Process: 493/2017-T

Date: March 16, 2018

Tax Type: IRC IRS

Source: Original CAAD Decision

Summary

CAAD Process 493/2017-T addresses the legitimacy of a law firm partner to challenge undue withholding tax payments made by the firm as tax substitute. The petitioner, a UK tax resident who remained a partner in a Portuguese law firm, sought reimbursement of €18,055.56 withheld on 2016 distributions. The firm's accountant incorrectly applied non-resident withholding rates, treating partnership distributions as if subject to withholding obligations. Under Portuguese tax law, law firms organized as partnerships benefit from fiscal transparency (transparência fiscal), meaning profits are taxed directly in partners' hands rather than at entity level. The Tax Authority acknowledged the withholdings were undue but argued only the withholding entity (firm), not the substituted taxpayer (partner), had standing to seek refund through gracious complaint procedures. The case raises fundamental questions about taxpayer rights when tax substitutes make erroneous payments, the distinction between true tax substitution and withholding regimes under IRC and IRS, and whether fiscal transparency principles grant partners direct legitimacy to challenge such acts. The tribunal examined whether CAAD's jurisdiction extends to undue payment claims not arising from assessment act challenges, and whether compensatory interest applies to refunds of improper retentions made by substitutes on transparent entity distributions.

Full Decision

ARBITRAL DECISION

1. Report

A…, tax identification number …, domiciled in … …– …, …, …, London …, United Kingdom, came, pursuant to Decree-Law no. 10/2011, of 20 January (Legal Framework for Tax Arbitration, hereinafter "LFTA") to request the constitution of the Arbitral Tribunal, petitioning the declaration of illegality of the tacit rejection of a gracious complaint that he filed regarding withholdings at source effected by the Law Firm with tax identification number …, by deduction in income made available to the Petitioner herein, relating to the year 2016.

The respondent is the Tax and Customs Authority (hereinafter "TCA" or "Respondent").

The Petitioner requests that the illegality of the rejection of the gracious complaint presented by him regarding the withholdings at source effected, as his substitute, by the Law Firm "B…, Sociedade de Advogados, R.L." (hereinafter "Firm"), of which he is a partner, by deduction in income made available to the Petitioner herein, be declared.

Further, he requests the annulment of the withholding at source forms improperly submitted by the Firm, and the consequent reimbursement in his favor of the amounts thus withheld and delivered to the State, in the total amount of € 18,055.56.

The Petitioner further requests that the TCA be condemned to pay him compensatory interest on the amounts thus withheld and delivered, from the date of submission of the gracious complaint.

Finally, he requests the condemnation of the TCA in the costs of the proceedings.

The request for constitution of the Arbitral Tribunal was accepted by the President of CAAD and the TCA was notified on 04.09.2017.

Pursuant to the provisions of subparagraph b) of no. 1 of art. 11 of the LFTA, the Deontological Council designated the undersigned as arbitrator of the singular Arbitral Tribunal, who timely accepted the appointment.

On 08.11.2017 the parties were notified of the designation of arbitrator and did not manifest intention to challenge it (see art. 11, no. 1, subparagraphs a) and b) of the LFTA and articles 6 and 7 of the Deontological Code).

Pursuant to the provisions of subparagraph c) of no. 1 of art. 11 of the LFTA, the singular Arbitral Tribunal was constituted on 28.11.2017.

Notified for this purpose, the TCA filed a Reply, arguing for the complete dismissal of the Petition. In summary, it argues that although the amounts delivered by the Firm to the State's coffers constitute an undue payment, which it acknowledges, nevertheless the official assessment of Personal Income Tax should not be censured. Further, it understands that the Petitioner cannot activate the legal means for regularization of undue payments and that it should be the Firm to do so. It further argues that there are no grounds for compensatory interest.

By Order of 15.01.2017 the Tribunal decided to dispense with the production of witness testimony as well as the hearing provided for in art. 18 of the LFTA, and that the proceedings continue with written arguments.

Both parties filed arguments, in which they essentially reaffirm what they had previously stated, further arguing: (i) the Petitioner, for his procedural and process legitimacy and further for there having been an error of the Services in disregarding the gracious complaint having knowledge of the withholdings at source and (ii) the Respondent for the undue payments not being attributable to its error and further for – the reimbursement request not resulting from a challenge of assessment acts – the intended arbitral decision exceeding the scope of the "cognizance powers of CAAD".

The Arbitral Tribunal was regularly constituted. It may be stated also, right away, that it is competent and that the parties have legal personality and capacity, are legitimate and are duly represented (see articles 4 and 10, no. 2 of the LFTA and article 1 of Ordinance no. 112-A/2011, of 22 March).

The Proceedings do not suffer from any nullities and it will be important to begin by examining the matter of exception. Which we shall do after treatment of the factual matter.

It should further be noted that, subsequently to the filing of the Petition and before the constitution of the Arbitral Tribunal, the Petitioner came to request, by petition filed in the proceedings, the condemnation of the TCA in compensatory interest "should it fail to comply with the [Arbitral] Decision" rendered in proceedings no. 248/2017-T "and maintain its position".

2. Factual Matter

2.1. Proven Facts

a) The Petitioner is a Lawyer.

b) Between the Petitioner and C… a law firm was constituted, in 1998, with the name B…, Sociedade de Advogados, R.L. (hereinafter "Firm").

c) The Firm was constituted to exercise the activity of provision of legal services.

d) The Petitioner changed his tax residence to the United Kingdom in 2014, becoming a non-resident for tax purposes in Portugal.

e) The Firm's accountant understood that the Petitioner herein, as to the income made available to him by the Firm, would be subject to withholding at source at the liberatory rates for non-residents.

f) The Firm opted, as a precaution, to proceed with the withholding at source of the income that it made available to its partner.

g) The withholdings were made regarding the income made available to the Petitioner between 6 January and 13 September 2016.

h) The Firm processed the withholdings through the forms of "Statements of Personal Income Tax Withholding at Source - Withholdings from non-residents - Withholdings made from non-resident taxpayers, in accordance with the provisions of no. 7 of article 119 of the Personal Income Tax Code" - see Assessments nos. … (in the amount of € 2,916.67), … (in the amount of € 6,805.56), … (in the amount of € 2,500.00), … (in the amount of € 2,500.00) and … (in the amount of € 3,333.33), all of 2016, totalling € 18,055.56.

i) The Firm paid all the withholding at source forms issued.

j) In September 2016 the Petitioner herein obtained a different understanding from a colleague in the profession also non-resident, to the effect of non-withholding, and communicated it to the Firm.

k) From September 2016 onwards the Firm adopted a different procedure, ceasing to make withholdings at source.

l) The total value of the withholdings made and delivered to the State by the Firm on income of the Petitioner in 2016, of € 18,055.56, was relative to values of € 118,055.56 made available to him, of which he thus received only € 90,000.00.

m) Upon presenting his Personal Income Tax Return for the year 2016 the Petitioner deducted the amounts withheld by the Firm, which led to the opening, by the TCA, of a divergence procedure due to error in "Withholding at Source".

n) From the attached Administrative Proceeding (PA.1.) it appears, with reference to the divergence procedure, informational print "Divergence Management", "Irregular Status Detail", where it reads, among other things:

(...)

2017-08-15 (SF … - LISBON-…) - Document Verification

The M30 income, from self-employment, was subject to withholding of 26.5% (Non-Resident Taxpayer – 25% art. 71 PIT Code). As it does not affect the assessment in the sense of tax in favor of the State I propose to close the proceedings.

(...)

2017-08-09 (SF…- LISBON-…) - Document Verification

The divergence arises because M30 income appears, self-employment income, with withholding at source, paid by the entity … which is the same entity that makes profit distribution (Annex D in accordance with Annex G of the Financial Statements). Under analysis.

(...)

o) The official Personal Income Tax assessment of the Petitioner for 2016 disregarded the amount delivered by the Firm as withholdings at source.

p) In the years 2014 and 2015 the Firm had likewise processed withholdings at source on the income then made available to the Petitioner herein and the TCA had assessed him for Personal Income Tax as if the same had not been made, instituting enforcement proceedings against him that obliged him to provide guarantees to stay the execution.

q) The Petitioner paid the Personal Income Tax for the year 2016 according to the official assessment.

r) The Petitioner paid the amount of € 62,793.82 of Personal Income Tax, corresponding to 25% of the totality of his income in 2016, without any withholding amount having been taken into account.

s) The Petitioner filed a gracious complaint on 7 April 2017.

t) The TCA did not decide the gracious complaint.

u) On 1 September 2017 the Petitioner filed a Request for constitution of an Arbitral Tribunal, which gave rise to the present proceedings.

2.2. Unproven Facts

There are no facts with relevance for the decision to be rendered that should be considered as unproven.

2.3. Justification of the Factual Matter

The facts determined as proven were so determined based on the documents attached with the Petition and in the Administrative Proceeding, which are taken as reproduced, as well as on the positions manifested by the parties in the pleadings, there being no controversy regarding the same.

It falls to the Tribunal to select, from among those alleged by the parties, the facts that matter to the examination and decision of the cause (see art. 16, subparagraph e) and art. 19 of the LFTA and, further, art. 123, no. 2 of the Tax Procedure Code and art. 596 of the Civil Procedure Code[1]).

3. Matter of Law

Preliminary Question

Even before the constitution of the present Tribunal, the Petitioner came to attach to the arbitral proceedings a copy of a Decision rendered in a Collective Arbitral Tribunal, which the undersigned participated in, whose proceedings had as its object a Petition, equally of the Petitioner herein, for declaration of illegality of additional Personal Income Tax assessments relating to 2014 and 2015. He thus intends by this means, in the proceedings that fall to the present Tribunal to decide, that the TCA be condemned to the payment of compensatory interest should it fail to comply with that Arbitral Decision (in proceedings no. 248/2017-T).

It does not fall within the competence of the present Arbitral Tribunal to decide on the object of another proceeding other than this one, or on the consequences of the eventual non-compliance with the Decision rendered therein. Indeed, each Arbitral Tribunal is constituted to decide, solely, on the proceedings that give rise to it. And the solution to which one would arrive would not be substantially different if we were in the scope of other Tribunals, also limited, in certain respects, by the Petition and Cause of Action. Or, if you will, one could in these, as one could in Arbitral proceedings, consider the admissibility or otherwise, in the case, of an expansion of the petition and cause of action. It is well known that in the context of tax litigation the admissibility of such expansion is limited, so there is no justification whatsoever for greater development of this point in the present case. Thus.

What the Petitioner comes to request in this side petition is, if we understand correctly, that this Arbitral Tribunal decide on the condemnation of the TCA, the losing party in that other proceeding, to the payment of compensatory interest in the event it comes to fail to comply with the Arbitral Decision rendered therein.

Now, without prejudice to the duty, constitutionally enshrined and reflected in the LFTA, that falls to the TCA to give compliance to Decisions of the Tribunals, among which are included Arbitral Tribunals (see articles 205, no. 2 and 209, no. 2 of the Constitution and article 24, no. 1 of the LFTA), a request with the cause of action of this one, and whatever the type or types of interest therein petitioned, should take place in the context of execution of judgments, a matter for which Arbitral Tribunals are not competent (see art. 2, no. 1 of the LFTA). Therefore, from the outset by here, the cognizance powers of the present Tribunal do not encompass those necessary for it to eventually be able to decide on this side petition.

It should further be noted that the executive force of an Arbitral Decision is exactly the same as that of a Judgment of a State Court[2], and the general rule on execution of decisions favorable to the taxpayer is that contained in article 100 of the General Tax Law.

Questions to be Decided

3.1. Matter of Exception

3.1.1. On the Competence of the Arbitral Tribunal

The Respondent argues in its arguments that "the request for reimbursement of the amount paid does not derive from the challenge of assessment acts", and "Consequently, an arbitral decision, as the request for arbitral pronouncement requests, which declares the right of the Petitioner to the reimbursement of the amounts improperly paid, escapes the cognizance powers of CAAD".

That is, in the understanding of the Respondent TCA, the Petitioner's Petition not being based on a challenge of assessment acts, the intended declaration of the right to reimbursement exceeds the competence of the Arbitral Tribunal.

It should be noted beforehand that the present Arbitral Tribunal understands that there is a case of manifest unnecessary contradiction, pursuant to article 3, no. 3 of the Civil Procedure Code and, further, under the principle of free conduct of arbitral proceedings (see art. 19 of the LFTA).

Let us see then.

On the competence of the Tribunal, as a procedural requirement that it is, depends the possibility and the duty of the judge to rule on the merit or admissibility of the petition. The procedural requirements condition the entire power-duty of examination of the merit of the action. Thus, "In order to be able to decide on the merit or substance of the question it is required that the tribunal, before which the action was brought, be competent."[3]

Article 13 of the Administrative Procedure Law[4], regarding knowledge of competence and scope of jurisdiction, establishes that "(...) the competence of administrative tribunals in any of their forms is of public order and its knowledge precedes that of any other matter". In turn, article 89, no. 2 of the Administrative Tax Procedure Code[5] provides that dilatory exceptions are subject to ex officio knowledge and preclude the Tribunal from knowing the merit, such exceptions being enumerated with that of incompetence of the tribunal in the first place (art. 89, no. 4, subparagraph a)). In the Civil Procedure Code (art. 96, subparagraph a)), without novelty, it is established that the infraction of the rules of competence ratione materiae determines the absolute incompetence of the Tribunal, may be argued by the parties and must be raised ex officio by the Tribunal (art. 97, no. 1).

Analyzing.

The Petitioner comes to challenge withholding at source acts. What is at issue in the proceedings is the assessment of the alleged illegality of withholding at source acts, as will be better developed below, with the consequent condemnation to return the amounts paid as such if the Petition is decided favorably.

Article 95, no. 1 of the General Tax Law establishes that "The interested party has the right to challenge or appeal any act harmful to his rights and legally protected interests, according to the procedural forms prescribed by law."

In turn, pursuant to subparagraph a) of no. 2 of the same article, "May be harmful, in particular: a) The assessment of taxes, also being considered as such for the purposes of this law acts of self-assessment, withholding at source and payment on account; (...)". (emphasis ours)

Article 34 of the General Tax Law, for its part, provides us with the concept of withholding at source, as follows: "The monetary deliveries effected by deduction from the income paid or made available by the taxpayer by the tax substitute constitute withholding at source."

The acts in question are, therefore, acts of withholding at source and these are equated, for purposes of judicial challenge, with acts of tax assessment.

Finally, combining articles 2, no. 1, subparagraph a) of the LFTA and article 2, subparagraph a) of the Binding Ordinance[6], it is confirmed that were included within the competence of Arbitral Tribunals functioning under the aegis of CAAD powers to decide on this matter in the same terms as the Administrative and Tax Tribunals ("ATT") have them.

It is thus that, pursuant to article 2, no. 1, subparagraph a) of the LFTA, the competence of Arbitral Tribunals comprises, among other things, the examination of petitions for declaration "of illegality of acts (...), of withholding at source, (...)". Being that the same derives, a contrario, from article 2 of the Binding Ordinance which, in coming to except from the binding of the TCA to the aforementioned jurisdiction certain acts, refers thus to those that occupy us here: "The services and organisms (...) [bind themselves to the jurisdiction of the arbitral tribunals functioning in CAAD] (...) with the exception of the following: subparagraph a) Petitions relative to the declaration of illegality of acts of self-assessment, withholding at source and payment on account that have not been preceded by recourse to the administrative avenue according to articles 131 to 133 of the Tax Procedure and Process Code; (...)". It becomes necessary to conclude that they were not excluded, provided they are preceded by recourse to the administrative avenue.

And, having arrived here, we are faced with an additional requirement of challengeability of these acts, namely, that of necessary prior recourse to the administrative avenue, as also occurs in the ATT. It should be noted from the outset that, examining the case file, it is verified that the Petitioner, in due time, filed a gracious complaint (see art. 132, no. 3 of the Tax Procedure and Process Code).

Now, having the Petitioner fulfilled the condition of challengeability, and, by force of the combination between the Binding Ordinance and the LFTA, also requirement of competence of the present Tribunal, by previously resorting to the administrative avenue, no doubts remain that the present Tribunal is materially competent to decide on the Petition, there being, thus far, no obstacles to the continuation of the proceedings.

3.1.2. On the Legitimacy of the Petitioner

The Petitioner in the present case is the taxpayer on whose income amounts were withheld and subsequently delivered to the TCA. That is, he came to present the Request for Arbitral Pronouncement, although the act placed in question was not performed by him, but rather by the professional firm that makes income available to him.

Professional firms are subject to the transparent taxation regime, pursuant to which their taxable income, determined according to the Corporate Income Tax Code, is imputed directly to the partners, integrating into their taxable income. Being that professional firms are considered, for this purpose, firms constituted for the exercise of one of the activities provided for in the list to which article 151 of the Personal Income Tax Code[7] refers in which all the partners, natural persons, are professionals of that activity.

This is what occurs in the case of the present proceedings: the Firm is a law firm, and the Petitioner is a Lawyer (see point 6 of the "Table of Activities Exercised by Personal Income Tax Taxpayers", to which article 151 of the Personal Income Tax Code[8] refers).

The Respondent invokes that it is the Firm that must activate the legal means to be reimbursed for the payment that it improperly effected, "to regularize the undue payments for withholding at source".

Underlying this argument of the Respondent is an invocation of non-verification of the procedural requirement of the Petitioner's legitimacy. A requirement that, in any case, will also always be subject to ex officio knowledge (see art. 97, no. 1 and 578 of the Civil Procedure Code). We are thus, once again, in the context of dilatory exceptions, this time see art. 278, no. 1, subparagraph d), 576, no. 2 and 577, subparagraph e), all of the Civil Procedure Code.

Let us see.

The requirement of process legitimacy relates directly to another that, although not expressly enumerated by our civil procedure law among the procedural requirements, is also necessarily subject to verification. This is the procedural interest to act which means, in summary, verifying itself, in that interested party, the necessity of resorting to the action. In other words, a necessity - justified, reasonable, founded - to resort to the action. And nothing more than that.[9]

Article 30 of the Civil Procedure Code defines the concept of legitimacy, thus establishing that: "no. 1 - The plaintiff is a legitimate party when he has direct interest in suing; (...) no. 2 – The interest in suing is expressed by the utility derived from the success of the action (...); no. 3 – In the absence of legal indication to the contrary, are considered holders of the relevant interest for the purpose of legitimacy the subjects of the controversial relationship, as configured by the plaintiff."

In the Tax Procedure and Process Code, article 9, in the combined terms of its no. 1 and no. 4, establishes that have legitimacy in the tax proceedings[10] taxpayers, including substitutes and liable persons, other obligated taxpayers, parties to tax contracts and any other persons who prove legally protected interest[11].

Article 132 of the Tax Procedure and Process Code, for its part, delimits procedural legitimacy in the context of challenge in the case of withholding at source, from which it follows that, as a rule, shall have legitimacy for the respective challenge either the substitute (see no. 3 of art. 132) or the substituted taxpayer (see no. 4). For the latter there being opened therein however an exception – that of situations in which the withholding at source has mere nature of payment on account.

To the contrary, whenever it is a question of withholding at source of a definitive nature the substituted taxpayer shall have procedural legitimacy directly derived from this legal provision. As is well understood, given his interest to act. For that, in all cases in which it is a question of withholding at source of a definitive nature he will no longer be able to benefit from the correctness thereof ultimately, when the annual assessment of the tax is made (contrary to what will occur in withholdings of a payment on account nature).

Returning to the case of the present proceedings, the Firm withheld – on the values it made available to the Petitioner, within the framework of the transparent taxation regime – amounts that it delivered to the TCA through official forms for withholding at source payments of Personal Income Tax from non-residents, in accordance with the provisions of no. 7 of article 119 of the Personal Income Tax Code (see proven facts, h).

The TCA does not question that the Petitioner was subject to withholding at source of a definitive nature on his income, as a non-resident, see articles 71 and 101, no. 2, subparagraph a) of the Personal Income Tax Code, through application of liberatory rates.

It is true that there exists, applicable to the case, a specific rule excluding the general rule of subjection to withholding at source. We refer to no. 11 of article 101 of the Personal Income Tax Code, which expressly excludes from withholding at source the income covered by article 20 of the same Legal Instrument, that is, the income of natural persons who are partners of firms subject to the transparent taxation regime, which result from imputation effected according to the terms provided in article 6 of the Corporate Income Tax Code.

However, it is not by the fact that such payment was made improperly, in the sense that the law did not require it, that the act ceases to be qualified as one of withholding at source, holding such nature. Let us refer again to article 34 of the General Tax Law and to the concept of withholding at source contained therein (see above). As the Respondent acknowledges.

We are faced with income of the Petitioner, taxable under Personal Income Tax, Category B, which only by falling into a situation treated by the legislator in a special manner - transparent taxation - the same excluded from the scope of subjection to withholding at source. Which does not detract from the fact that the taxpayer found himself dispossessed of the amounts that were his, as a result of the entity that made the income available to him, erroneously and for the benefit of the TCA, proceeded with withholding at source operations. Indeed formalized through forms that were obtained and submitted to the TCA, in declaration of official form (see 119, no. 7, subparagraph A of the Personal Income Tax Code), and by the latter accepted, and received the corresponding amounts.

And to this it is not opposed that the figure of substitution would only occur, also it, when the law required its occurrence. The truth is that the Firm acted as a tax substitute upon withholding the referred amounts to deliver them, as it did, to the TCA. There was withholding at source of the tax owed (Personal Income Tax) through the mechanism of tax substitution – see article 20, no. 2 of the General Tax Law.

Although the substitution took place when it was not owed, the fact is that the taxpayer found himself, by means of it, dispossessed of amounts that were his (income that was his) which the TCA received as if it were withholding at source actually owed.

Therefore it is undeniable the direct economic interest of the Petitioner in the correction of the acts in question – see article 9 of the Tax Procedure and Process Code.

The Petitioner thus has interest to act and is a legitimate party.

Furthermore, if it were not understood thus we would incur in the emptying of the principles enshrined in article 268, no. 4 of the Constitution and in articles 9 and 95, no. 1 of the General Tax Law[12], for the act performed has harmful effects for the Petitioner, who thus is interested, having him the right to challenge it.

Finally, it should further be noted, and in view of everything that has been stated, that it will not be by the letter of the law, in no. 1 of article 132, referring to "error in the delivery of tax superior to that withheld" that shall not be considered therein also included situations of error in the delivery of tax by simply being undue.[13]

3.2. On the Illegality of the Rejection of the Gracious Complaint and Withholding at Source Acts / Annulment and Right to Reimbursement

In the year 2016, the Firm, subject to the transparent taxation regime see article 6 of the Corporate Income Tax Code, proceeded, as a substitute, to the withholding at source of amounts on income that it made available to the Petitioner.

The withholdings were made of a definitive nature by application of liberatory rates, since the Petitioner is a non-resident, and processed through the respective official forms, see article 119, no. 7 of the Personal Income Tax Code, which the Firm obtained and delivered to the TCA, which accepted them, receiving the respective amounts.

The Petitioner, to avoid incurring in greater losses, paid the official assessment of Personal Income Tax for the year 2016 without the withheld amounts, in the total of € 18,055.56, having been taken into account therein, thus continuing dispossessed of the same until the present date.

The Petitioner has legitimacy, procedural and process, as we have seen.

On 1 April 2017 the Petitioner filed a gracious complaint, timely as it was within the two-year period of which he had for such purpose (see art. 132, nos. 2, 3 and 4 of the Tax Procedure and Process Code[14]), arguing for the illegality of the withholding at source acts and return of the respective amounts.

The TCA did not decide the complaint by which, on 1 August 2017, the presumption of tacit rejection operated (pursuant to the combined terms of article 106 of the Tax Procedure and Process Code and article 57, nos. 1 and 5 of the General Tax Law).

On 1 September 2017 the Petitioner also timely filed the Request for Arbitral Pronouncement, pursuant to articles 2, no. 1, subparagraph a) and 10, no. 1, subparagraph a) of the LFTA and article 102, no. 1, subparagraph d) of the Tax Procedure and Process Code, petitioning the declaration of illegality of the rejection of the gracious complaint.

As a corollary of the petitioned declaration of illegality of the second-level act, there is requested the declaration of illegality of the primary acts, of withholding at source, and the annulment of the respective forms, with the consequent return to the Petitioner of the amounts delivered to the TCA.

Let us see then.

The Request for Arbitral Pronouncement in the present case has formally as its immediate object the rejection of the gracious complaint and as its mediate object the defects attributed to the withholding at source acts[15]. Indeed, the decision regarding the challenge of the rejection of the gracious complaint necessarily implies examining and deciding on the legality of the underlying act.

Which in situations in which the rejection has operated tacitly is even more evident, for, there being a mere legal fiction of decision, the act whose legality will be examined in the context of challenging (or, in our case, of Request for Arbitral Pronouncement), is indeed the first-level act[16], in the case the withholding at source acts.

That the Arbitral Tribunals constituted under the aegis of CAAD are competent to decide on the challenge of second-level acts is given as settled, from the outset because being contained among their competencies – article 2, no. 1, subparagraph a) of the LFTA – that of the examination of petitions for declaration of illegality of withholding at source acts, and the challengeability of these acts being dependent – article 132 of the Tax Procedure and Process Code – on necessary gracious complaint, one could not understand it in a different sense. And the same comes to be confirmed by article 2, subparagraph a) of the Binding Ordinance, by which the TCA, regarding these acts, only accepted binding itself to the jurisdiction of these Arbitral Tribunals when preceded by recourse to the administrative avenue.

That the rejection of such acts being tacit is equally challengeable also leaves no doubts. Tacit rejection is a legal fiction precisely intended to allow recourse to administrative or contentious defense means (see art. 57, no. 5 of the General Tax Law). And also here the competence for its examination is similar between these Arbitral Tribunals and the ATT, from the outset by in the LFTA, article 10, no. 1, subparagraph a), it refers to article 102 of the Tax Procedure and Process Code, among whose subparagraphs of no. 1 the case of the formation of tacit rejection is included.

In our case, therefore, a presumption of tacit rejection formed, that is, it is presumed that the TCA examined the legality of the challenged acts not recognizing the illegalities that the complainant (now Petitioner) attributed to them.

It is now our turn to examine and decide whether we recognize the illegalities pointed out to them.

As to the withholding at source acts, and taking into account what we have already examined.

The withholdings at source were effected in relation to the income made available to the Petitioner, by the Firm, between January and September 2016, which, constituting taxable income of the Firm, are directly imputable in the taxable income of the partner under Personal Income Tax, as it is a professional firm, subject to the transparent taxation regime (see article 6 of the Corporate Income Tax Code). The income thus made available to the Petitioner by the Firm were by him received less the amounts withheld.

Notwithstanding, upon making the official assessment of Personal Income Tax for 2016 the TCA disregarded such withheld amounts, which it recognizes were delivered to it by the Firm as withholdings at source from non-residents regarding that part of the income earned by the Petitioner in 2016.

The Petitioner paid the Personal Income Tax assessment in the terms processed by the TCA, in the amount of € 62,793.82 of Personal Income Tax. Being that, for payment of his Personal Income Tax there had already been withheld at source and delivered the amount of € 18,055.56, which remains in the possession of the TCA.

The Petitioner remains dispossessed of the amounts that were withheld from him.

The Firm is a professional firm, see article 6 of the Corporate Income Tax Code, which in fulfillment of its tax obligations, not being unaware of the responsibility that the law places on substitutes, opted to proceed with the withholding at source of the amounts that it made available to the non-resident partner. Which it did in the terms in which the law provides for withholdings from non-residents, that is, definitive nature through liberatory rates, according to the general rules of articles 98 to 102 of the Personal Income Tax Code and article 71 of the same Code.

The Firm was in error as to the obligation of withholding at source in the case, for that pursuant to article 101, no. 11 of the Personal Income Tax Code the situations provided for in article 20 of the same Code - precisely those of special imputation, in the transparent taxation regime - are exempted from withholding at source.

Withholding at source was not owed. But it was made, by its processing mechanism which is tax substitution. And the TCA received the corresponding amounts as such.

It becomes evident, after all that has been explained, that the amounts withheld and delivered to the TCA were done so improperly, that the respective withholding at source acts are affected by the vice of illegality, and that in consequence they should be annulled, with the further consequences.

The Petitioner is the holder of the right to reimbursement of the amounts improperly delivered as withholding at source, as results, with the necessary adaptations, from the provision of article 78, no. 3 of the Personal Income Tax Code, and as it could not be otherwise. In the same way that he is the taxpayer of the obligation to pay the tax, he is the creditor of the obligation of reimbursement that falls upon the TCA[17].

Thus is he owed the reimbursement of the amounts delivered, in the total of €18,055.56.

3.4. On Compensatory Interest

The Petitioner requests the condemnation of the TCA to the payment of compensatory interest, on the amount to be reimbursed, counted from the date of submission of the gracious complaint.

It is unanimous understanding that the Arbitral Tribunals functioning under the aegis of CAAD also have competence for condemning decisions in the same terms as tax tribunals have them in the process of judicial challenge. Either because in terms of the Authorization Law at the basis of the approval of the LFTA it is clear the intention of the legislator to confer on the tax arbitral process the nature of procedural means alternative to the judicial challenge process and to action for the recognition of a right or legitimate interest in tax matters, either because the LFTA itself (article 24, subparagraph b)) imposes on the TCA the obligation, with respect to arbitral decisions having passed into judgment, to "re-establish the situation that would exist if the tax act object of arbitral decision had not been performed, adopting the acts and operations necessary for such purpose."

Pursuant to article 100 of the General Tax Law, for its part, the TCA "is obliged, in case of total or partial success of (…) or of judicial proceedings in favor of the taxpayer, to the immediate and full reconstitution of the situation that would exist if the illegality had not been committed, comprising the payment of compensatory interest, according to the terms and conditions provided by law". (emphasis ours)

And as to this same matter article 43, no. 1 of the General Tax Law provides thus: "Compensatory interest is owed when it is determined, in gracious complaint or judicial challenge, that there was error attributable to the services from which results payment of the tax debt in an amount superior to that legally owed." (emphasis ours)

In the case, it was the substitute Firm that incurred in error upon proceeding with the withholding at source, the practice of this act being unable to be considered as error, whether of fact or of law, attributable to the services, a requirement that the law (art. 43, no. 1 of the General Tax Law) makes depend on the right to compensatory interest. This, even if the Firm attempted to obtain clarifications from the services and decided, as a precaution, to proceed with the withholdings at source.

It should however be understood that, having the Petitioner filed a gracious complaint, the TCA having a legal period to decide and not having done so, allowing the tacit rejection to operate, took the same position on the petition of the gracious complaint. There was formed a presumption that, having examined the complaint, it rejected it. Therefore, that from that date it took position on what was being petitioned, denying allowance. And, thus being, one must consider that from then on the situation persists due to error attributable to the services, error of law by the rejection.

As Jorge Lopes de Sousa so clearly explains, "In situations in which the practice of the act that defines the tax debt falls to the taxpayer (as occurs, in particular, in the aforementioned cases of self-assessment, withholding at source and payment on account), (…), the error will become attributable to the Tax Administration after the eventual rejection of the petition presented by the taxpayer, that is, from the moment in which, for the first time, the Tax Administration takes position on the taxpayer's situation (…). It shall be indifferent, for this purpose of attribution of error, generating compensatory interest debt, whether it is a case of necessary administrative challenge or of facultative, for, in either case, the decision on the challenge is an act of the authorship of the Tax Administration, for which the eventual error will be attributable to it, from the moment it performed it." And it continues, thus: "To the practice of express act should be equated, for this purpose, tacit rejection, formed by the elapsing of the legal period for decision on administrative challenge (art. 57, no. 5 of the General Tax Law), for it is this moment in which the Tax Administration should have uttered a legal act and, with its omission, maintained the situation of illegality, which allows attributing to it responsibility for the maintenance of the situation of error and undue payment."[18]

Therefore, having formed the tacit rejection on 7 August 2017, the petition for condemnation in compensatory interest should be granted only in this measure, that is, compensatory interest is owed calculated from 8 August 2017 (inclusive) and, see art. 61, no. 5 of the Tax Procedure and Process Code, until the date of processing of the respective credit note.

4. Decision

In these terms this Arbitral Tribunal decides:

a) To judge the Request for Arbitral Pronouncement well-founded as to the declaration of illegality of the rejection of the gracious complaint;

b) To judge the Request for Arbitral Pronouncement well-founded as to the declaration of illegality of the withholding at source acts;

c) To annul the withholding at source acts and their forms.

d) To judge well-founded the petition for reimbursement of the amount of € 18,055.56 to the Petitioner;

e) To condemn the Respondent to the payment of compensatory interest, calculated on the amount to be reimbursed, counted from the rejection of the gracious complaint until issuance of the credit note.

5. Value of Proceedings

Pursuant to the combined provisions of articles 3, no. 2 of the Regulation of Costs in Tax Arbitration Proceedings, 97-A, no. 1, subparagraph a) of the Tax Procedure and Process Code, and 306, no. 2 of the Civil Procedure Code, the value of the proceedings is fixed at € 18,055.56.

6. Costs

In accordance with the provision of article 22, no. 4 of the LFTA, article 4, no. 4 of the aforementioned Regulation, and Table I attached thereto, the amount of costs is fixed at € 1,224.00, to be borne by the Respondent.

Lisbon, 16 March 2018

The Arbitrator

(Sofia Ricardo Borges)

[1] These latter Legal Instruments applicable to our proceedings ex vi art. 29, no. 1 of the LFTA (and thus whenever reference is made to them in the present Decision).

[2] See art. 46 of the Compulsory Arbitration Law (subsidiarily applicable ex vi art. 29, no. 1, subparagraph c) of the LFTA and art. 181, no. 1 of the Administrative Procedure Code).

[3] See Antunes Varela et al., "Manual of Civil Procedure", Coimbra Publisher, 2nd Ed., 1985, p. 195

[4] Applicable ex vi art. 29, no. 1 of the LFTA.

[5] Applicable ex vi art. 29, no. 1 of the LFTA.

[6] Ordinance no. 112-A/2011, of 22 March.

[7] See art. 6, no. 1, subparagraph b) and no. 4, subparagraph a) of the Corporate Income Tax Code.

[8] Approved by Ordinance no. 1011/2001, of 21 August.

[9] See Antunes Varela et al., "Manual of Civil Procedure", Coimbra Publisher, 2nd Ed., 1985, p. 179 et seq.

[10] As also in the tax procedure.

[11] Besides the TCA and, in the tax proceedings, also the Public Prosecutor and the Representative of the Public Treasury.

[12] See also article 2, no. 2 of the Administrative Procedure Code.

[13] See also in this sense (although the Challenger in the case was the substitute) the Court of Appeal Decision of 09.09.2009, in proceedings no. 362/09.

[14] Two-year period which, in our view, is counted from 20 January 2017 (see art. 140, no. 3 of the Personal Income Tax Code).

[15] Which, we have already seen, for purposes of challenge are equated to assessment acts (art. 95, no. 2, subparagraph a) of the General Tax Law).

[16] In this sense, see Court of Appeal Decision of 28.10.2009, in proceedings no. 0595/09.

[17] See Rui Duarte Morais, "On Personal Income Tax", Almedina, 3rd Ed., 2016, p. 216.

[18] See Jorge Lopes de Sousa, "Code of Tax Procedure and Process", Áreas Ed., 6th Edition, 2011, Vol. 1, p. 537.

Frequently Asked Questions

Automatically Created

What is fiscal transparency under Portuguese IRC and IRS tax law and how does it affect partners of law firms?
Fiscal transparency (transparência fiscal) under Portuguese IRC and IRS law means that certain entities, including law firms organized as partnerships (sociedades de advogados), are not subject to corporate income tax at the entity level. Instead, profits and losses are attributed directly to partners in proportion to their participation rights, who then declare this income in their personal tax returns (IRS for individuals, IRC for corporate partners). Article 6 of the IRC Code establishes this regime for partnerships and civil law companies. For law firm partners, this means partnership profits are taxed as professional income (Category B under IRS) regardless of whether actually distributed, eliminating the need for withholding tax on distributions since they represent already-attributed income rather than new taxable events.
Can a tax substitute (substituído) directly challenge undue withholding tax payments made by the substituting entity?
The legitimacy of a tax substitute (substituído) to directly challenge undue withholding tax payments is a contested issue under Portuguese tax law. Generally, tax substitution regimes designate one party (the substitute - substituto tributário) to withhold and remit tax on behalf of another (the substituted - substituído). The Tax Authority traditionally argues that only the substitute entity that actually made the payment has standing to file gracious complaints or seek refunds of erroneous withholdings, since they were the party that paid the State. However, taxpayers argue the substituted party suffers the economic burden and should have direct legitimacy to challenge unlawful retentions, particularly when the substitute refuses to act or when fiscal transparency principles mean the income is taxable directly to the substituted party. CAAD tribunals have addressed this issue with varying approaches, examining whether the specific withholding regime constitutes true substitution or merely a collection mechanism.
What is the procedure for filing a gracious complaint (reclamação graciosa) against unlawful withholding tax in Portugal?
Filing a gracious complaint (reclamação graciosa) against unlawful withholding tax in Portugal follows procedures established in Article 68 of the LGT (Lei Geral Tributária). The complaint must be filed within two years from the payment date or from when the taxpayer became aware of the grounds for complaint. It should be submitted to the Tax Authority office responsible for the tax assessment or withholding, identifying the specific acts challenged, stating the legal and factual grounds, and requesting annulment and refund. For withholding tax cases, the complaint should reference the specific withholding forms (declarações de retenção) and amounts. The Tax Authority has four months to decide; silence constitutes tacit rejection. Following rejection (express or tacit), taxpayers may appeal to administrative courts or, for matters within CAAD jurisdiction, request tax arbitration within 90 days. Documentation proving undue withholding, such as legal opinions on tax residence status or entity classification, strengthens the complaint.
Is the Tax Authority (AT) required to pay compensatory interest on refunds of undue withholding tax retentions?
The Tax Authority is required to pay compensatory interest (juros indemnizatórios) on refunds of undue tax payments under Article 43 of the LGT, but only when specific conditions are met. Compensatory interest applies when tax collection resulted from error attributable to the tax services, calculated from the date of undue payment until refund. However, the Tax Authority argues that when errors originate with taxpayers or their representatives (such as a law firm's accountant incorrectly processing withholdings), the error is not attributable to tax services, disqualifying compensatory interest. The burden lies with taxpayers to demonstrate the error was attributable to tax administration. In withholding tax cases where private entities made erroneous retentions based on their own interpretation, tax authorities typically deny compensatory interest claims, arguing they merely received payments voluntarily made by third parties. Courts and arbitral tribunals examine whether tax services contributed to the error through incorrect guidance, deficient information systems, or improper assessment procedures that should have detected and corrected the undue withholdings.
How does CAAD arbitral tribunal process 493/2017-T address the legitimacy of partners to reclaim withholding tax paid by their law firm?
CAAD arbitral tribunal Process 493/2017-T directly addresses whether a law firm partner has legitimacy (legitimidade) to reclaim withholding tax paid by the firm on distributions made to him. The tribunal confronted the Tax Authority's argument that only the law firm, as the withholding entity (entidade substituta), could seek refund of the €18,055.56 in undue retentions. The petitioner argued that as the party economically burdened by the withholdings (having received only €90,000 of €108,055.56 distributed) and as the taxpayer to whom income is directly attributed under fiscal transparency principles, he possessed direct legitimacy to challenge the unlawful acts through gracious complaint and subsequent arbitration. The case examined whether CAAD's jurisdiction, typically limited to challenging tax assessment acts, extends to undue payment scenarios involving withholding tax, and whether the partner's request for refund and compensatory interest falls within arbitral cognizance powers. The tribunal analyzed the intersection of fiscal transparency regimes, tax substitution principles, and taxpayer standing rights to determine if partners can directly activate legal mechanisms for regularization of undue payments made by their transparent entities.