Process: 489/2017-T

Date: February 1, 2018

Tax Type: IVA

Source: Original CAAD Decision

Summary

CAAD Process 489/2017-T addressed whether a Portuguese municipality could correct VAT deduction errors through a substitute return filed within the 4-year limitation period. Municipality A discovered in 2016 that during 2013, it had unduly limited its VAT deduction rights by only deducting input tax on resources directly allocated to water distribution (fully taxable activity) using the actual allocation method. The municipality failed to deduct VAT on common resources used in both taxable and non-taxable activities (recoverable via pro rata method per Article 20 CIVA) and resources wholly allocated to taxable operations (fully deductible under Article 19 CIVA). The municipality submitted a substitute periodic return for Q4 2013 in February 2016, claiming €39,943.71 VAT credit, arguing that Article 98(2) CIVA permits deduction within 4 years from the right's accrual. The Tax Authority issued an additional assessment, maintaining that Article 22 combined with Article 78 CIVA limits deduction to the period following invoice receipt, with exceptional corrections permitted only for invoice rectifications or material errors within 2 years. The central legal dispute concerned whether correcting a legal error in deduction methodology constitutes a timely exercise of deduction rights under the 4-year limitation (Article 98(2)) or an impermissible late deduction beyond the 2-year regularization window. The arbitral tribunal examined the distinction between initial deduction exercises, regularizations under Articles 23-24 CIVA, and error corrections, considering whether municipalities can recover undeducted input VAT attributable to legal misunderstandings about applicable deduction methods for mixed-use and fully-taxable resources.

Full Decision

ARBITRAL DECISION

I. REPORT

  1. On September 1, 2017, Municipality A…, Tax Identification Number…, with registered office in …, … (hereinafter, Claimant), filed a petition for the constitution of an arbitral tribunal, under the combined provisions of Articles 2, paragraph 1, subparagraph a), and 10, paragraphs 1, subparagraph a), and 2, of Decree-Law No. 10/2011, of January 20, which approved the Legal Framework for Arbitration in Tax Matters, as amended by Article 228 of Law No. 66-B/2012, of December 31 (hereinafter, briefly referred to as LFTAM), seeking:

  • The declaration of illegality and the annulment of the act dismissing the administrative complaint No. …2016…, which was processed by the Finance Bureau of …, which concerned the act of additional VAT assessment No. 2016…;

  • The declaration of illegality and the annulment of the act of additional VAT assessment No. 2016….

The Claimant attached three (3) documents and did not request the production of any other evidence.

The Respondent is the AT – Tax and Customs Authority (hereinafter, Respondent or AT).

1.1. In essence and in brief summary, the Claimant alleged the following (transcription):

"In the course of the year 2013, the Municipality only deducted the tax incurred in the acquisition of certain resources directly related to the distribution of water to residents (activity fully subject to tax of the Municipality) based on the application of the actual allocation method."

"Within the scope of a review of procedures internal to the year 2013, and having regard to the provisions of Articles 19, 20 and 23 of the VAT Code, the Claimant verified that it had unduly limited the exercise of the right to deduct the VAT incurred, having thus borne tax which, in accordance with the rules of the VAT Code, would be recoverable."

"In concrete terms, the Claimant now verified that, during the year 2013, it had unduly limited its right to deduct the VAT incurred in the acquisition of "common" resources (i.e., resources used, simultaneously, in taxable and non-taxable activities – whose VAT is recoverable by the pro rata method or based on objective criteria)."

"In the same sense, the Claimant now also verified that, during the year 2013, it had unduly limited its right to deduct VAT incurred on certain resources wholly allocated to the realization of taxable operations (whose VAT is, therefore, recoverable in full)."

"In this context, and having regard to the provisions of Articles 22 and 98 of the VAT Code, the Claimant made, in the year 2016, the deduction of the VAT incurred in the acquisition of goods and services related to the aforementioned "common" resources, as well as in the acquisition of goods and services directly allocated to taxable operations."

"For this purpose, the Municipality submitted, on February 12, 2016, a replacement periodic return relating to the 4th quarter of 2013, determining a VAT credit in the amount of € 39,943.71 (…)."

"The replacement periodic return (…) was, therefore, submitted within the legal deadline for this purpose, since the return initially delivered for the period in question had been submitted on February 17, 2014 (…)."

"…the non-recognition of the VAT credit, by the Tax Authority, is related only to the deadline and the moment in which the Municipality exercised its right to deduction (…)."

"…Articles 23 and 24 of the VAT Code provide for the moment to carry out the regularization of VAT (e.g. regularization of VAT resulting from the fact that the calculation of the final deduction percentage occurs only at the end of each year) and not for the deduction of the tax."

"Now, in the case under analysis, we are not facing a situation of tax regularization resulting from the calculation of the final deduction percentage, but rather a deduction of VAT not carried out at the moment of registration of the invoice that supports that same right."

"…taxpayers may exercise the right to deduction in any period subsequent to the receipt (and respective accounting) of the invoices, having, naturally, to do so within the deadline provided in paragraph 2 of Article 98 of the VAT Code (i.e. 4 years) (…)."

"…understanding the contrary would not only contradict expressly the letter of the law (that is, paragraph 2 of Article 22 of the VAT Code), but also empty of content paragraph 2 of Article 98 of the VAT Code, which allows the deduction of tax up to the expiration of 4 years after the birth of the right to deduction (that is, in practice, after the date of the invoices, these being issued within the legal deadlines)."

"In this context, the moment to exercise the right to deduction must always attend to the limitation period that results from paragraph 2 of Article 98 of the VAT Code, which determines that the time limit for the exercise of this right is 4 years."

"…there can be no doubt about the possibility of the right to deduction being exercised at a time subsequent to the date of receipt of the invoices, under Article 22 of the VAT Code, always having as a limit the period of 4 years provided for in Article 98 of the same Code."

"In this way, the Claimant proceeded to the deduction of the VAT borne in excess, based on Articles 22 and 98 of the VAT Code."

"…the Municipality A… incurred an error of law, namely in the qualification and framing of its right to deduction."

"Furthermore, compensatory interest is owed by the Tax Authority."

The Claimant concludes its initial pleading by requesting the following (transcription):

"In these terms, and in all other matters of Law which Your Excellency shall duly supply, this Illustrious Arbitral Tribunal should annul the decision dismissing the Administrative Complaint No. …2016…, whose subject is related to the additional VAT assessment No. 2016… and, consequently, condemn the Tax Authority to recognize the VAT credit of € 39,943.71 in favor of the Municipality, as well as to pay compensatory interest owed to Municipality A…."

  1. The petition for the constitution of an arbitral tribunal was accepted and automatically notified to the AT on September 19, 2017.

  2. The Claimant did not appoint an arbitrator, so, under the provisions of paragraph 1 of Article 6 and subparagraph a) of paragraph 1 of Article 11 of the LFTAM, the President of the Deontological Council of CAAD appointed the undersigned as arbitrator of the singular Arbitral Tribunal, who accepted the appointment within the applicable deadline.

  3. On November 3, 2017, the parties were duly notified of this appointment and did not manifest their intention to challenge the appointment of the arbitrator, in accordance with the combined provisions of Article 11, paragraph 1, subparagraphs b) and c), of the LFTAM and Articles 6 and 7 of the Deontological Code of CAAD.

  4. Thus, in accordance with the provisions of subparagraph c) of paragraph 1 of Article 11 of the LFTAM, the singular Arbitral Tribunal was constituted on November 23, 2017.

  5. On January 9, 2018, the Respondent, duly notified for this purpose, presented its Response in which it specifically challenged the arguments put forward by the Claimant and concluded for the inadmissibility of the present action, with its consequent dismissal of the claim.

The Respondent did not attach documents, nor did it request the production of any other evidence.

6.1. In essence and also in brief form, it is important to glean the most relevant arguments on which the Respondent based its Response (transcription):

"…it follows from the combined reading of the norms contained in Articles 22 and 78 of the VAT Code that there is a temporal limitation for the exercise of the right to deduction, which should be exercised in the return of the period following that in which receipt of the invoices took place, exceptionally being admitted the deduction at a later moment, namely in case of invoice rectification or to correct material or calculation errors, but always within the limit of two years."

"However, what results from the case at hand is another reality: the claim that results in the petition for arbitral determination of the Claimant has no support neither in Articles 22 and 23 of the VAT Code, nor in Article No. 78, paragraph 6 of the VAT Code – since we are not facing the correction of material or calculation errors in registration…."

"The same is to say that what is sought by the Claimant, which amounts, briefly, to a retroactive change of the deduction method, has no legal basis whatsoever."

"…the exercise of the right to deduction should be exercised in the period of receipt of the invoices, as follows from the transcribed article, and the choice (or, a fortiori, the change of choice) of a calculation method should be made in accordance with the provisions of Article 23 of the VAT Code."

"After this moment, the law only allows changes to be made in the situations provided for in Article 78 of the VAT Code and, as already mentioned, both Claimant and Respondent agree with the fact that this situation does not fall within this legal provision."

"…the system legally established for the functioning of VAT presupposes the exercise by the taxpayer of a right of option regarding the calculation method of deductible tax;"

"And it is certain that, as determined by Article 23 of the VAT Code, this right of option is not unlimited, there being legally mandatory constraints and, furthermore, the attribution to the Administration of discretionary powers."

"Thus, the exercise of the choice between deduction methods also obeys temporal conditions, which must be made, at the latest, in accordance with the provisions of Article 23, paragraph 6 of the VAT Code, that is, in the return relating to the last period of the year in question, and not, as the Claimant seeks to make believed, at the moment that best suits it, within the alleged limit of four years, as it refers in the petition for arbitral determination."

"…there are special norms, and the exercise of the right to deduction should be exercised in the period of receipt of the invoices, as follows from Article 22 of the VAT Code and the choice (or, a fortiori, the change of choice) of a calculation method should be made in accordance with the provisions of Article 23 of the VAT Code."

"It is required, (…), for the AT to incur the duty to pay compensatory interest, that there be any illegality that denotes the improper character of the tax obligation in light of the substantive norms, illegality that must necessarily be imputable to an error of the services."

"However, the assessment in question does not result from any error of the Services but follows directly from the application of the law."

"The AT merely limited itself, therefore, to applying the legal consequences, which, from the fiscal point of view, were required given the occurrence of the factual requirements underlying the correction made, so that it should also be judged inadmissible the challenge regarding the interest requested."

The Respondent thus concludes its pleading (transcription):

"In these terms, and in all other matters of Law which Your Excellency shall duly supply, the present petition for arbitral determination should be judged inadmissible, as unproven, maintaining in the legal order the tax assessment acts being challenged and, accordingly, absolving the requested entity of the claim."

6.2. On the same date, the Respondent attached to the case file the respective administrative file (hereinafter, briefly referred to as AF).

  1. On January 10, 2018, an order was issued dispensing with the holding of the meeting referred to in Article 18 of the LFTAM, as well as the presentation of arguments, and the date of May 23, 2018, was set as the deadline for the issuance of the arbitral decision.

II. PRELIMINARY MATTERS

The Arbitral Tribunal was regularly constituted and is competent.

The case is not affected by any nullities.

The parties enjoy legal personality and capacity, are duly represented and are properly interested.

There are no exceptions or any prior matters that preclude knowledge of the merits and that need to be addressed.

III. REASONING

III.1. REGARDING FACTS

§1. FACTS ESTABLISHED AS PROVEN

The following facts are considered as proven:

a) The Claimant is a legal entity under public law, whose activity consists in the pursuit of its municipal attributions in the most diverse areas of activity.

b) The Claimant is subject, for VAT purposes, to the normal regime with quarterly periodicity, since January 1, 1986, with the main activity of "Local Administration" – CAE 08413. [cf. AF attached to the case file]

c) In the pursuit of its attributions, the Claimant carries out operations outside the scope of VAT, operations subject to VAT but exempt from this tax, which do not grant the right to deduction of the tax and also operations subject to and not exempt from VAT.

d) In the course of the year 2013, the Claimant only deducted the VAT incurred in the acquisition of certain resources directly related to the distribution of water to residents – activity fully subject to tax of the Municipality – based on the application of the actual allocation method.

e) In the scope of an internal review of the year 2013, the Claimant verified that, during that same year, it had limited its right to deduct the VAT incurred in the acquisition of common resources, that is, resources used, simultaneously, in taxable and non-taxable activities, having, in this context, determined additional VAT to be deducted by the pro rata method in the amount of € 20,328.57.

f) The Claimant also verified that, during the year 2013, it had limited its right to deduct the VAT incurred on certain resources wholly allocated to the realization of taxable operations, having, in this context, determined additional VAT to be deducted by the actual allocation method in the amount of € 20,074.22.

g) In that sequence, on February 12, 2016, the Claimant submitted a replacement periodic return relating to the 4th quarter of 2013, determining a VAT credit in the amount of € 39,943.71, resulting from the sum of the following items [cf. document No. 1 attached to the Initial Pleading and AF attached to the case file]:

  • Field 20 of the PR, relating to VAT borne on acquisitions of Fixed Assets (Tangible Fixed Assets), where the amount of € 17,271.48 increased;

  • Field 24 of the PR, relating to VAT borne with acquisition of Other Goods and Services, in which the total amount of € 2,802.74 increased;

  • Field 40 of the PR, relating to VAT regularizations in favor of the Taxpayer, where the value of € 20,328.57 increased;

  • Field 41 of the PR, relating to VAT regularizations in favor of the State, where the value of € 10,634.36 decreased; and

  • Field 61 of the PR, relating to excess to be carried forward from the previous period, where it withdrew the amount of € 3,555.74.

h) Under the Service Orders Nos. OI2015…, OI2015…, OI2014…, OI2015… and OI2015…, the Claimant was subject to tax inspection procedures, focusing on VAT relating, respectively, to the fiscal years 2011, 2012, 2013, 2014 and first quarter of 2015. [cf. AF attached to the case file]

i) From those inspection procedures resulted the following corrections in the area of VAT, in the total value of € 95,484.08 [cf. AF attached to the case file]:

Years | VAT Corrections
2011 | € 12,259.07
2012 | € 24,627.16
2013 | € 15,030.01
2014 | € 39,614.44
2015 | € 3,953.40

j) The aforementioned VAT corrections concern the following items of the Claimant's accounting records [cf. AF attached to the case file]:

Corrected Items | VAT Values Corrected
VAT assessed and not remitted to the State | € 18,282.06
Improper VAT deductions (arts. 19 to 21 VAT Code) | € 3,079.48
Deduction of VAT not borne | € 1,360.03
Improper Deduction - Civil Construction Services | € 33,311.66
Acquisition of electricity | € 2,345.61
VAT borne activities exempt or resulting from powers of authority | € 11,503.89
Water self-consumption | € 25,601.35

k) Following the aforementioned corrections, an additional VAT assessment No. 2016…, relating to the period 201312T, was issued on January 12, 2016, notified to the Claimant and received by it on February 10, 2016. [cf. AF attached to the case file]

l) On May 16, 2016, the Claimant submitted a petition to the Finance Bureau of … – which is hereby deemed to be entirely reproduced [cf. document No. 2 attached to the Initial Pleading] – in order to obtain confirmation of the value of the credit existing in its favor as a result of the submission of the aforementioned replacement return for the last quarter of 2013, as well as to request clarification on when the said amount of € 39,943.71 could be used as compensation for future payments.

m) The aforementioned petition was converted into an administrative complaint, which was registered under case No. …2016… at the Finance Bureau of …, forwarded to the Finance Bureau Directorate of … and, once the case was processed, the respective Draft Decision was drawn up, which was notified to the Claimant, by letter dated April 26, 2017, from the Finance Bureau Directorate of …, for the purpose of exercising, if it so wishes, the right of participation in the form of prior hearing. [cf. AF attached to the case file]

n) The Claimant did not exercise the hearing right. [cf. AF attached to the case file]

o) By order of May 26, 2017, of the Head of Division of the Finance Bureau Directorate of …, by delegation, the aforementioned administrative complaint was dismissed, in the terms and with the grounds proposed in the Information dated April 24, 2017, which is contained in document No. 3 attached to the Initial Pleading and AF attached to the case file and which is hereby deemed to be entirely reproduced, the following segments being important to highlight that are transcribed [cf. document No. 3 attached to the Initial Pleading and AF attached to the case file]:

"5. Of the Law Applicable to the Procedure

5.1. From the content of the petition that gave rise to the present procedure, as well as from the content of the replacement return for the fourth quarter of 2013, which the claimant submitted on 2016-02-12, and also from the question which it submitted on the Finance Portal on 2016-03-15, it is extracted that, although it has not contested the corrections determined, in the area of VAT, by the Tax Inspection, which it considered correct (with the exception of those relating to "water self-consumption"), intends, as regards the fourth quarter of 2013 of VAT, to see attended to the right to deduction of the total value of € 39,943.71, supporting the claim in "internal review of procedures", as regards the criteria for VAT deduction, for that year, because it is a partial or mixed taxpayer (carrying out, simultaneously, operations included within the scope of its powers of authority – excluded from VAT liability – as well as operations outside those powers – subject to VAT, being, some of which, exempt from tax);

5.2. As previously seen, as regards the method of VAT deduction, the claimant informed the Tax Inspector that it uses(d) the system of actual allocation, as an alternative to the method of the deduction percentage (or pro rata), both provided for in Art. 23 of the VAT Code;

5.3. It now comes to allege, in the administrative complaint petition, that it carried out an internal review of procedures for the year 2013, regarding the method of VAT deduction, which gave rise to the claim for VAT credit of € 39,943.71;

5.4. However, it follows expressly from the VAT Code that the regularizations relating to corrections or changes in the pro rata calculation must be made in accordance with the provisions of Art. 23, paragraph 6 of the VAT Code, and such corrections/changes are not susceptible to being framed in Art. 78, paragraph 6 of the same VAT Code;

5.5. In fact, paragraph 6 of Art. 23 of the VAT Code ("Methods of deduction relating to goods of mixed use") provides: "The deduction percentage referred to in subparagraph b) of paragraph 1, calculated provisionally on the basis of the amount of operations carried out in the previous year, as well as the deduction made in accordance with paragraph 2, calculated provisionally on the basis of the objective criteria initially used for application of the actual allocation method, are corrected in accordance with the final values relating to the year to which they relate, giving rise to the corresponding regularization of the deductions made, which must be included in the return of the last period of the year to which it relates.";

5.6. Similarly, and as regards the regularizations to be carried out by partial or mixed taxpayers, regarding the deductible tax from the acquisition of fixed asset goods (tangible fixed assets, in accordance with the Accounting Standardization System [ASS]), Art. 24 of the VAT Code provides, in its paragraph 8: "The regularizations provided for in the previous paragraphs must be included in the return of the last period of the year to which it relates.";

5.7. Given the existence of a rule that specifically prescribes how and when the regularizations relating to VAT deduction methods by taxpayers carrying out operations that give rise to the right to deduction and operations that do not give rise to this right should be made, the application of any other rule is ruled out, namely paragraph 6 of Art. 78 of the VAT Code (implicitly invoked by the claimant, when mentioning, in point 8 of its petition, the replacement of the periodic return within the period of 2 years), which, unlike the grounds invoked by Municipality A…, concerns the correction of material or calculation errors and not corrections or changes in the pro rata calculation;

5.8. In this regard, it will be useful to note the heading of the sections of the annex to the replacement PR filled in by the claimant on 2016-02-12, relating to the regularizations of fields 40 and 41 (regularizations covered by Articles 23 to 26 of the VAT Code), which is transcribed here: "other regularizations not covered by Art. 78 and the new regime of Art. 78-A to 78-D";

5.9. Concomitantly, the following is asserted, as regards the matter at hand, by the opinion of the Center for Fiscal and Customs Studies (CFCS) No. 41/2013, of 2013-10-08, authored by Dr. Cidália Lança: "18. It follows from what precedes that there is no legal support that allows authorizing a retroactive change in the calculation method of the initial right to deduction relating to goods and services of mixed use, on the basis of Article 71 [current Art. 78 of the VAT Code], paragraphs 6 and 7 of the VAT Code, in the version in force in 2004, since this choice, as previously demonstrated, can only be made for each acquisition of goods or services at the moment when the right to deduction is constituted under the conditions provided for in paragraph 1 of Article 20, paragraph 1 of Article 22 and in Article 23 of the VAT Code.";

5.10. Next, in the same opinion: "19. Similarly, paragraphs 6 and 7 of Article 71 [current Art. 78 of the VAT Code] do not constitute legal basis for any retroactive correction of the pro rata deduction percentage calculation.";

5.11. Continues, further on, the same opinion: "… the corrections to the pro rata deduction percentage calculation must be made at the end of the year in question and also that they must be reflected in the return relating to the last period of the year in question.";

5.12. And also, in point 20 of the same opinion: "It should also be noted that within the legal framework in force it also results clearly that it is not possible to proceed with retroactive changes in the calculation method of the initial right to deduction of goods and services of common use in exempt and taxable activities, nor to proceed with corrections to the definitive deduction percentage calculation determined in a given year on the basis of Article 78 of the VAT Code, insofar as such corrections do not fall within the provisions contained therein. It should be noted that this matter is adequately clarified in the circular letter No. 30082, of November 17, 2005, from the Office of the Deputy Director-General of VAT.";

5.13. In fact, the circular letter No. 30082, of November 17, 2005, from the Office of the Deputy Director-General of VAT, states as follows, in the part that is relevant to the matter at issue in the present complaint: "IV – Scope of application of Art. 71 [current Art. 78 of the VAT Code]: 8. The regularizations provided for in Art. 71 of the VAT Code are intended to correct, in favor of the taxpayer or in favor of the State, the tax already remitted or already deducted in a given tax period, as a result of various circumstances occurring after the submission of the periodic return and that are not contemplated in other legal norms. In that sense, the mechanisms provided for in Art. 71 may not be used in other situations, namely: - change in the tax deduction method for mixed taxpayers; - pro rata determination; - VAT regularizations on real estate and other fixed asset goods or relating to the allocation of real estate to purposes other than those for which they are intended. These situations should be regularized under Arts. 23, 24, 24-A and 25 of the VAT Code, as appropriate.";

5.14. Further on, the same circular letter proceeds as follows: "9.3 Regularizations provided for in paragraph 6 of Art. 71 (renumbered to Art. 78, in the current wording): This is the correction of material or calculation errors made in the records or in the periodic returns. Material or calculation errors are considered to be those that result from internal errors of the company and have no interference in the sphere of third parties. Normally they consist of errors in the transcription of invoices to the records or from the records to the periodic return, not including those listed in point 8 of this circular letter.";

5.15. Equally, clarifies the Circular Letter No. 30103, of 2008-04-23, from the Office of the Deputy Director-General of VAT, in its point V. (criteria to be used for the purposes of paragraph 2 of Article 23 of the VAT Code), No. 5: "The criteria adopted by the taxpayer at the beginning of each calendar year should be used consistently in that period, and the necessary adjustments can be made at the end of each year.", and the same clarification states, in point VIII. (annual regularizations), No. 1: "Regularizations under paragraph 6 of Article 23 of the VAT Code: Similar to what happens with the use of pro rata, the deduction using actual allocation according to objective criteria is also calculated provisionally, and should be corrected in accordance with the final values as of the end of each year, in the last periodic return of the year to which it relates.";

5.16. We can therefore conclude with certainty, from the content of the applicable legal norms and, in particular, from the excerpts transcribed above, that, given the existence of special rules that regulate the corrections invoked by the claimant – namely Articles 23 and 24 of the VAT Code – the same do not find legal support in the norm invoked by it in the claim – Art. 78, paragraph 6 of the VAT Code – nor do such corrections obtain protection in Art. 98 of the VAT Code (which, in turn, refers to Art. 78, paragraph 1 of the General Tax Code), as there are no "reasons imputable to the services", or even in Art. 131 of the Tax Procedure Code, as we are not facing "error in self-assessment", but rather an alteration of VAT deduction criteria;

5.17. As previously clarified, the omission of deduction of tax borne with common costs does not constitute an error, but rather an option or legitimate practice common among mixed taxpayers, to whom the right belongs, on the basis of the autonomy of action of economic operators (even if they are entities under public law), to choose not to deduct the tax borne with common costs, a right that the Tax Authority cannot put into question, by substituting itself for the taxpayer, but the same Tax Authority cannot, however, agree with a negative repercussion on taxes, on the basis of changes to the management options invoked by the taxpayers, when the fiscal impact of these options collide and/or antagonize legal norms ordering tax law, especially since the performance of the tax administration aims at the pursuit of the public interest, being the same always subordinate to strict compliance with the principle of tax legality;

5.18. In this way, the claim of the claimant, to see recognized the VAT credit of € 39,943.71, by its activity of the fourth quarter of 2013, shows itself to be at odds with the law."

p) The Claimant was notified, by letter dated June 2, 2017, from the Finance Bureau Directorate of …, of the decision dismissing the aforementioned administrative complaint. [cf. document No. 3 attached to the Initial Pleading and AF attached to the case file]

q) On September 1, 2017, the Claimant filed the petition for the constitution of an arbitral tribunal that gave rise to the present case. [cf. management information system of CAAD]

§2. FACTS NOT ESTABLISHED AS PROVEN

With relevance to the appreciation and decision of the case, there are no facts that have not been proven.

§3. MOTIVATION REGARDING FACTS

Regarding the proven facts, the Tribunal's conviction was based on the facts alleged by the parties, whose correspondence with reality was not put in question, on the documents and on the respective administrative file attached to the case.

III.2. REGARDING LAW

§1. ON THE VIOLATION OF ARTICLE 98, PARAGRAPH 2, OF THE VAT CODE: THE ADMISSIBILITY OF THE DISPUTED TAX DEDUCTION

Article 98 of the VAT Code provides for the general regime for official review and exercise of the right to deduct VAT, establishing the following:

1 - When, for reasons imputable to the services, tax has been assessed in an amount higher than that due, official review shall proceed in accordance with Article 78 of the general tax law.

2 - Without prejudice to special provisions, the right to deduct or reimburse the tax delivered in excess may only be exercised up to the expiration of four years following the birth of the right to deduction or payment in excess of the tax, respectively.

3 - No assessment shall be annulled when its value is less than the limit provided for in paragraph 4 of Article 94.

This legal provision thus contains two rulings, namely: in its paragraph 1 it imposes on the Tax Authority the obligation to proceed with official review in the cases provided for therein; and in its paragraph 2 it establishes a general and subsidiary time period for VAT taxpayers to promote, in their favor, the correction of assessed and deducted tax.

Regarding the four-year period provided for in that paragraph 2, it shall only be applicable in the absence of special provisions, which we can find in Article 78 of the VAT Code.

Thus, it is important to note paragraphs 2, 3 and 6 of that Article 78, which read as follows:

2 - If, after the registration referred to in Article 45 has been made, the operation is annulled or its taxable value is reduced as a consequence of invalidity, rescission, cancellation or reduction of the contract, by the return of goods or by the granting of discounts or rebates, the supplier of the goods or service provider may effect the deduction of the corresponding tax up to the end of the tax period following that in which the circumstances that determined the annulment of the assessment or the reduction of its taxable value occur.

3 - In cases of inaccurate invoices that have already given rise to the registration referred to in Article 45, the rectification is mandatory when there is tax assessed at less, and may be made without any penalty up to the end of the period following that to which the invoice to be rectified relates, and is optional when there is tax assessed at more, but may only be made within the period of two years.

6 - The correction of material or calculation errors in the registration referred to in Articles 44 to 51 and 65, in the declarations mentioned in Article 41 and in the guides or declarations mentioned in subparagraphs b) and c) of paragraph 1 of Article 67 is optional when it results in tax in favor of the taxpayer, but may only be made within the period of two years, which, in the case of the exercise of the right to deduction, is counted from the birth of the respective right under paragraph 1 of Article 22, being mandatory when it results in tax in favor of the State.

In light of these legal norms, we can group the situations in which there is the faculty (and, possibly, the obligation) to regularize assessed and deducted VAT as follows (as systematized by Alexandra Martins and Pedro Moreira, "VAT Regularizations - The Subsequent Alteration of the Elements of the Transaction, the Material or Calculation Error and the Error of Classification or Law", in AA. VV., Coordination of Sérgio Vasques, VAT Notebooks 2014, Coimbra, Almedina, 2014, pp. 61-62):

"i) The subsequent alteration of the objective and subjective conditions that presided over the realization of the operations, reflected in the annulment of the operation or in the reduction of its taxable value;

ii) The inaccuracy of the invoice or the material or calculation error in the transcription of its elements into the accounting or periodic VAT returns of the taxpayers;

iii) The error of classification of the operation, reflected in the invoice or in the accounting of the taxpayers."

In the case sub judice, it is important to determine whether the error that the Claimant made in the self-assessments of VAT relating to the year 2013 falls within the second (material or calculation error) or the third of the aforementioned groups of situations, as this classification will determine the solution of the specific case and, therefore, the decision of this process, to the extent that the correction of material or calculation error will correspond to the two-year period provided for in paragraph 6 of Article 78 of the VAT Code and the correction of an error of law will correspond to the four-year period provided for in paragraph 2 of Article 98 of the VAT Code, due to the non-existence of a special norm that encompasses it.

Regarding material or calculation errors, it is important to first note that the Tax Authority, through Circular Letter No. 30082, of November 17, 2005, from the VAT Services Directorate, proceeded to jointly define what it understands by material or calculation errors, considering that these are "those that result from internal errors of the company and have no interference in the sphere of third parties. Normally they consist of errors in the transcription of invoices to the records or from the records to the periodic return, not including" the following situations: "change of the deduction method of tax for mixed taxpayers; determination of pro rata and VAT regularizations on real estate and other fixed asset goods or relating to the allocation of real estate to purposes other than those for which they are intended."

This is not an uncontested matter, particularly in case law, as is well illustrated by the decisions issued by arbitral tribunals constituted under the auspices of CAAD, advocating opposite solutions, to which we shall next allude.

In the arbitral decision issued in case No. 91/2013-T, it was held that, in a situation where a VAT taxpayer had carried out an internal review of its procedures and concluded that it could exercise its right to deduct VAT by the method of actual allocation, that entity had incurred a material error, which could only be corrected through paragraph 6 of Article 78 of the VAT Code and within the two-year period provided for therein, which, in the specific case, had already elapsed.

In the scope of case No. 117/2013-T, an arbitral decision was issued in which the following was held:

"As results from the literal content of that paragraph 6 of Article 78 of the VAT Code, it is applicable only to the 'correction of material or calculation errors', including in periodic returns. (…)

The association of calculation error to material error that is made in this paragraph 6 of Article 78 of the VAT Code, in the same way as happens in other norms (such as Article 249 of the Civil Code, Article 667 of the 1961 Code of Civil Procedure and Article 614 of the 2013 Code of Civil Procedure) reveals that the calculation errors to which it is intended to allude will be of this type, namely arithmetic errors in the calculation operations of the amount to be deducted.

Thus, we will be facing a material error in the filling of the amount of deductible VAT in a return when it was intended to write a certain amount and, by oversight or lapse, ended up writing a different amount or when the error in filling the return results from an earlier error of the same type that exists in the accounting or in some document that serves as the basis for the exercise of the right to deduction. We will be facing a calculation error when the arithmetic operations to determine the amount of deductible VAT were incorrectly performed, either in the return itself or in some of the documents on which it was based."

Given the wording given to paragraph 6 of Article 78 of the VAT Code, we consider that this latter position is the one that appears to be correct, for we also understand that the legislator had in view here, only and exclusively, the lapses in the transposition of the elements of the invoices to the accounting and from there to the periodic returns.

In the same sense, Afonso Arnaldo and Tiago Albuquerque Dias ("After All What is the Deadline for Deducting VAT? Limitation Rules and (In)Legal Certainty", in AA. VV., Coordination of Sérgio Vasques, VAT Notebooks 2014, Coimbra, Almedina, 2014, p. 44) state that "the errors referred to in number 6 of Article 78 of the VAT Code are reduced to situations where the taxpayer errs in the materialization of the act of deduction or assessment, namely, by lapse in the transcription of values or for arithmetic reasons, i.e., in both situations minor and obvious errors.

Thus, these error concepts (typically) will cover situations where the taxpayer errs in performing an arithmetic operation, namely, when it intends to determine the deductible tax contained in an invoice (with VAT included) from a service provider (calculation error), or, although performing the calculation correctly, commits a lapse in the entry of the amount of tax to be deducted in the periodic return (material error)."

Whenever the occurrence of material or calculation errors results in a regularization of tax in favor of the taxpayers, these may promote it within the period of two years counted from the moment when the tax became due, as provided for in paragraph 6 of Article 78 of the VAT Code.

Given this, let us now proceed to the analysis of the aforementioned third group of situations, alluding to errors of classification or errors of law.

In this context, it will be useful to begin by defining what should be understood by factual error so that, in light of this, we delimit the concept of error of law.

Thus, we consider that factual errors are covered by "situations in which the taxpayer makes an incorrect representation of the factual reality (which determines its subsumption to an incorrect rule)" (Afonso Arnaldo and Tiago Albuquerque Dias, loc. cit., pp. 45-46), and "the factual error that does not originate a consequent error of law, will have no relevance for these purposes, insofar as it will have no influence on the amount of tax to be deducted or assessed" (idem, ibidem).

By contrast, an error of law occurs in "situations in which, despite correct representation of the factual reality, the taxpayer errs in determining the applicable rule" (idem, ibidem), that is, in which there is an error of classification, because the taxpayer has made an incorrect interpretation of the factual situation or an incorrect application of the law and, consequently, assesses or deducts tax in a higher or lower amount.

As encompassed within errors of law, we have, by way of example, "situations in which there is an incorrect determination of the pro rata, motivated by an inaccurate subsumption in the applicable provision of the operations that influence the calculation, namely, regarding the classification of an operation as taxable when it is exempt" (idem, ibidem), as well as those situations "in which the taxpayer, developing various activities, effects the deduction by resorting to the pro rata in a first moment and then proceeds to use the method of actual allocation to effect the deduction of the tax exclusively allocated to a certain activity, seeking to correct the deduction that it made in the past based on the pro rata method." (idem, ibidem).

When the verification of an error of classification or error of law results in a regularization of tax in favor of the taxpayers, these may promote it in accordance with the provisions of Article 98 of the VAT Code, that is, within the general and subsidiary four-year period provided for therein.

Arriving at this point, returning to the specific case, it is necessary to conclude that the aforementioned lapses committed by the Claimant in the self-assessments of VAT relating to the year 2013, from which resulted a deduction of tax lower than that to which it would be entitled, constitute errors of classification or errors of law. In fact, due to an incorrect or incomplete interpretation of the law, the Claimant incorrectly applied the deduction methods provided for in Article 23 of the VAT Code.

Thus, we understand that these errors in VAT deduction do not constitute material or calculation errors, but rather errors of classification or errors of law and, accordingly, are not applicable to them the regime contained in paragraph 6 of Article 78 of the VAT Code.

Consequently, given the inapplicability of that norm or any other special provision, in case of an error of law in the deduction of VAT the general and subsidiary four-year period counted from the birth of the right to deduction, contained in Article 98 of the VAT Code, should be applied.

This was, moreover, the position taken in the decision issued in the cited case No. 117/2013-T, in which it was concluded that "not being applicable the regime of Article 78, paragraph 6, nor there existing any special time limit regime for the exercise of the right to deduction on the basis of an error of law, the general regime on this matter contained in Article 98, paragraph 2, of the VAT Code shall be applicable, which, as stated in the ruling of the Supreme Administrative Court of 18-5-2011, issued in case No. 966/10, sets a maximum limit of four years that cannot be exceeded in any case."; in the same sense, among others, the arbitral decisions issued in the cases cited by the Claimant and in case No. 251/2014-T also go.

Thus being the case, as it indeed is, the act dismissing the aforementioned administrative complaint suffers from a defect of violation of law, due to an error in the legal premises, constituted by the incorrect interpretation of Article 98, paragraph 2, in conjunction with Articles 22, paragraph 2, 23, paragraph 6, and 78, paragraph 6, all of the VAT Code, which implies the declaration of its illegality and consequent annulment insofar as it refused recognition of the tax credit in the amount of € 39,943.71, determined by the Claimant in the replacement periodic return relating to the 4th quarter of 2013.

The act of additional VAT assessment being challenged suffers from an equal defect of invalidity, which implies likewise the declaration of its illegality and consequent annulment insofar as it did not consider the aforesaid tax credit in the amount of € 39,943.71, in favor of the Claimant.

§2. ON COMPENSATORY INTEREST

The Claimant also petitions for the condemnation of the Tax Authority to the payment of compensatory interest.

It is necessary to appreciate and decide.

Article 24, paragraph 1, subparagraph b), of the Legal Framework for Arbitration in Tax Matters provides that the arbitral decision on the merits of the claim to which no appeal or challenge is admissible binds the tax administration from the end of the period provided for the appeal or challenge, the latter must, in the exact terms of the success of the arbitral decision in favor of the taxpayer and up to the end of the period provided for the execution of decisions from tax courts, reestablish the situation that would have existed by adopting the necessary acts and operations for this purpose, which should be understood, in accordance with the provisions of Article 100 of the General Tax Code, applicable ex vi subparagraph a) of paragraph 1 of Article 29 of the Legal Framework for Arbitration in Tax Matters, as encompassing the payment of compensatory interest, in accordance, moreover, with the provisions of paragraph 5 of that Article 24 of the Legal Framework for Arbitration in Tax Matters.

Article 43, paragraph 1, of the General Tax Code determines that "compensatory interest is due when it is determined, in an administrative complaint or judicial challenge, that there was an error imputable to the services from which results payment of the tax debt in an amount higher than legally due", and paragraph 5 of Article 61 of the Tax Procedure Code provides that the "interest is counted from the date of improper payment of the tax until the date of processing of the respective credit note, in which they are included".

In the specific case, it is verified that the illegality of the additional tax assessment being challenged, due to an error in the legal premises, in the part in which it did not consider the said tax credit in the amount of € 39,943.71, in favor of the Claimant, is imputable to the Tax Authority, as in that assessment it proceeded to an incorrect interpretation of Article 98, paragraph 2, in conjunction with Articles 22, paragraph 2, 23, paragraph 6, and 78, paragraph 6, all of the VAT Code, whereby the Claimant is entitled, in accordance with the provisions of Article 24, paragraph 1, subparagraph b), of the Legal Framework for Arbitration in Tax Matters and Article 100 of the General Tax Code, to compensatory interest, in accordance with the provisions of Articles 43, paragraph 1, of the General Tax Code and Article 61 of the Tax Procedure Code, calculated at the rate resulting from paragraph 4 of Article 43 of the General Tax Code, up to the date of processing of the respective credit note, in which they are included.

IV. DECISION

In the terms set forth above, this Arbitral Tribunal decides:

  • To declare the claim successful, due to an error in the legal premises, for a declaration of illegality:

  • of the act dismissing the administrative complaint No. …2016…, with its consequent annulment, insofar as it refused recognition of the tax credit in the amount of € 39,943.71, determined by the Claimant in the replacement periodic return relating to the 4th quarter of 2013;

  • of the act of additional VAT assessment No. 2016…, with its consequent annulment, insofar as it did not consider the tax credit in the amount of € 39,943.71, determined by the Claimant in the replacement periodic return relating to the 4th quarter of 2013;

  • To declare the claim successful for the petition for condemnation of the Tax and Customs Authority to the payment of compensatory interest, in accordance with the law;

  • To condemn the Tax and Customs Authority to the payment of the costs of the proceedings.

VALUE OF THE PROCEEDINGS

In accordance with the provisions of Articles 306, paragraph 2, of the Code of Civil Procedure, 97-A, paragraph 1, subparagraph a), of the Tax Procedure Code and Article 3, paragraph 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceedings is fixed at € 39,943.71 (thirty-nine thousand nine hundred and forty-three euros and seventy-one cents).

COSTS

In accordance with Article 22, paragraph 4, of the Legal Framework for Arbitration in Tax Matters, the amount of costs is fixed at € 1,836.00 (one thousand eight hundred and thirty-six euros), in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, charged to the Tax and Customs Authority.

Lisbon, February 1, 2018.

The Arbitrator,

(Ricardo Rodrigues Pereira)

Frequently Asked Questions

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Can a Portuguese municipality correct errors in VAT deduction methods used for mixed-use resources?
Yes, Portuguese municipalities can correct errors in VAT deduction methods for mixed-use resources, but the timing and nature of the correction determine its validity. Under Article 20 of the Portuguese VAT Code (CIVA), common resources used simultaneously in taxable and non-taxable activities require the pro rata method or objective allocation criteria. If a municipality initially applied only the actual allocation method (Article 19) to directly attributable inputs while failing to deduct VAT on common resources, this constitutes a legal error in qualifying deduction rights. Article 98(2) CIVA establishes a 4-year limitation period for exercising deduction rights. However, the Tax Authority argues that Article 22 combined with Article 78 limits deduction to the return period following invoice receipt, with corrections permitted only within 2 years for specific circumstances like invoice rectifications. The key issue is whether correcting a methodological error qualifies as exercising deduction rights within the statutory period or as an impermissible late regularization.
What is the difference between the pro rata method and the real allocation method for VAT deduction in Portugal?
The pro rata method and actual allocation method are distinct VAT deduction mechanisms under Portuguese law. The actual allocation method (afetação real), governed by Article 19 CIVA, applies when goods and services are wholly and exclusively used for taxable operations, permitting full deduction of input VAT. The pro rata method (método de dedução pro rata), regulated by Article 23 CIVA, applies to common resources used simultaneously in both taxable and non-taxable activities. Under pro rata, deductible VAT is calculated by multiplying total input tax by the ratio of taxable turnover to total turnover. Article 20 permits alternative objective allocation criteria if they more accurately reflect actual usage. Municipalities often engage in mixed activities—taxable operations like water distribution and non-taxable services like administrative functions—requiring proper distinction between directly attributable inputs (actual allocation) and common costs (pro rata or objective criteria). Misapplying these methods, such as using only actual allocation while ignoring pro rata deduction on shared resources, results in under-recovery of legitimately deductible input VAT.
What is the legal deadline for correcting VAT deduction errors under Articles 22 and 98 of the Portuguese VAT Code?
The legal deadline for correcting VAT deduction errors under Portuguese law depends on the interpretation of Articles 22, 78, and 98 of the VAT Code. Article 98(2) CIVA establishes a general 4-year limitation period for exercising the right to deduction, calculated from when the right accrues (typically invoice date if issued within legal deadlines). This provision suggests taxpayers can claim undeducted input VAT within four years. However, Article 22 specifies that deduction should occur in the return for the period following invoice receipt, with paragraph 2 allowing deduction in subsequent periods subject to conditions in Article 98. The Tax Authority interprets Article 78, which addresses regularizations, as imposing a stricter 2-year limit for corrections, arguing that late deductions are only permitted for invoice rectifications or material/calculation errors. The central legal controversy in Process 489/2017-T concerned whether correcting a legal error in deduction methodology (failing to apply pro rata or recognize fully deductible inputs) constitutes exercising deduction rights within the 4-year Article 98(2) period or an impermissible late regularization exceeding Article 78's 2-year window.
Can a municipality submit a substitute periodic VAT return to recover previously undeducted input VAT?
Portuguese municipalities can submit substitute periodic VAT returns (declarações periódicas de substituição) to correct errors, but their validity depends on timing and the nature of corrections. Under Article 22(2) CIVA, taxpayers may exercise deduction rights in periods subsequent to invoice receipt, subject to Article 98(2)'s 4-year limitation. Substitute returns are the procedural mechanism for amending previously filed declarations. In Process 489/2017-T, Municipality A submitted a substitute return for Q4 2013 in February 2016 (within four years of the original February 2014 filing) to recover €39,943.71 in previously undeducted VAT. The municipality argued this represented a timely exercise of deduction rights for invoices properly accounted but not claimed due to legal error in applying deduction methods. The Tax Authority contested this, asserting that substitute returns for deduction purposes are only valid within two years and only for specific circumstances like invoice corrections or calculation errors, not for correcting legal errors in methodology. The arbitral tribunal's analysis would determine whether Article 98(2)'s 4-year period encompasses all deduction exercises regardless of reason or whether stricter temporal limits apply to methodological corrections.
How does CAAD arbitration handle disputes over additional VAT assessments issued to local authorities?
CAAD (Centro de Arbitragem Administrativa) arbitration handles disputes over additional VAT assessments issued to local authorities through specialized tax arbitration procedures under the Legal Framework for Tax Arbitration (RJAT - Decree-Law 10/2011). Municipalities, as taxable persons for VAT purposes regarding economic activities like water distribution, can challenge Tax Authority decisions including additional assessments and administrative complaint dismissals. In Process 489/2017-T, Municipality A invoked CAAD jurisdiction under Articles 2(1)(a) and 10 of RJAT to challenge both the dismissal of administrative complaint No. ...2016... and the underlying additional assessment No. 2016.... The arbitral procedure follows formal stages: petition filing, tribunal constitution, respondent's reply, evidence production if requested, and final decision. The tribunal examines the legality of tax acts, applying substantive VAT law (Articles 19, 20, 22, 23, 78, 98 CIVA) to determine whether the municipality validly exercised deduction rights or whether the Tax Authority properly limited corrections. CAAD decisions provide binding resolution of tax disputes, offering municipalities an alternative to judicial courts with specialized expertise in complex issues like deduction methodology, temporal limitations, and the distinction between initial deductions, regularizations, and error corrections.