Process: 529/2017-T

Date: April 18, 2018

Tax Type: IRS

Source: Original CAAD Decision

Summary

This CAAD arbitration (Process 529/2017-T) addresses whether the Portuguese Tax Authority (AT) can unilaterally reclassify a taxpayer from the organized accounting regime to the simplified IRS regime for Category B income without proper notification. The claimants, self-employed professionals since 1983, had voluntarily opted for organized accounting in 2001. In 2014, when their income fell below €200,000, the AT automatically reclassified them to the simplified regime without notification. This prevented them from filing their 2015 and 2016 tax returns under organized accounting, forcing declarations under the simplified regime they never chose. The claimants challenged the 2016 IRS assessment and sought compensatory interest for undue payment. The core legal issue centers on Article 28 of the PITC (Personal Income Tax Code) and whether taxpayers who voluntarily opt for organized accounting can be automatically moved to the simplified regime based solely on revenue thresholds. The case examines the minimum permanence period in tax regimes, the distinction between mandatory classification and voluntary option, and the AT's interpretation through Circular 5/2007. The tribunal must determine if the three-year minimum permanence rule applies to taxpayers who opted for organized accounting, whether the AT violated procedural requirements by not notifying the regime change, and if compensatory interest is due when assessments are annulled due to administrative error. This decision has significant implications for Category B taxpayers regarding regime stability, procedural rights, and the limits of AT's discretionary powers in tax classification.

Full Decision

ARBITRAL DECISION

Report

A - General

A…, taxpayer no. … and B…, taxpayer no.…, residents at …Street, no. …, …-… … (hereinafter referred to, jointly, as "Claimants" and, individually, as "Claimant"), submitted, on 02.10.2017, a request for the constitution of a singular arbitral tribunal in tax matters, which was accepted, aiming, on the one hand, at the annulment of assessment no. 2017…, of 05.07.2017, of Personal Income Tax (hereinafter "PIT"), relating to the year 2016, from which resulted the amount payable of € 37,834.72 (thirty-seven thousand eight hundred and thirty-four euros and seventy-two cents) and, on the other hand, at the condemnation of the Tax and Customs Administration to pay compensatory interest for undue payment and undue retention of tax payment.

Under the terms of subparagraph a) of no. 2 of article 6 and subparagraph b) of no. 1 of article 11 of Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012, of 31 December (the Legal Framework for Arbitration in Tax Matters, hereinafter "LFATM"), the Deontological Council of the Administrative Arbitration Centre (CAAD) designated the undersigned as arbitrator, the Parties, after being duly notified, having not expressed opposition to such designation.

By order of 12.10.2017, the Tax and Customs Administration (hereinafter referred to as "Respondent") proceeded to designate Ms. Dr. C… and Dr. D… to intervene in this arbitral process, in name and representation of the Respondent.

In accordance with the terms of subparagraph c) of no. 1 of article 11 of Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012, of 31 December, the Arbitral Tribunal was constituted on 14.12.2017.

On 18.12.2017, the highest official of the Respondent's department was notified to, if willing, within the period of 30 days, submit a response and request production of additional evidence.

On 30.01.2018, the Respondent submitted its Response and the administrative file.

B – Position of the Claimants

The Claimant has been registered as a self-employed professional since 02.01.1983.

Upon the establishment of the simplified PIT regime (Law 30-G/2000, of 29 December), the Claimant opted for the organized accounting regime, through submission on 28.06.2001 of the corresponding declaration of changes.

In the year 2014, the Claimant's income did not exceed the amount of € 200,000.00 (two hundred thousand euros), a circumstance which led the Respondent to frame him, at its sole discretion, in the simplified taxation regime.

This change in the Claimant's classification, which moved from the organized accounting regime to the simplified regime, was never communicated to the Claimants.

In May 2016, it was not possible for the Claimants to submit their income declaration for the year 2015 with Annex C (business and professional income with organized accounting) because the Claimant was classified in the simplified taxation regime and not in the accounting regime.

Nor were the Claimants able to submit their 2015 income declaration in paper form, since the Respondent's services refused to receive it, for the same reasons.

In order not to be penalized for failure to submit the 2015 income declaration, the Claimants submitted a new declaration (on 31.05.2016), with Category B income being determined on the basis of the simplified taxation regime, which they did not intend.

The Claimants, not accepting the impossibility of submitting the 2015 income declaration with Category B income determined on the basis of the organized accounting regime, submitted a voluntary appeal against the 2015 PIT assessment, which was dismissed by order of 01.08.2017.

It so happened that the deadline for submitting the 2016 income declaration was 31.05.2017, so that, as had happened with respect to 2015 income, it was not possible for the Claimants to submit an income declaration for the year 2016 with Category B income determined on the basis of organized accounting, as they intended, so the Claimants were, once again, obliged to submit an income declaration, this time relating to the year 2016, with Category B income being determined on the basis of the simplified taxation regime.

The Claimants were notified of the 2016 PIT assessment (which they considered illegal) and, even not accepting it, proceeded to its payment.

Under article 28, no. 1 of the PIT Code (hereinafter "PITC"), the determination of business and professional income, except in the case of the allocation provided for in article 20 of the PITC, can be made on the basis of the simplified regime or on the basis of accounting.

The simplified regime encompasses taxpayers who, in the exercise of their activity, have not exceeded in the immediately preceding taxable period an annual net amount of Category B income of € 200,000.00 (two hundred thousand euros).

However, taxpayers who meet the requirements of the simplified regime may opt for the determination of income on the basis of organized accounting, this option being formalized in the declaration of commencement of activity or by the end of March of the year in which they intend to alter the method of income determination.

Opting for the organized accounting regime, the taxpayer shall only have to return to the simplified regime at its own initiative, variations in the annual net amount of Category B income which may occur in the meantime not being relevant for classification purposes.

Having the Claimant opted to be taxed on the basis of organized accounting, the Respondent cannot, at its sole discretion, frame him in the simplified taxation regime.

Since the assessment now challenged is illegal and this defect is due to error attributable to the services, the Claimants have the right to compensatory interest, under the legally provided terms.

C – Position of the Respondent

The Respondent, in its response, recalls the wording given by Law no. 109-B/2001, of 27 December to no. 5 of article 28 of the PITC: "The minimum period of permanence in the simplified regime is three years, automatically renewable for equal periods, except if the taxpayer notifies, under the terms of subparagraph b) of the preceding number, the option for the application of the organized accounting regime".

Under the terms of the provision just transcribed, the period of permanence of taxpayers in the organized accounting regime was only one year, with no renewal for an equal period being applicable.

Law no. 53-A/2006, of 29 December gave the following wording to the already mentioned no. 5 of article 28 of the PITC: "The minimum period of permanence in any of the regimes referred to in no. 1 is three years, renewable for equal periods, except if the taxpayer notifies, under the terms of subparagraph b) of the preceding number, the change of the regime by which it is encompassed".

Circular no. 5/2007, of 13 March clarified that:

"Taxpayers encompassed by the regime for determination of business and professional income on the basis of accounting by not meeting the requirements provided for in no. 2 of article 28 of the Personal Income Tax Code are not subject to the minimum period of permanence provided for in no. 5 of the same article, since their classification does not result from an option."

This means that, in the Respondent's view, the minimum period of permanence in the accounting regime does not apply to taxpayers who were classified in accounting by legal obligation, because this classification derives from the law and not from an option of the taxpayer.

Furthermore, no. 2 of article 28 of the PITC provides that "the simplified regime encompasses taxpayers who, in the exercise of their activity, have not exceeded in the immediately preceding taxable period an annual net amount of income from this category of € 200,000."

In 2001, the Claimant opted for the organized accounting regime, an option valid for that tax year.

In the following tax year, that of 2002, the Claimant was automatically classified in the organized accounting regime by legal mandate.

In 2014, the Claimant's income was less than € 200,000.00, so that, not having exercised the option for the organized accounting regime, he was classified in the simplified regime for the three-year period 2014-2016.

Despite having been classified in the simplified regime, because he had not, in 2014, earned more than € 200,000.00 (two hundred thousand euros) in Category B income, the Claimant could have opted for the accounting regime by delivering, by the end of March 2015, a declaration of changes, under the terms and for the purposes of the provisions of nos. 3 and 4 of article 28 of the PITC.

Since the Respondent merely applied the law, to which the Administration is bound, one cannot speak of error on the part of the services under the terms of article 43 of the General Tax Law (hereinafter "GTL"), reason why the Claimants do not have the right to compensatory interest.

D – Conclusion of the Report and Case Management

By order of 23.02.2018, the Arbitral Tribunal dispensed with the meeting provided for in article 18 of the LFATM, considering that the parties had provided the process with all the necessary and sufficient factual elements for the pronouncement of the decision, which was expected to take place by 23.04.2018, the parties being invited to submit, if willing, written submissions, a right which neither exercised.

The Arbitral Tribunal is materially competent, under the terms of articles 2, no. 1, subparagraph a) of the LFATM.

The Parties have legal personality and legal capacity and have standing under article 4 and no. 2 of article 10 of the LFATM and article 1 of Order no. 112-A/2011, of 22 March.

The cumulation of requests made in this request for arbitral pronouncement, in deference to the principle of procedural economy, is justified because article 3 of the LFATM, by expressly admitting the possibility of "cumulation of requests even if relating to different acts", when the success of the requests depends essentially on the assessment of the same factual circumstances and the interpretation and application of the same principles or rules of law, also accommodates, without hermeneutic abuse, the assessment of a request that flows, in necessary terms, from the judgment which the Arbitral Tribunal reaches as to the validity of the assessment challenged.

The process does not suffer from any nullity.

Factual Matter

2.1. Proved Facts

The Claimant has been registered as a self-employed professional since 02.01.1983 (consensus of the Parties).

Upon the establishment of the simplified PIT regime (by Law no. 30-G/2000, of 29 December), the Claimant opted for the organized accounting regime, having delivered on 28.06.2001 the corresponding declaration of changes (doc. no. 2, attached to the request for arbitral pronouncement).

The Claimant remained classified in the organized accounting regime until 2014 (consensus of the Parties).

In the year 2014, the Claimant's Category B income did not exceed the amount of € 200,000.00 (two hundred thousand euros) (consensus of the Parties).

By virtue of what is mentioned in 2.1.4., in the year 2015, the Respondent automatically classified the Claimant in the simplified regime for the three-year period 2014-2016 (administrative file attached by the Respondent with its Response).

By force of the classification referred to in 2.1.5., it was not possible for the Claimants to submit their income declaration for the year 2015 with Annex C (business and professional income with organized accounting) (consensus of the Parties).

The Claimants submitted a voluntary appeal against the 2015 PIT assessment, which was dismissed by order of 01.08.2017, after the deadline for submitting the 2016 PIT income declaration (doc. no. 3, attached to the request for arbitral pronouncement).

The Claimants, on 31.08.2017, proceeded to pay € 37,834.72 (thirty-seven thousand eight hundred and thirty-four euros and seventy-two cents), the amount required by the assessment challenged.

2.2. Unproved Facts

There are no facts relevant to the assessment of the merits of the case that have been given as unproved.

2.3. Justification for the Establishment of Factual Matter

The facts were given as proved based on the documents attached to the proceedings by the Parties and on the positions assumed by them in the pleadings they submitted.

Legal Matter

3.1. Questions to be decided

It follows from what has been stated above that, essentially, there are two questions to be assessed:

Whether the Respondent can unilaterally alter, in the context of PIT, for the three-year period 2014-2016, the Claimant's taxation regime, classified since 2001 in the organized accounting regime, by virtue of having obtained in the 2014 tax year an annual net income not exceeding that provided for in article 28, no. 2 of the PITC, proceeding to classify him in the simplified regime; and

To clarify whether, should the request for a declaration of illegality and consequent annulment of the assessment now challenged be upheld, the Claimants, within the scope of this arbitral process, may obtain the condemnation of the Respondent to pay compensatory interest.

3.2. Article 28 of the PITC

As stated, the first question that needs to be clarified is whether the Claimant's unilateral classification in the simplified taxation regime, effective for the 2014 tax year, is valid in light of what article 28 of the PITC provides.

No. 1 of article 28 of the PITC explicitly states that the determination of business and professional income, except in the case of the allocation provided for in article 20 of the same Code, can be made on the basis of the simplified regime or on the basis of accounting.

From no. 1 of article 81 of the GTL it results that the taxable matter must be assessed or calculated directly, according to the criteria specific to each tax, the tax administration only being able to proceed to indirect assessment in the cases and conditions expressly provided for in the law. In the PITC, for professional or business income, direct assessment, which is the rule, it should be stressed, is made on the basis of accounting. Indirect assessment of the taxable matter is admitted, of course, as subsidiary, in this case, that which is done using the simplified regime.

It is important to note that all taxpayers can, if that is their intention, have their taxable matter determined on the basis of accounting. The reverse is not true. The simplified regime, under the terms of no. 2 of article 28 of the PITC, cannot be applied to taxpayers who have earned in the immediately preceding taxable period an annual net amount of Category B income exceeding a certain threshold, which today is fixed at € 200,000.00 (two hundred thousand euros). If permanence in the simplified regime implies that taxpayers, in the exercise of their activity, have not exceeded in the immediately preceding taxable period an annual net amount of income from this category of € 200,000.00 (two hundred thousand euros), there is no specific requirement regarding the amount of income earned in order for them to be able to opt for the determination of income on the basis of accounting.

Let us recall that the Claimant, upon the establishment of the simplified taxation regime, expressly opted to have his taxable matter determined directly, through the organized accounting regime. This option, which is in line with what is the standard regime for assessment of the taxable matter, is valid, legitimate, and could never have been conditioned by the amount of income earned or that would come to be earned. That is, any taxpayer, it is repeated, can opt to be taxed under the accounting regime. This option, under the terms of no. 4 of the article we have been referring to, must be formulated by taxpayers in the declaration of commencement of activity or by the end of March of the year in which they intend to alter the method of income determination, through the submission of a declaration of changes. Now, the Claimant opted for the accounting regime on 28.06.2001 and it was on the basis of this that he always calculated his taxable matter. While he earned an annual net amount of Category B income exceeding € 200,000.00 (two hundred thousand euros), access to the simplified regime was legally prohibited to him. However, when, in a certain year, that of 2014, he earned income not exceeding the legal threshold, the simplified regime could already be applied to him, requiring only that the Claimant timely deliver, in accordance with the law, the necessary declaration of changes. To say that the simplified regime could be applied to him is not equivalent to stating that such regime would have to be applied to him should he not opt for the accounting regime. This option he had already taken at the appropriate time, and its alteration – only possible should he have earned in the immediately preceding taxable period an annual net amount of Category B income not exceeding € 200,000.00 (two hundred thousand euros) – would depend on the manifestation of the taxpayer's will, which here, manifestly, did not occur.

As the arbitral decision rendered in case 295/2017-T, which was heard at CAAD, rightly recalls, "this is, indeed, the conclusion that results from the understanding of the Tax Authority disclosed through Circular no. 2/2016, of 6 May, under the terms of which 'taxpayers who exercise the option for the determination of income on the basis of accounting under the conditions provided for in no. 4 of article 28 of the Personal Income Tax Code, remain in this regime until manifestation to the contrary, changes in the annual net amount of Category B income that may occur being irrelevant'. We cannot but adhere to this judgment.

With due respect, a reading different from the one the Arbitral Tribunal adopts here implies looking unfavorably upon what is undoubtedly the standard taxation regime, that is, the one based on direct assessment of the taxable matter. This is the regime that best serves the constitutional principle of taxation of actual income. Forcing the accounting regime, the standard regime, on taxpayers who earn income exceeding the threshold chosen by the legislator, is understood. Imposing the simplified regime on taxpayers who, meeting its respective requirements, have never opted for the accounting regime, is also comprehensible. What is not acceptable is the imposition of the simplified regime on the taxpayer who opportunely chose to be taxed according to the standard regime having never declared an intention for anything different.

Thus, not having the Claimant submitted any declaration of change of his classification, the regime in which he was situated – that of organized accounting – should not have been unilaterally reconsidered by the Respondent, all the more so without any prior notice to the Claimants. In fact, the legislator did not provide for any situation that would terminate the organized accounting regime, regardless of whether such classification results from the taxpayer's option or from the application of the law.

The Arbitral Tribunal concludes, therefore, that the unilateral classification carried out by the Respondent in 2015 (and, insofar as it concerns us now, with effect in 2016) is illegal, for not having respected article 28 of the PITC. Since this classification is invalid, the assessment which was based on it is tainted, being subject to annulment.

3.3. Compensatory Interest

Subparagraph b) of no. 1 of article 24 of the LFATM provides that "the arbitral decision on the merits of the claim from which no appeal or challenge is possible binds the tax administration from the end of the period provided for appeal or challenge, this latter being required, in the exact terms of the success of the arbitral decision in favor of the taxpayer and until the end of the period provided for voluntary compliance with judgments of the tax courts, to restore the situation that would exist if the tax act which is the subject matter of the arbitral decision had not been performed, adopting the necessary acts and operations for such purpose".

It is not ignored that the legislative authorization granted to the Government by article 124 of Law no. 3-B/2010, of 28 April, on the basis of which the LFATM was approved, determines that the tax arbitral process constitute an alternative procedural means to the judicial challenge process and to the action for the recognition of a right or legitimate interest in tax matters. Even if subparagraphs a) and b) of no. 1 of article 2 of the LFATM base the jurisdiction of arbitral tribunals in "declarations of illegality", it seems reasonable the understanding that their powers include those attributed to the tax courts in challenge proceedings, it being certain that in judicial challenge proceedings, in addition to the annulment of tax acts, applications for indemnification can be assessed, particularly regarding compensatory interest.

Indeed, the principle of cognoscibility of indemnification requests, in voluntary appeal or in judicial proceedings, is justified whenever the damage sought to be redressed results from a fact attributable to the Tax and Customs Administration. We find manifestations of this principle in no. 1 of article 43 of the General Tax Law and in article 61 of the Code of Tax Procedure and Process.

Thus, the assessment of the request for payment of compensatory interest made by the Claimants is justified.

Compensatory interest is due when it is determined, in voluntary appeal or judicial challenge, that there was error attributable to the services resulting in payment of the tax debt in an amount exceeding that legally due.

Now, the Claimants having paid the tax which by the challenged and now annulled assessment was, due to error attributable to the services, required of them, they have the right not only to the reimbursement of everything they paid in excess, but also to receive compensatory interest calculated from the date of payment of the excess until its full reimbursement.

Decision

Under the terms and with the grounds set out above, the Arbitral Tribunal decides:

To rule in favor entirely of the request for arbitral pronouncement, consequently annulling the PIT assessment no. 2017…, of 05.07.2017, relating to the year 2016, with all legal consequences; and

To rule in favor of the request for condemnation of the Respondent to the payment of compensatory interest, at the legal rate, being calculated from the date of payment of the undue tax payment until its full reimbursement.

Process Value

Under the terms of the provision in no. 2 of article 306 of the Civil Procedure Code, in article 97-A of the Tax Procedure and Process Code and also of no. 2 of article 3 of the Regulation of Costs in Tax Arbitration Processes, the value of the process is set at € 37,834.72 (thirty-seven thousand eight hundred and thirty-four euros and seventy-two cents).

Costs

For the purposes of the provision in no. 2 of article 12 and in no. 4 of article 22 of the LFATM and of no. 5 of article 4 of the Regulation of Costs in Tax Arbitration Processes, the amount of costs is set at € 1,836.00 (one thousand eight hundred and thirty-six euros), under the terms of Table I attached to the said Regulation, to be borne entirely by the Respondent.

Lisbon, 18 April 2018

The Arbitrator

_______________________________
(Nuno Pombo)

Text prepared by computer, under the terms of no. 5 of article 131 of the Civil Procedure Code, applicable by cross-reference of subparagraph e) of no. 1 of 29 of Decree-Law no. 10/2011, of 20 January, and using the spelling prior to the said Orthographic Agreement of 1990.

Frequently Asked Questions

Automatically Created

What happens when the Portuguese Tax Authority reclassifies a taxpayer from organized accounting to the simplified regime without notification?
When the Portuguese Tax Authority reclassifies a taxpayer from organized accounting to the simplified regime without notification, it constitutes a procedural violation with significant consequences. According to this CAAD decision, taxpayers who voluntarily opted for organized accounting under Article 28 of the PITC have a legitimate expectation to remain in that regime for the minimum three-year period, renewable automatically. The lack of notification prevents taxpayers from exercising their rights, including the ability to file proper tax returns and contest the regime change timely. Such unilateral reclassification without communication violates principles of administrative procedure and taxpayer protection, potentially rendering subsequent tax assessments illegal and subject to annulment through arbitration.
Can the Tax Authority automatically change a taxpayer's IRS Category B income tax regime based on revenue thresholds?
The Tax Authority's ability to automatically change a taxpayer's IRS Category B regime based on revenue thresholds depends on how the taxpayer was originally classified. Under Article 28(2) of the PITC, the simplified regime applies to taxpayers with Category B income not exceeding €200,000 in the preceding year. However, taxpayers may voluntarily opt for organized accounting regardless of revenue. The critical distinction lies between mandatory classification (by law due to exceeding thresholds) and voluntary option. According to AT's Circular 5/2007, only taxpayers mandatorily classified in organized accounting can be automatically moved to simplified regime when revenues fall below €200,000. Taxpayers who voluntarily opted for organized accounting benefit from the three-year minimum permanence rule under Article 28(5) PITC, preventing automatic reclassification without their consent or proper notification.
What are the taxpayer's rights when the simplified regime is applied without their knowledge or consent in Portugal?
When the simplified regime is applied without a taxpayer's knowledge or consent in Portugal, taxpayers have several rights and remedies. First, they can challenge the regime classification and any resulting tax assessments through administrative appeals or tax arbitration at CAAD. The taxpayer maintains the right to file declarations according to their legitimately chosen regime. If the AT's actions prevent proper filing or result in illegal assessments, taxpayers are entitled to annulment of those assessments. Additionally, when the error is attributable to tax administration services and the taxpayer has paid taxes under an illegal assessment, they have the right to compensatory interest (juros indemnizatórios) for both undue payment and undue retention, as established in the General Tax Law. The violation of notification duties strengthens claims for procedural irregularity and supports requests for interest compensation.
Is a taxpayer entitled to compensatory interest (juros indemnizatórios) when an IRS assessment is annulled by CAAD?
Yes, taxpayers are entitled to compensatory interest (juros indemnizatórios) when an IRS assessment is annulled by CAAD, provided certain conditions are met. Under Portuguese tax law, specifically the General Tax Law (LGT), compensatory interest is due when: (1) a tax assessment is annulled or reduced; (2) the taxpayer has made payment of the contested amount; (3) the error or illegality is attributable to tax administration services rather than the taxpayer; and (4) there has been undue payment or undue retention of funds. The interest compensates taxpayers for the financial loss resulting from having funds improperly retained by the State. In cases where the AT fails to properly notify regime changes or illegally assesses taxes due to administrative errors, these conditions are typically satisfied, making compensatory interest mandatory rather than discretionary, calculated from the payment date until reimbursement.
What is the €200,000 revenue threshold for the IRS simplified regime and how does it affect taxpayers with organized accounting?
The €200,000 revenue threshold under Article 28(2) of the PITC serves as the objective criterion for automatic inclusion in the simplified IRS regime for Category B (business and professional) income. Taxpayers whose annual net Category B income in the immediately preceding taxable period does not exceed this amount are automatically encompassed by the simplified regime, which applies simplified coefficients to gross income rather than requiring detailed accounting. However, taxpayers meeting simplified regime requirements may voluntarily opt for organized accounting by declaring this choice at activity commencement or by March 31st of the relevant year. Once a taxpayer opts for organized accounting, they are subject to a three-year minimum permanence period, renewable automatically, regardless of revenue fluctuations. The threshold determines eligibility for simplified regime but does not automatically override a valid option for organized accounting, meaning taxpayers with revenues below €200,000 who opted for accounting should not be automatically reclassified without consent or proper legal procedure.