation and should, as such, be deductible under article 41 of the Personal Income Tax Code.

In turn, the Authority…

6- It alleges that the assessments in question embody a correct interpretation and application of law to the facts, are duly reasoned, do not suffer from a defect of violation of law, and in consequence, the claim made should be judged unfounded and it should be absolved from the request.

7- In its view, in summary, the Authority argues:

Since, for the purposes of taxation under Category F of the Personal Income Tax Code, account is taken of the net income obtained, i.e., the rent received less the expenses and charges incurred to produce the rental real property income included and to maintain intact the respective income-producing source, that is, the properties subject to lease, such expenses should appear to be proportionally considered on the basis of the number of months of lease.

8- Moreover, any other interpretation, other than the aforementioned, would plainly violate Constitutional provisions, namely the principle of equality (article 13 of the Constitution of the Portuguese Republic) and also that of tax capacity (article 104 of the Constitution of the Portuguese Republic), by discriminating against those who lease a property for just a few days, deducting all and any expenses provided for in article 41 without any limit, from those who, using the property for lease constantly and throughout the entire tax year, find themselves in the contingency of being placed on the same level of tax capacity (which is not at all equal) as those others.

9- The proceedings do not suffer from nullities.

10- There is no obstacle to consideration of the merits of the case.

II - MATTER OF FACT

1- The Applicant is a non-resident individual, without a permanent establishment, recording the activity of "Lease of real property" with a scheme for determination of taxable profit in Corporate Income Tax.

2- The Applicant is the owner of a real property (dwelling) intended for housing located in …, …, registered in the urban property registry of …, Loulé, under article …, unit A.

3- In the years 2012, 2013 and 2014, under analysis, the property was made available for paid use by third parties, for 66, 95 and 121 days, respectively.

4- The Applicant filed a Gracious Complaint concerning the years 2012, 2013 and 2014, aiming at the correction of the tax acts relating to additional assessments of Corporate Income Tax, which had occurred in the meantime, having requested the reimbursement of the tax paid in the amount of € 5,588.57 and the amount of € 307.02 of compensatory interest, plus indemnificatory interest.

5- On 17 October 2016, the Applicant was notified of the final decision dismissing the said Gracious Complaint, considering for the deduction only the amount of € 573.80 of the total expenses presented.

Validating the terms of the Inspection Report, it was concluded that the Applicant should have applied a coefficient of proportionality to the deductible expenses under article 41 of the Personal Income Tax Code, on the basis of the number of days the property was leased.

6- Expenses were made (and proven) relating to the property, set out in the Inspection Report, although part relating to the period when the property was not occupied.

Facts Deemed Proven

All those referred to above.

Facts Deemed Not Proven

There is no proof (or even direct allegation) that the property was used for the benefit of the owner, of another person/entity other than the contractor, or for other purposes, during the reference period of taxation in the present proceedings.

Reasoning for the Matter of Fact Proven and Not Proven

With respect to the matter of fact, the Tribunal need not pronounce on everything alleged by the parties, but rather has the duty to select the facts that matter for the decision and to distinguish the proven from the unproven matter (see article 123, paragraph 2, of the Code of Tax Procedure and Process and article 607, paragraph 3, of the Code of Civil Procedure, applicable by virtue of article 29, paragraph 1, subsections (a) and (e), of the Legal Framework for Arbitration in Tax Matters).

In this way, the facts pertinent to the judgment of the case are selected and delimited according to their legal relevance, which is established in light of the various plausible solutions of the question(s) of law (see previous article 511, paragraph 1, of the Code of Civil Procedure, corresponding to the current article 596, applicable by virtue of article 29, paragraph 1, subsection (e), of the Legal Framework for Arbitration in Tax Matters).

It is true that the Respondent contests in a global and abstract manner all the facts that are in opposition to the present defense, considered as a whole, under the terms set forth in article 574, paragraph 2, of the Code of Civil Procedure, by virtue of article 1 of the Code of Tax Procedure and Process.

However, given that there is no minimum concretization, specific contradiction, or minimum demonstration that sustains such challenge, the veracity of the elements presented is not questioned, nor are other elements that support the consideration as proven of the factuality referred to in paragraph 6 of the proven facts.

Thus, taking into consideration the positions assumed by the parties, in light of article 110, paragraph 7, of the Code of Tax Procedure and Process, and the documentary evidence attached to the file, the facts listed above were considered proven, with relevance to the decision.

III - ON THE LAW

The central controversial point in the present arbitral action points to the question of whether expenses relating to real properties that are sources of income should be declared, recorded and accepted as such, for the purposes of the provision of article 41 of the Personal Income Tax Code and its consequences.

It makes sense, as the Authority criticizes, that those relating to conservation and maintenance of the property, condominium expenses, taxes and municipal fees for real property, which generated income for only a few months, be associated and considered as annual expenses or should account be taken of the "occupancy coefficient" in their respective recording?

This question has already received careful treatment in this CAAD, as is shown in the case law, resulting, as far as we know, in unanimous understanding.

As we agree with it, we transcribe, with due deference, extracts from decisions that ground and clarify it:

Case no. 201/2015-T

"the income (gross) earned in each year constitute the positive elements that contribute to determining the annual taxable income, and there must also be considered the negative elements of the same period, which are deductions and abatements. It must thus be concluded that the general rule of Personal Income Tax affirms that the tax has an annual nature and it is in relation to each calendar year that the elements must be considered that allow for determining the incidence, namely gross income, deductions and abatements".

"It does not appear that this article 41 [of the Personal Income Tax Code], or any other, can lead to a regime of exception in relation to the aforementioned general rule of the annual nature of Personal Income Tax. Indeed, this provision does nothing more than state the general rule: from the gross income the maintenance and conservation expenses (...) are deducted. Of course, nothing is said as to the period to be considered, as this was already established in article 1; it is the annual period".

"There can thus be no doubt that there is no need to make any other temporal correspondence between the gross income and the expenses to be deducted. There is only the need to ensure that the deductions concern the calendar year in which the rental real property income was received or made available".

Case no. 294/2015-T:

"With respect to the reduction of expenses and charges through the application of an "occupancy coefficient", such procedure cannot be accepted, since all expenses incurred, such as cleaning of the dwellings and the swimming pool and their respective sanitation treatment, water, electricity, insurance, IMI and others, will always have to be borne, regardless of the occupancy rate".

"Such "occupancy coefficient", as was referred to, a "sui generis" basis which apparently had not until now been used by Inspection, has, in the view of this tribunal, no legal basis".

Case 434/2016-T

(...) With respect to the deductibility of such expenses as a function of an "occupancy coefficient" (maximum, the proportional reduction thereof based on the number of days of lease), there is nothing in the law that permits the conclusion that such reduction can occur; quite the contrary: knowing, as has been said, that these are (necessary) expenses of a fixed character (i.e., expenses whose incurrence and corresponding amount do not depend on actual occupancy of the property) – and that, if they were not incurred, would inevitably imply loss of income for their owner...

In the same sense, see, e.g.: "With respect to the reduction of expenses and charges through application of an "occupancy coefficient", such procedure cannot be accepted, since all expenses incurred, such as cleaning of the dwellings and the swimming pool, and their respective sanitation treatment, water, electricity, insurance, IMI and others, will always have to be borne, regardless of the occupancy rate(...).

In the case, the cost-benefit relationship shows, it is true, an apparent imbalance in terms of economic rationality. Nevertheless, we do not find in the proceedings sufficient reasons or pertinent arguments, (whether factual or legal) that permit us to conclude for the exclusion of any of the expenses presented.

WHEREFORE PROCEEDS, thus, the request for arbitral pronouncement in this part, as to the illegality of the assessments.

5- It is important to note, because invoked in the Authority's response, that we cannot see how the understanding propounded could be in breach of the constitutional principles of equality and tax capacity (articles 13 and 104 of the Constitution of the Portuguese Republic).

We do not notice, in fact, any violation of constitutional precepts and principles, in particular the latter which, rather, at least in one of its aspects, appears to be at issue if we were to proceed with the understanding defended by the Authority.

Concluding…

In light of the sense of consolidated case law, transcribed above, to which we adhere in its entirety, as it is important to contribute to a uniform interpretation and application of law (article 8, paragraph 3, of the Civil Code), it is imperative to conclude that there is no legal basis for the fact that with respect to expenses actually borne and paid in the year by the taxpayer in relation to properties that are sources of income, only those corresponding to the period in which the property was leased or used should be declared, recorded and accepted, in particular those relating to conservation and maintenance of the property, condominium expenses, taxes and municipal fees.

For that reason, the disputed assessments suffer from a defect of error as to the assumptions of law, requiring their annulment.

The other issues raised by the Applicant are, to that extent, moot.

As for the request for indemnificatory interest formulated by the Applicant, article 43, paragraph 1, of the General Tax Law establishes that indemnificatory interest is due when it is determined that there was an error attributable to the services from which results payment of the tax debt in an amount greater than that legally due.

In this case, the error affecting the assessment is attributable to the Tax and Customs Authority, which performed the assessment act on its own initiative.

Indeed, the Tax Administration is generically obliged to act in accordance with the law (articles 266, paragraph 1, of the Constitution of the Portuguese Republic and article 55 of the General Tax Law), so that, regardless of proof of fault of any of the persons or entities that comprise it, any illegality not resulting from an action of the taxpayer will be attributable to the fault of the services themselves.

The Applicant thus has the right to be reimbursed of the amount paid (under the terms set forth in articles 100 of the General Tax Law and article 24, paragraph 1, of the Legal Framework for Arbitration in Tax Matters) and also to be indemnified for the improper payment through the payment of indemnificatory interest by the Respondent, from the date of payment of the amount, until reimbursement, at the legal supplementary rate, under the terms of articles 43, paragraphs 1 and 4, and article 35, paragraph 10, of the General Tax Law, article 559 of the Civil Code and Ordinance no. 291/2003, of 8 April.

DECISION

Therefore, it is decided in this Arbitral Tribunal to judge the arbitral request filed as founded and, in consequence:

a- Not to consider the request for declaration of unconstitutionality invoked by the Respondent;

b- To declare the annulment of the decision dismissing the Gracious Complaint and the tax acts relating to additional assessments of Corporate Income Tax for 2012, 2013 and 2014;

c- To determine the reimbursement of the improperly paid tax and compensatory interest;

d- To condemn the Authority to the payment of indemnificatory interest due from the date of payment of the tax until the full reimbursement of the amount paid;

e- To condemn the Respondent to the payment of the costs of the proceedings, fixed below.

Value of the Proceedings

The value of the proceedings is fixed at € 5,895.59, under the terms of article 97-A, paragraph 1, subsection (a), of the Code of Tax Procedure and Process, applicable by virtue of subsections (a) and (b) of paragraph 1 of article 29 of the Legal Framework for Arbitration in Tax Matters and paragraph 2 of article 3 of the Regulation of Costs in Proceedings of Tax Arbitration.

Costs

The value of the arbitration fee is fixed at €612.00, under the terms of Table I of the Regulation of Costs in Proceedings of Tax Arbitration, to be paid by the Respondent, since the request was considered completely founded, under the terms of articles 12, paragraph 2, and 22, paragraph 4, both of the Legal Framework for Arbitration in Tax Matters, and article 4, paragraph 4, of the aforesaid Regulation.

Lisbon, 27 June 2017

The Arbitrator,

(Fernando Miranda Ferreira)

Frequently Asked Questions

Automatically Created

What expenses qualify as deductible maintenance and conservation costs under Article 41 of the Portuguese IRS Code for Category F rental income?
Under Article 41 of the CIRS, maintenance and conservation expenses deductible from gross rental income (Category F) include costs directly related to keeping the property in condition to generate rental income. The case reveals a dispute over whether these expenses must be proportionally allocated based on actual rental days. The taxpayer argued that all expenses with direct causality to the property's income-producing capacity should be deductible, while the Tax Authority contended that deductions should be proportional to the period the property was actually leased. The interpretation affects whether expenses incurred during non-rental periods qualify for deduction, with the Authority arguing that proportionality prevents unfair discrimination between occasional and year-round landlords.
Can property-related expenses beyond strict maintenance be deducted from gross rental income under IRS Category F in Portugal?
According to Article 41 CIRS, deductible expenses from Category F gross income are limited to maintenance and conservation expenses. This case illustrates the interpretative challenges of these indeterminate legal concepts. The taxpayer argued these terms should not be interpreted rigidly and should encompass expenses maintaining the property's economic capacity to produce rental income, regardless of actual occupancy. However, the Tax Authority applied a restrictive interpretation, limiting deductions to expenses corresponding to actual rental periods through a proportionality coefficient. The Authority invoked constitutional principles of equality and tax capacity, arguing that only expenses causally connected to actual income-generating periods should be deductible.
What is the procedure for challenging additional IRS tax assessments on rental income through CAAD tax arbitration?
The procedure involves multiple stages as demonstrated in this case. First, the taxpayer filed a Gracious Complaint (Reclamação Graciosa) against the additional IRS assessments, which was dismissed on October 17, 2016. Following this administrative dismissal, the taxpayer filed a request for constitution of a single arbitral tribunal with CAAD on January 13, 2017, under Articles 2 and 10 of Decree-Law 10/2011. The CAAD President accepted the request and notified the Tax Authority on January 20, 2017. The Deontological Council appointed an arbitrator on March 6, 2017, and the arbitral tribunal was formally constituted on March 22, 2017. CAAD arbitration is thus available after exhausting administrative remedies.
How does the Portuguese Tax Authority interpret the scope of deductible expenses for Category F income under Article 41 CIRS?
The Tax Authority adopts a restrictive interpretation based on proportionality principles. It argues that since Category F taxation considers net income (rent received minus expenses to produce that income), deductible expenses should be proportionally allocated based on the number of days the property was actually leased. The Authority invokes constitutional principles of equality (Article 13 CRP) and tax capacity (Article 104 CRP), contending that allowing full deductions for minimally-rented properties would discriminate against taxpayers who lease properties year-round. According to this interpretation, expenses are only deductible to the extent they correspond to periods when the property actually generated rental income, preventing full annual deductions for properties rented only briefly.
What are the grounds for filing a Reclamação Graciosa against additional tax assessments on rental property income in Portugal?
In this case, the taxpayer filed a Gracious Complaint based on several grounds: (1) lack of proper reasoning in the Tax Inspection Report supporting the additional assessments; (2) alleged legal error in applying Article 41 CIRS regarding interpretation of deductible maintenance and conservation expenses; (3) incorrect application of proportionality coefficients to limit expense deductions based on rental days; and (4) post hoc reasoning in the dismissal decision. The taxpayer sought correction of additional IRS assessments for 2012-2014 and reimbursement of €5,588.57 in tax plus €307.02 in compensatory interest and indemnificatory interest. These grounds reflect typical challenges: procedural defects, substantive legal errors, and incorrect calculation methodologies.