Process: 434/2017-T

Date: May 17, 2018

Tax Type: IRS

Source: Original CAAD Decision

Summary

This CAAD arbitral decision (Process 434/2017-T) addresses the Portuguese Tax Authority's unilateral reclassification of a taxpayer from organized accounting to the simplified regime for IRS Category B income without prior notification. The taxpayer had originally opted for organized accounting in 2000 and never changed this election. However, when filing the 2014 IRS return, the taxpayer discovered the Tax Authority had automatically reclassified them to the simplified regime based on the 2013 return, with effects from 2014-2016. The Tax Authority argued the arbitral tribunal lacked jurisdiction, claiming the challenge concerned a classification act rather than a tax assessment. The tribunal rejected this objection, affirming its competence under Article 2(1) of RJAT to review tax assessment acts. The decision emphasizes the principle of unitary challenge under Article 54 of the Tax Procedural Code, noting that the automatic classification was never communicated to the taxpayer, who only discovered it when attempting to file their return. The ruling establishes that CAAD tribunals have jurisdiction over IRS assessments resulting from regime classification, even when the underlying dispute involves the classification itself. This decision protects taxpayers' rights by ensuring automatic regime changes by the Tax Authority can be challenged through arbitration when they result in concrete tax assessments, preventing the Tax Authority from insulating classification decisions from review.

Full Decision

ARBITRAL DECISION

The arbitrator João Taborda da Gama, designated by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 20-09-2017, decides as follows:

Report

A…, Tax Identification Number …, resident at Rua …, …, …-… Porto, (hereinafter referred to as "Claimant"), filed a request for constitution of an arbitral tribunal, pursuant to the combined 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 RJAT), in which the TAX AND CUSTOMS AUTHORITY (hereinafter referred to as "TA") is the Respondent.

The Claimant requests the declaration of illegality of the rejection order of 20-04-2017, issued by the Deputy Director of the Finance Directorate of Porto, in review request No. …2016… regarding the classification within the organized accounting scheme for Personal Income Tax (IRS), for the year 2014, and the consequent annulment of the tax assessment act No. 2015…, of 29-07-2015.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 18-07-2017. Pursuant to the provisions of paragraph a) of Article 6, subsection 2, and paragraph b) of Article 11, subsection 1, of the RJAT, as amended by Article 228 of Law No. 66-B/2012, of 31 December, the Deontological Council designated as arbitrator of the arbitral tribunal the undersigned, who communicated acceptance of the appointment within the applicable deadline.

On 05-09-2017, the parties were duly notified of this designation and did not express the will to refuse the arbitrator's designation, pursuant to the combined provisions of Article 11, subsection 1, paragraphs a) and b) of the RJAT and Articles 6 and 7 of the Deontological Code.

Thus, in compliance with the provision contained in paragraph c) of Article 11, subsection 1, of the RJAT, as amended by Article 228 of Law No. 66-B/2012, of 31 December, the arbitral tribunal was constituted on 20-09-2017.

By order of 08-01-2018, a hearing was dispensed with and it was decided that the case should proceed with written submissions.

The parties did not submit any submissions.

The arbitral tribunal was duly constituted (Articles 2, subsection 1, paragraph a), and 10, subsection 1, of Decree-Law No. 10/2011, of 20 January), and is competent.

The parties have legal personality and capacity, are legitimate, and are duly represented (Articles 4 and 10, subsection 2, of the same instrument and Article 1 of Ordinance No. 112-A/2011, of 22 March).

The case is free of nullities.

Objections

The TA raises the issue of absolute incompetence of the Arbitral Tribunal as to subject matter jurisdiction. According to the TA, what is in question is the assessment of an act of classification of the taxpayer within a form of determination of taxable income, an act that does not constitute acts susceptible to being assessed in arbitral proceedings.

The Claimant petitioned for the annulment of the rejection order of its review request and the "consequent annulment of the tax assessment act No. 2015… which gave rise to the amount to be paid of €2,847.78, issued on 2015.07.29" and, at the end of its pleadings "the assessment of Personal Income Tax for 2014 No. 2015… should be considered illegal."

According to Article 2, subsection 1, of the RJAT, among the claims whose assessment falls within the competence of arbitral tribunals is "declaration of illegality of acts of tax assessment," precisely what the Claimant petitions and which constitutes the subject matter of the present case, therefore making the Tribunal's competence evident.

The TA's thesis – that what is at issue here is the act of classification within the simplified scheme, an act outside the competence of arbitral tribunals – is unrelated to the fact that the Claimant has defined the subject matter of the case by reference to a Personal Income Tax assessment act and ignores the principle of unitary challenge (Article 54 of the Tax Procedural Code). However, it is a procedural construction whose artificiality is all the more apparent insofar as the tax classification act which would, in the TA's view, be the subject matter of the case was an automatic act, not communicated to the taxpayer, and whose effects – and not even the reasoning – the taxpayer only became aware of when he attempted to submit his Personal Income Tax return.

Given that this is a request for assessment of a claim for declaration of illegality of a Personal Income Tax assessment act, the Tribunal is competent.

The same issue was decided in cases No. 530/2017-T, of 28-03-2018; No. 295/2017-T, of 27-10-2017; and No. 114/2017-T, of 20-09-2017.

Findings of Fact

3.1 Proven Facts

Based on the elements contained in the case file and the administrative proceedings annexed to the case, the following facts are considered proven:

The Claimant submitted on 12.01.2000 a declaration of changes of activity in which it opted for the organized accounting scheme for the taxation of Category B income.

After this date, the Claimant did not exercise any further option regarding the form of determination of Category B income.

On 13-05-2015, it submitted its Personal Income Tax return model 3 for income in 2014, determining its Category B income through organized accounting.

On 21.05.2015, it was notified of an "incompatibility between the annex and the option on file."

On a date that could not be ascertained, but based on the income return for the year 2013, the TA had unilaterally altered the form of determination of the Claimant's Category B income, reclassifying it under the simplified taxation scheme, attributing to this new classification effects for the period between 01-01-2014 and 31-12-2016.

The alteration of the form of taxation and the resulting classification on file were not communicated to the Claimant.

Due to the incompatibility referred to above, the Claimant submitted on 28-07-2015 a new Personal Income Tax return model 3, determining the classification of its income under the simplified scheme.

On 29-07-2015, the Personal Income Tax assessment 2015… was issued, which results from the application of the simplified taxation scheme to the Claimant's Category B income.

The Claimant paid the tax relating to the aforementioned assessment.

The Claimant filed a request for review of the tax assessment act pursuant to Article 78 of the General Tax Law.

The Review Request was entirely rejected on 20-04-2017.

Unproven Facts

There are no facts relevant to the determination of the case that should be considered unproven.

Basis for the Findings of Fact

The proven facts are based on the examination of documents annexed to the case and the administrative proceedings.

Matters of Law

Scheme for Determination of Income for 2014

The question to be assessed is whether the Claimant's Category B income for the year 2014 should be determined in accordance with the simplified scheme – as the TA contends – or in accordance with the organized accounting scheme – as the taxpayer contends.

In 2014, the Personal Income Tax Code established the following:

"Article 28

Forms of Determination of Business and Professional Income

1 – The determination of business and professional income, except in the case of allocation provided for in Article 20, is made:

a) On the basis of the application of the rules arising from the simplified scheme;

b) On the basis of accounting.

2 – Taxpayers who, in the exercise of their activity, have not exceeded in the immediately preceding taxable period an annual net amount of income of this category of €200,000, are covered by the simplified scheme. (As amended by Law No. 83-C/2013 - 31/12)

3 – Taxpayers covered by the simplified scheme may opt for the determination of income on the basis of accounting. (As amended by Decree-Law 211/2005-07/12)

4 – The option referred to in the preceding paragraph shall be made by taxpayers: (As amended by Law 53-A/2006-29/12)

a) In the declaration of commencement of activity;

b) By the end of March of the year in which they intend to alter the form of determination of income, by means of submission of a declaration of changes. (As amended by Law 53-A/2006-29/12)

5 – The minimum period of permanence in any of the schemes referred to in subsection 1 is three years, renewable for equal periods, except if the taxpayer communicates, pursuant to paragraph b) of the preceding number, the alteration of the scheme under which it is covered. (As amended by Law 53-A/2006-29/12)

(...)"

In the present case, it was proven that the Claimant had exercised its option for taxation under the organized accounting scheme in January 2001. The rule that emerges from the transcribed Article 28 is that once a taxpayer has exercised an option for a method of taxation, this must be maintained until the taxpayer exercises a different option, or until the occurrence of a fact to which the law attaches as a consequence the alteration of the taxation scheme.

Since the Claimant did not alter its option made in 2001 for taxation in accordance with the rules of organized accounting, it could only have been classified under the simplified scheme if some fact had occurred for which the law provided this consequence, which also did not occur. Indeed, the fact alleged by the TA – that the taxpayer in the fiscal year 2013 had an annual net amount of Category B income below €200,000 – does not have as a consequence the automatic inclusion of taxpayers in the simplified scheme. The provision of a maximum limit for the simplified scheme does mean that taxpayers who exceed that limit are classified under organized accounting in subsequent fiscal years. It is a rule designed to ensure that taxpayers with income above a certain threshold cannot benefit from the relative advantages of the simplified scheme (which contains a presumption of costs and waives intense cooperation duties), partly because these are taxpayers presumably with a larger structure and scale. The fact that a taxpayer who validly exercised in the past its option for the scheme of determination of income based on organized accounting has, in a given fiscal year, income below the maximum threshold to be able, if willing, to be classified under the simplified scheme, does not mean that the TA may revoke the classification option made by the taxpayer itself pursuant to the same Article 28, proceeding to determine its Category B income on the basis of the simplified scheme, a scheme for which it never opted.

As is abundantly stated in legal scholarship, the presumptive characteristics of the simplified scheme remove taxation from its objective of taxing real income, the most perfect expression of contributory capacity, and therefore taxation based on organized accounting should always be privileged, or at least taxpayers should be given the right to opt for it. This was the right that the Claimant exercised in 2001 and which, until the Claimant exercises it differently, or until facts legally provided for occur that remove its effect, must be respected by all assessment acts, on pain of invalidity, as is the case with the one that is the subject matter of the present case. (Among others, J. L. Saldanha Sanches, Manual de Direito Fiscal³, Coimbra, 2007, 328 "we are faced with a system that, if it were not optional, would be unconstitutional for violating the principle of taxation according to real income" and Sérgio Vasques, Manual de Direito Fiscal, Coimbra, 2015, 301 "the taxation of real income may also give way in common cases in which small taxpayers opt for the application of the simplified taxation scheme provided for in the Personal Income Tax Code, suffering estimated taxation that has the relative advantage of dispensing them from organized accounting and various ancillary duties").

The solution we sustain is also that found in superior and arbitral case law.

On this matter, the Supreme Administrative Court affirmed that "pursuant to the provision of Article 28 of the Personal Income Tax Code, the determination of business income may be made on the basis of the application of the rules arising from the simplified scheme or on the basis of accounting. If permanence in the simplified scheme implies that taxpayers, in the exercise of their activity, have not exceeded in the immediately preceding taxable period an annual net amount of income of this category of €200,000, there is no specific requirement as to the value of income earned for them to be able to opt for the determination of income on the basis of accounting. In the present situation, the appellees, in their 2009 return, opted for taxation based on accounting, having maintained this option since then, as shown by their returns, even when the annual net amount of income was below €200,000. Thus, the Tax Administration could not have substituted itself for the taxpayers in this option, because the minimum period of permanence in the chosen scheme was not exceeded, but, above all, because only taxpayers may opt for a different scheme, except when classified under the simplified scheme they exceed the amount of income previously mentioned for two successive periods – Article 28, subsection 6 of the Personal Income Tax Code. The rule of taxation of business income is based on accounting, which must reflect, according to international accounting rules, business reality. This has been the interpretation given to said provision by various decisions of the Supreme Administrative Court, examples of which are mentioned in the appealed judgment." (Supreme Administrative Court Decision P. 01536/15, of 11-05-2016).

In the same sense as the Supreme Administrative Court, the arbitral tribunals constituted within the scope of CAAD have decided in cases identical to the one decided here (Cases No. 484/2017-T, of 27-03-2018; 114/2017-T, of 20-09-2017; 97/2017-T, of 19-02-2018; 760/2015-T, of 01-03-2015).

For all the foregoing, the Personal Income Tax assessment in question is illegal, since it was based on the determination of taxable income of the taxpayer in violation of the provision of Article 28 of the Personal Income Tax Code.

Compensatory Interest

The Claimant also requests compensatory interest for the overpayment of tax.

Article 43, subsection 1, of the General Tax Law (LGT) establishes that compensatory interest is due when it is determined, in a reclamation procedure or judicial challenge, that there was error attributable to the administration resulting in payment of the tax debt in an amount greater than legally due. According to subsection 5 of Article 24 of the Legal Regime for Tax Arbitration, interest payment is due, regardless of its nature, pursuant to the provisions of the LGT and the Tax Procedural Code. For there to be a right to compensatory interest, it is necessary that the process determine that in the assessment "there was error attributable to the administration," understood as "error concerning the factual or legal prerequisites attributable to the Tax Administration."

In the present case, this requirement is met insofar as it was the TA that unilaterally proceeded to alter the classification of the form of determination of the Claimant's Category B income, reclassifying it under the simplified taxation scheme in violation of applicable law.

Therefore, the Tax and Customs Authority is condemned to reimburse the amounts paid and to pay compensatory interest accruing on said amounts pursuant to Article 43 of the General Tax Law.

Decision

Therefore, this Arbitral Tribunal decides:

  1. To decide the request for arbitral decision is well-founded, with the consequent annulment of the challenged assessment, with all legal consequences, namely the reimbursement to the Claimant of the amounts paid thereunder, relating to the assessment now annulled;

  2. To decide that the request for condemnation of the Respondent for payment to the Claimant of compensatory interest, at the legal rate, counted from the date of payment of the amount until the date of its complete reimbursement, is well-founded.

Case Value

In accordance with the provisions of Article 306, subsection 2, of the Code of Civil Procedure and Article 97-A, subsection 1, paragraph a), of the Tax Procedural Code and Article 3, subsection 2, of the Regulation of Costs in Tax Arbitration Proceedings, the case is assigned a value of €2,847.78 (two thousand, eight hundred and forty-seven euros and seventy-eight cents).

Costs

Pursuant to Article 22, subsection 4, of the RJAT, the amount of costs is fixed at €612.00, pursuant to Table I annexed to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Tax and Customs Authority.

Lisbon, 17 May 2018

The Arbitrator,

(João Taborda da Gama)

Frequently Asked Questions

Automatically Created

What happens when a taxpayer is automatically classified under the IRS simplified regime instead of organized accounting in Portugal?
When a taxpayer is automatically classified under the IRS simplified regime instead of organized accounting, the Tax Authority applies simplified regime rules to calculate Category B income, often resulting in different tax liabilities. According to this CAAD decision, the Tax Authority made this reclassification automatically based on prior year returns without notifying the taxpayer. The taxpayer only discovered the change when attempting to file their return and receiving an incompatibility notice. This automatic reclassification overrode the taxpayer's original election for organized accounting made in 2000, demonstrating that the Tax Authority can unilaterally change regime classifications, though such changes can be challenged through the tax assessment resulting from them.
Can CAAD arbitral tribunals review decisions about taxpayer classification into different tax assessment regimes?
Yes, CAAD arbitral tribunals can review decisions about taxpayer classification into different tax assessment regimes, but indirectly through challenges to the resulting tax assessments. In this decision, the tribunal affirmed its competence under Article 2(1) of RJAT to assess the legality of IRS tax assessment acts, even when the underlying dispute concerns regime classification. The Tax Authority argued the tribunal lacked jurisdiction over classification acts themselves, but the tribunal rejected this objection, applying the principle of unitary challenge from Article 54 of the Tax Procedural Code. The tribunal characterized the Tax Authority's position as an artificial procedural construction, particularly since the classification was automatic and never communicated to the taxpayer. This ruling establishes that regime classification disputes fall within CAAD competence when manifested through concrete tax assessments.
What is the procedure for requesting a review of IRS tax regime classification with the Portuguese Tax Authority?
To request a review of IRS tax regime classification, taxpayers must challenge the tax assessment resulting from the classification through a review request under Article 78 of the General Tax Law (Lei Geral Tributária). In this case, the taxpayer filed such a review request after paying the IRS assessment based on the simplified regime. When the Finance Directorate rejected the review request on April 20, 2017, the taxpayer then filed for CAAD arbitration under Decree-Law 10/2011. The procedure demonstrates a two-step process: first, administrative review with the Tax Authority; second, arbitration following rejection. Taxpayers cannot directly challenge the classification act itself if it was never formally communicated, but must challenge the concrete tax assessment that applies the disputed regime classification, invoking the principle of unitary challenge to address both the assessment and underlying classification simultaneously.
Does the Portuguese Tax Authority have the right to automatically assign taxpayers to the simplified regime for IRS purposes?
The Portuguese Tax Authority has the administrative power to automatically assign taxpayers to the simplified regime for IRS purposes based on criteria in Article 28 of the IRS Code, which establishes that taxpayers not exceeding €200,000 in annual net income are covered by the simplified regime. However, this decision reveals problems with how this power is exercised. The Tax Authority automatically reclassified the taxpayer from organized accounting to the simplified regime based on 2013 return data, with effects for 2014-2016, without communicating this change. While the Tax Authority has this classification power, the decision implies this must be exercised with proper notification to taxpayers. The automatic nature of the classification and lack of communication meant the taxpayer only discovered the change when filing their return and receiving an incompatibility error, raising procedural fairness concerns about unilateral, uncommunicated regime changes.
What are the legal grounds for challenging an IRS tax assessment based on incorrect regime classification in Portugal?
The legal grounds for challenging an IRS tax assessment based on incorrect regime classification include filing a review request under Article 78 of the General Tax Law, followed by arbitration under Article 2(1) of RJAT (Decree-Law 10/2011) for declaration of illegality of tax assessment acts. The taxpayer can invoke the principle of unitary challenge from Article 54 of the Tax Procedural Code, which allows challenging both the tax assessment and the underlying classification act simultaneously in a single proceeding. In this case, the taxpayer argued their original 2000 election for organized accounting remained valid because they never changed it, and the Tax Authority's automatic reclassification was procedurally defective for lack of notification. The challenge encompasses substantive grounds (incorrect application of regime rules) and procedural grounds (failure to notify of classification changes). This decision confirms that taxpayers can use arbitration to challenge assessments even when the Tax Authority characterizes the dispute as concerning only classification.