Process: 517/2017-T

Date: April 30, 2018

Tax Type: IRC

Source: Original CAAD Decision

Summary

This CAAD arbitral decision (Process 517/2017-T) addresses whether a Portuguese company can claim an IRC tax credit for taxes paid in Morocco when those taxes were levied in violation of the Portugal-Morocco Double Taxation Convention. The claimant, A… S.A., operated a Moroccan branch that made payments to its Portuguese parent company for services (equipment transport, project studies, administrative support). Morocco applied a 10% withholding tax on these payments under its domestic law, totaling €14,683.69 (2007), €10,000.00 (2008), and €254,002.56 (2009). The Portuguese Tax Authority denied the IRC tax credit under Article 91(2) of the IRC Code, arguing Morocco's taxation violated Article 7(1) of the bilateral treaty, which allocates taxation rights for business profits exclusively to the residence state unless attributable to a permanent establishment. The claimant contended that signing a tax treaty guarantees Portuguese residents taxation according to treaty terms and invoked constitutional principles of good faith, trust, equality, and legal certainty. The tribunal ruled against the claimant, confirming that Morocco indeed breached the convention by taxing income not attributable to the permanent establishment. However, the tribunal held that Portugal is not obligated to bear the financial consequences of another state's treaty violation. The affected taxpayer must pursue remedies in Morocco through domestic courts or invoke the mutual agreement procedure under Article 25 of the treaty. Since Morocco's taxation was non-compliant with the convention, Article 23(1) does not mandate Portugal to grant the tax credit. The decision establishes that tax credits for international double taxation require the foreign tax to comply with applicable treaty provisions, and taxpayers must actively challenge unlawful foreign taxation rather than automatically shifting the burden to their residence state.

Full Decision

ARBITRAL DECISION

The arbitrators constituting this Arbitral Tribunal agree as follows:

I - REPORT

Constitution of the arbitral tribunal and procedural handling

A…, S.A., with registered office at Rua …, no.…, …, Braga, NIPC…, duly presented a request for arbitral pronouncement, with the Tax and Customs Authority as Respondent.

The Claimant designated Prof. Dr. Rui Duarte Morais as arbitrator. The head of the Tax Administration designated Prof. Dr. Manuel Pires as arbitrator. The arbitrators designated by the parties, who accepted such function, agreed to designate Councillor Carlos Cadilha as presiding arbitrator, who also accepted the designation.

The Collective Arbitral Tribunal was constituted on 20/12/2017.

The Tax and Customs Authority submitted its response, in which it concluded for the dismissal of the request.

As the Claimant waived the production of witness evidence, the meeting referred to in article 18 of the RJAT was dispensed with, due to lack of subject matter.

The parties submitted written submissions, in which they sustained their initial positions.

Request for arbitral pronouncement

The Claimant requests the annulment of the additional Corporate Income Tax (IRC) assessments no. 2017…, in the amount of € 73,521.48, relating to the tax year 2007, of assessment no. 2017…, in the amount of € 10,753.90, relating to the tax year 2008, and of IRC assessment no. 2013… in the amount of € 277,825.74, relating to the tax year 2009.

Subject matter of the dispute

The Claimant contends that the impugned assessments are illegal insofar as they result from the non-acceptance of the deduction from IRC collection (tax credit) of the amount corresponding to the tax paid by it in Morocco, levied on payments made by its branch located there to the "parent company", to which it would be entitled under the terms of article 23 of the Tax Treaty in force between the two countries.

Beyond sustaining its right to such tax credit, the Claimant contends that the assessments in question violate the constitutional principles of good faith, confidence, equality, and legal certainty. More specifically, it argues that Portugal, by signing a Tax Treaty with another country, guarantees to its residents that they will be taxed in accordance with the terms arising from such treaty and, further, that if a Tax Treaty did not exist between the Kingdom of Morocco and Portugal, that country would be free to tax the transactions in question, but then the deduction made as a tax credit for international double taxation would not be questioned in Portugal, by reason of the provisions in Portuguese domestic law.

The TA counters that, since the tax levied by Morocco does not comply with the Tax Treaty in force between the two countries, the amount paid there is not deductible in Portugal by virtue of the provisions in no. 2 of article 91 (former article 85) of the IRC Code.

II - ESTABLISHED FACTS

The following facts are considered established:

The Claimant is a commercial company whose corporate purpose consists of carrying out public works projects, civil construction industry, purchase and sale of real estate, and provision of engineering services.

The Claimant carries on business in Morocco through a branch — B….

The "parent company" of the Claimant, based in Portugal, invoiced to the branch (permanent establishment) in Morocco, by reference to the taxation periods in question, invoices related to the transport and assembly of equipment; invoices related to studies and projects associated with the works carried out in Morocco; invoices related to administrative support for the operation of the branch (invoices of which copies are attached as appendices to the RIT).

The payments made by branch B… to its respective "parent company" were subject, in Morocco, to taxation at the rate of 10%, in amounts corresponding to €14,683.69 (2007), €10,000.00 (2008), and €254,002.56 (2009).

The Claimant filed a gracious administrative review of the self-assessed assessments issued by the Portuguese TA and, following the denial of such reviews, appealed hierarchically, appeals which obtained partial success regarding the tax years 2007 and 2008, with the assessments now impugned, relating to these two tax years, resulting from the administrative correction of those initially issued.

Between Portugal and the Kingdom of Morocco, the Tax Treaty approved by Resolution of the Assembly of the Republic no. 69-A/98, published on 23.12.1998, is in force, which, regarding the allocation of the right to tax the profits of enterprises (article 7), follows the OECD Model in force at that date.

On 23 January 2012, the Claimant requested the Directorate of Services for International Tax Relations to take steps to resolve the described problem of double taxation, resulting from Morocco's non-compliance with the provisions of such Tax Treaty, through a mutual agreement procedure with the competent authorities of that country.

III - Unproven Facts

It was not established that the Claimant (in particular, through its branch in Morocco) made any efforts with the Moroccan tax administration to annul the tax assessments levied on the payments made to the "parent company" and/or that it appealed against such assessments before the courts of the Kingdom of Morocco.

IV - CASE MANAGEMENT

The parties have legal personality and legal capacity, are legitimate, and are properly represented.

No exceptions were alleged that warrant consideration.

There are no irregularities that preclude examination of the merits.

The requests formulated by the Claimant are cumulative, pursuant to article 3 of the RJAT.

V – DECISION

It is necessary to begin by clarifying the following: the services in question were rendered by the "parent company", located in Portugal, to the Moroccan branch. The income derived from such operations is therefore attributable to the "parent company" and not to the activity of the permanent establishment located in Morocco. From the perspective of Morocco's taxation of the profit of the permanent establishment located there, the amounts in question constitute expenses, as indeed provided for in article 7, no. 3, of the Convention between the Portuguese Republic and the Kingdom of Morocco, which, moreover, were accepted there, as the Claimant itself admits. What is therefore not in question is the taxation, by Morocco, of the income (profit) of a permanent establishment located there, an extension of a company resident in Portugal, but rather the taxation (by the country of source) of the profit of a non-resident not attributable to the activity carried on in that country through a permanent establishment. It was, indeed, in this perspective that the Moroccan tax administration proceeded to tax the income (amounts paid by the Moroccan branch) in question, invoking in doing so the provisions of article 5, II, of its Code Général des Impôts relating to income earned in that country by non-resident companies, not attributable to the activity of a permanent establishment located there.

The question will then arise: in this situation, can it be stated that Morocco breached the Tax Treaty, as the Claimant contends? The answer is affirmative by virtue of the provisions in article 7, no. 1 of the aforementioned treaty.

However, contrary to what the Claimant appears to contend, it is not incumbent upon one Contracting State to bear, without more, the financial consequences of the breach of conventional obligations by the other Contracting State, and affected taxpayers should activate the guarantees provided for by the law of the "offending" country or/and by the treaty (article 25 of the aforementioned Portuguese-Moroccan treaty) so that that State recognizes the illegality. Accordingly, since the taxation that occurred in Morocco did not comply with the Tax Treaty, the tax credit considered by the now Claimant violates the provisions in article 23, no. 1 of the aforementioned treaty and in article 91, no. 2 (former article 85) of the IRC Code: when there exists a treaty to eliminate double taxation concluded by Portugal, the deduction to be made under the preceding number cannot exceed the tax paid abroad in accordance with the provisions of the treaty.

What is in reality at issue is the erroneous application by Morocco of the Tax Treaty concluded with Portugal, a matter which, as noted above, should have been raised with the competent entities of that country, which did not happen. Only in the face of Morocco's final refusal to recognize its breach of its conventional obligations could the Claimant question whether the constitutional principles of good faith, confidence, equality, and legal certainty would be violated, since only then would there have been a greater taxation of a resident in Portuguese territory who obtained income in another country with which there exists a treaty of the aforementioned type, but which did not fulfill its respective obligations, than a resident who obtains income in another country with which there is no treaty, since this latter would benefit from the credit for international double taxation granted unilaterally by Portuguese law.

There remains the issue of the opening of the mutual agreement procedure requested by the Claimant. Whether or not the TA fulfilled its obligations arising from the request presented to it in this regard is a matter which manifestly exceeds the subject matter of this proceeding, which is confined — moreover, as petitioned — to the examination of the legality of the impugned assessments. Furthermore, arbitral tribunals (CAAD) would in any case be incompetent, ratione materiae, to examine such a matter.

VI – DECISION

In view of the foregoing, it is concluded that the request is wholly without merit.

Having regard to the provisions in articles 306, no. 2 of the CPC, article 97-A, no. 1 of the CPPT, and article 3, no. 2 of the Regulation on Costs in Tax Arbitration Proceedings, the value of the case is set at € 358,536.50, with the costs being the responsibility of the claimant in light, in particular, of the provisions in no. 2 of article 5 of the Regulation on Costs in Tax Arbitration Proceedings.

Notification is hereby ordered.

Lisbon, 30 April 2018

The Presiding Arbitrator

(Carlos Cadilha)

The Member Arbitrator

(Rui Duarte Morais)

The Member Arbitrator

(Manuel Pires)

Frequently Asked Questions

Automatically Created

What happens to the IRC tax credit when the source state collects tax in violation of a double taxation convention?
When the source state collects tax violating a double taxation convention, the residence state (Portugal) is not automatically required to grant an IRC tax credit. The CAAD tribunal ruled that Portugal does not bear financial consequences of another state's treaty breach. Article 91(2) of the IRC Code and Article 23 of the applicable treaty only provide credits for taxes levied in compliance with the convention. Taxpayers must challenge the unlawful taxation in the source state through domestic remedies or invoke the mutual agreement procedure under Article 25 of the treaty to resolve the double taxation issue.
Can a Portuguese company deduct foreign tax paid in Morocco under Article 91 of the IRC Code if the tax was not compliant with the applicable tax treaty?
No, a Portuguese company cannot deduct foreign tax paid in Morocco under Article 91 of the IRC Code if the tax violated the applicable tax treaty. The CAAD established that the tax credit mechanism in Article 91(2) IRC Code and Article 23 of the Portugal-Morocco Convention requires the foreign tax to comply with treaty provisions. In this case, Morocco taxed payments to the Portuguese parent company under its domestic law (Article 5, II of Code Général des Impôts), breaching Article 7(1) of the treaty which reserves taxation rights to Portugal for business profits not attributable to a Moroccan permanent establishment. Consequently, the non-compliant Moroccan tax does not qualify for credit relief in Portugal.
How does the CAAD arbitral tribunal address the credit method for eliminating international double taxation under bilateral tax conventions?
The CAAD tribunal applies a strict compliance approach to the credit method under bilateral tax conventions. Article 23 of tax treaties following the OECD Model provides that the residence state grants credits to eliminate double taxation, but only for taxes lawfully levied by the source state according to treaty provisions. The tribunal clarified that the credit method does not operate as an unconditional guarantee; it presupposes the source state's taxation conforms to treaty allocation rules. When the source state breaches the convention (as Morocco did by taxing income under Article 7(1)), the residence state is not obligated to grant credits. Instead, taxpayers must pursue remedies in the source state or activate the mutual agreement procedure to enforce treaty compliance and obtain relief from illegitimate taxation.
Does signing a double taxation convention between Portugal and another country guarantee Portuguese residents the right to deduct all taxes paid in the source state?
No, signing a double taxation convention does not guarantee Portuguese residents the automatic right to deduct all taxes paid in the source state. The CAAD rejected the claimant's constitutional arguments based on good faith, trust, equality, and legal certainty. The tribunal emphasized that tax treaties allocate taxation rights between contracting states and establish procedures for eliminating double taxation when taxes are levied in accordance with treaty provisions. Portugal's obligation under the credit method (Article 23) is conditional upon the source state's compliance with the convention. If the source state taxes in violation of treaty provisions, the residence state does not automatically compensate taxpayers. Instead, affected taxpayers must invoke remedies against the offending state, either through domestic legal challenges or the mutual agreement procedure under Article 25.
What constitutional principles (good faith, trust, equality, legal certainty) apply when challenging IRC additional assessments related to international double taxation credits?
Constitutional principles of good faith, trust, equality, and legal certainty have limited application when challenging IRC assessments related to international double taxation credits where the source state violated treaty provisions. The CAAD tribunal rejected these constitutional arguments, clarifying that Portugal's obligations under tax treaties are defined by the treaty text itself, particularly the credit method provisions in Article 23. The principle of good faith does not transform the conditional credit mechanism into an absolute guarantee against all foreign taxation. While Portugal must honor its treaty commitments, it is not constitutionally required to bear financial consequences of another state's treaty breach. Taxpayers' legitimate expectations extend to Portugal applying treaty provisions correctly, but not to automatic credit for non-compliant foreign taxes. The proper remedy lies in challenging the unlawful taxation in the source state or through diplomatic mutual agreement procedures, not in imposing additional constitutional obligations on Portugal beyond treaty terms.