Process: 55/2016-T

Date: September 5, 2016

Tax Type: IRC

Source: Original CAAD Decision

Summary

This arbitration case involves A… S.A., a wholesale and retail company, challenging an additional IRC (Corporate Income Tax) assessment of €825,797.84 for fiscal year 2011. The dispute centers on the inland development tax benefit (benefício à interioridade) under Article 43 of the Tax Benefits Statute, which allows qualifying companies located in interior regions to apply a reduced IRC rate of 15% instead of the standard rate. The company, headquartered in an eligible inland municipality since 1960, applied this reduced rate in its 2011 tax return, believing it met all legal requirements. During a 2015 tax inspection, authorities determined the company failed to comply with a key requirement: use of the Permanent Inventory System as mandated by Article 12(b) of Decree-Law 158/2009. Tax inspectors found that the company only recorded inventory movements on December 31st, maintaining zero balances in Cost of Goods Sold accounts until year-end, effectively showing 100% profit margins throughout the year. This practice violated the continuous inventory tracking requirement, disqualifying the company from the tax benefit. The company challenged the assessment through CAAD (Centre for Administrative Arbitration) on three legal grounds: error in legal requirements, defect in reasoning, and abuse of power. The arbitral tribunal, comprised of three arbitrators appointed by CAAD's Ethics Council, accepted jurisdiction under the Legal Regime for Arbitration in Tax Matters (RJAT). The tribunal found no procedural irregularities and dispensed with oral hearings per efficiency principles. The case demonstrates how technical accounting compliance requirements can determine eligibility for significant tax benefits, and illustrates the arbitration process available to companies disputing IRC assessments in Portugal.

Full Decision

ARBITRATION AWARD

The Arbitrators José Pedro Carvalho (President Arbitrator), Maria Cristina Aragão Seia and Sofia Cardoso, appointed by the Ethics Council of the Centre for Administrative Arbitration to form an Arbitral Tribunal, hereby award:

I – REPORT

On 2 February 2016, A…, S.A., with Tax Identification Number … and with registered office at avenue …, n.…, …, …-… …, filed a request for constitution of an arbitral tribunal, pursuant to the combined provisions of Articles 2 and 10 of Decree-Law No. 10/2011, of 20 January, which approved the Legal Regime for Arbitration in Tax Matters, as amended by Article 228 of Law No. 66-B/2012, of 31 December (hereinafter, abbreviated as RJAT), seeking the declaration of illegality of the additional corporate income tax assessment No. 2015…, relating to the fiscal year 2011, in the amount of € 825,797.84, and the respective compensation note No. 2015…, from which resulted tax payable in the amount of € 93,110.62.

To support its request, the Claimant alleges, in summary, that the additional assessment suffers from:

Error in the legal requirements;

Defect in reasoning;

Abuse of power.

On 04-02-2016, the request for constitution of the arbitral tribunal was accepted and automatically notified to the Tax Authority.

The Claimant did not proceed to appoint an arbitrator, and therefore, pursuant to the provisions of subparagraph (a) of paragraph 2 of Article 6 and subparagraph (a) of paragraph 1 of Article 11 of the RJAT, the President of the Ethics Council of the CAAD appointed the signatories as arbitrators of the collective arbitral tribunal, who communicated acceptance of the appointment within the applicable period.

On 05-04-2016, the parties were notified of these appointments and did not manifest any intention to refuse any of them.

In accordance with the provisions of subparagraph (c) of paragraph 1 of Article 11 of the RJAT, the collective Arbitral Tribunal was constituted on 20-04-2016.

On 24-05-2016, the Respondent, duly notified for this purpose, filed its defence opposing solely through challenge.

Given that in arbitral proceedings the general procedural principles of procedural efficiency and prohibition of unnecessary acts apply, pursuant to the provisions of subparagraphs (c) and (e) of Article 16 of the RJAT, the hearing referred to in Article 18 of the RJAT was dispensed with.

Having been granted a period for the submission of written arguments, these were presented by the parties, making statements regarding the evidence produced and reiterating and developing their respective legal positions.

A period of 30 days was set for the delivery of the final award, following the presentation of arguments by the Tax Authority.

The Arbitral Tribunal is materially competent and is regularly constituted, in accordance with Articles 2, paragraph 1, subparagraph (a), 5 and 6, paragraph 1, of the RJAT.

The parties have legal personality and capacity, are legitimate and are legally represented, in accordance with Articles 4 and 10 of the RJAT and Article 1 of Administrative Order No. 112-A/2011, of 22 March.

The proceedings do not suffer from nullities.

Thus, there is no obstacle to the examination of the merits of the case.

All matters considered, it is appropriate to deliver:

II. AWARD

A. FACTUAL MATTERS

A.1. Facts established as proven

  1. The Claimant is a limited company engaged in the wholesale and retail trade of domestic appliances, electrical materials, hydraulic equipment, decoration items, water drilling, metalworking, manufacture of hydraulic equipment, electrical installations, solar equipment and air conditioning.

  2. Since its incorporation, on 28 December 1960, the Claimant has had its registered office in the Municipality of….

  3. Since the tax year 2011, the Claimant has consistently calculated its taxable income using direct methods, maintains its tax situation properly regularized with the Tax and Customs Authority and Social Security, and has never presented any overdue salaries.

  4. The Claimant, at the date of the tax event, was legally constituted, complied with the legal conditions necessary for the exercise of its activity, and located its principal activity in …, where it concentrated 100% of its payroll.

  5. With reference to the tax year 2011, believing that all requirements for the benefit of the inland development tax incentive, provided for in paragraph 1 of Article 43 of the Tax Benefits Statute, in the version prior to Law No. 64-B/2011, of 30 December, were met, the Claimant applied, in its respective Tax Return Form ("Model 22") for corporate income tax, the reduced corporate income tax rate of 15% on its taxable income.

  6. Between 22-05-2015 and 11-08-2015, the Claimant was subject to a tax inspection action, relating to the tax year 2011.

  7. In said action it was established that, with respect to accounting movements, as of 31 December 2011, the accounting extracts of accounts 61 – Cost of Goods Sold and Materials Consumed and 71 – Sales, presented a balance of €6,569,176.70 and €8,963,030.84, respectively.

  8. It was further established that, as of 30 December 2011, the balance of account 61 – Cost of Goods Sold and Materials Consumed was "Zero", as movements were only recorded on 31 December.

  9. It was further verified that until 30 December, the Claimant had not recorded any costs of sales made throughout the year, that is, it had recorded sales with a 100% margin.

  10. It was also verified that accounts 32-Merchandise and 33-Raw Materials had only opening balance entries (transfer of balances from the prior year) and on 31 December, when determining the cost of sold inventory and consumed materials, revealing the company's inventory on 31 December of each year.

  11. As a result of said tax inspection action, the corresponding Tax Inspection Report was issued, notified to the Claimant on 9 September 2015.

  12. In that Report it was determined that there was a failure to comply with the requirements to benefit from the reduced rate provided for in Article 43 of the Tax Benefits Statute, as the Claimant was not using the Permanent Inventory System, thus disregarding the provisions of subparagraph (b) of paragraph 1 of Article 12 of Decree-Law 158/2009 of 13 July, and therefore the accounting could not be considered organized in accordance with the Accounting Standardization System.

  13. In said report, the following correction was proposed at the level of tax payable for corporate income tax purposes, in the amount of € 80,891.72:

  14. Following the proposal formulated, the additional corporate income tax assessment No. 2015…, relating to the fiscal year 2011, in the amount of € 825,797.84, and the respective compensation note No. 2015…, from which resulted tax payable in the amount of € 93,110.62, was issued, with a final payment deadline of 11 November 2015.

A.2. Facts established as not proven

With relevance to the decision, there are no facts that should be considered as not proven.

A.3. Reasoning of the proven and not proven factual matters

With respect to the factual matters, the Tribunal does not have to rule on everything that was alleged by the parties; rather, it is incumbent upon it to select the facts that matter for the decision and distinguish the proven from the not proven matters (cf. Article 123, paragraph 2, of the Tax Procedure and Process Code and Article 607, paragraph 3 of the Civil Procedure Code, applicable by virtue of Article 29, paragraph 1, subparagraphs (a) and (e), of the RJAT).

In this manner, the facts relevant for the judgment of the case are chosen and defined according to their legal relevance, which is established in light of the various plausible solutions of the legal question(s) (cf. former Article 511, paragraph 1, of the Civil Procedure Code, corresponding to the current Article 596, applicable by virtue of Article 29, paragraph 1, subparagraph (e), of the RJAT).

Thus, taking into account the positions taken by the parties, in light of Article 110/7 of the Tax Procedure and Process Code, the documentary evidence and the file attached to the record, the facts listed above were considered proven, with relevance to the decision, taking into account that, as stated in the Decision of the Administrative Court of South, of 26-06-2014, delivered in case 07148/13[1], "the probative value of the tax inspection report (…) may have probative force if the assertions contained therein are not challenged".

B. ON THE LAW

The question presented for decision by this arbitral tribunal is only one, and of simple formulation, concerning whether the circumstance established that the Claimant was not using the Permanent Inventory System, allows the conclusion, as the Tax Authority did and is underlying the contested tax act, that the Claimant's accounting could not be considered organized in accordance with the Accounting Standardization System, thereby verifying the failure to comply with the requirements to benefit from the reduced rate provided for in Article 43 of the Tax Benefits Statute.

Article 43, paragraph 1, of the Tax Benefits Statute, in the applicable version, provides as follows:

"To companies that directly and primarily exercise an economic activity of an agricultural, commercial, industrial or service provision nature in inland areas, hereinafter referred to as 'beneficiary areas', the following tax benefits are granted:

a) The corporate income tax rate provided for in paragraph 1 of Article 80 of the respective Code is reduced to 15% for entities whose principal activity is located in beneficiary areas;"

Decree-Law No. 55/2008, of 26 March, in turn, established the regulatory norms necessary for the proper implementation of tax incentives for inland development, including the regime for reduction of corporate income tax rate, as stated in its Article 1, which provides that: "This decree-law aims to establish the regulatory norms necessary for the proper implementation of measures to encourage accelerated recovery of Portuguese regions that suffer from inland development problems".

In Article 2 of that decree-law, the conditions for access of beneficiary entities are defined as follows:

"Without prejudice to the provisions of Article 39-B of the Tax Benefits Statute, beneficiary entities must meet the following access conditions:

a) Be legally constituted and comply with the legal conditions necessary for the exercise of their activity;

b) Be in a regularized situation with the tax administration, social security and the respective municipality;

c) Have accounting organized in accordance with the Official Chart of Accounts;

d) Locate their principal activity in the beneficiary areas;(...)".

It is, in this manner, believed to be indisputable that one of the essential requirements for the Claimant to benefit from the reduced rate regime provided for in Article 43 of the Tax Benefits Statute is that of having accounting organized, in accordance with the Official Chart of Accounts which, in 2010, was replaced by the Accounting Standardization System, established by Decree-Law No. 158/2009, of 13 July which, in paragraph 1 of its Article 12, provides as follows:

"The entities to which the Accounting Standardization System or the international accounting standards adopted by the EU are applicable are obliged to adopt the permanent inventory system in the accounting of inventories, in the following terms:

a) Proceed to physical counts of inventories with reference to the end of the fiscal year, or, throughout the year, on a rotative basis, so that each item is counted, at least, once in each fiscal year;

b) Identify the items as to their nature, quantity and unitary and global costs, in such a way as to permit verification, at any time, of the correspondence between the physical counts and the respective accounting entries."

As the Claimant did not meet the requirements referred to in paragraph 2 of Article 12 of that Decree-Law No. 158/2009 for exemption from use of the permanent inventory system, and from the inspection and analysis of its accounting it was verified that it did not use, for accounting purposes, the permanent inventory system, the Tax Authority concluded that the Claimant did not have its accounting organized in accordance with the Accounting Standardization System and, as such, was not qualified for the tax benefit of the reduced corporate income tax rate, provided for in Article 43 of the applicable Tax Benefits Statute.

It is not, however, possible to ratify such understanding, it being that the Tax Authority itself, represented by its Assistant Director-General for Personal Income Tax and International Relations, already reached this conclusion, in Circular Memorandum 20191, of 23-06-2016, where it can be read, in point 7, among other things, that: "the fact that an entity does not adopt the permanent inventory system, being obliged to do so, is not by itself reason to conclude that the Accounting Standardization System was not adopted and that the accounting is not properly organized."

Said Circular Memorandum arose following the Opinion of the Accounting Standardization Commission, in response to a request formulated by the Corporate Income Tax Service Directorate, where it was written, among other things, that:

"a) It results from point 1.3 of Annex I to Decree-Law No. 158/2009, of 13 July, that the permanent inventory system is not an accounting instrument that is part of the Accounting Standardization System (SNC), being instead, in accordance with the provisions of Article 12 of that decree-law, an obligation of entities to which the Accounting Standardization System or the international accounting standards adopted by the EU are applicable.

b) The fact that an entity does not adopt the permanent inventory system when obliged to do so, does not allow the conclusion, by itself, that the Accounting Standardization System was not adopted and does not prevent its financial statements from presenting truthfully and fairly its financial position, financial performance and changes in financial position (...)".

In this manner, the tax act subject to the present arbitration action suffering from error in the legal requirements, it must be annulled, with the annulment petition formulated by the Claimant proceeding.

The Claimant joins with the annulment petition formulated, the petition for condemnation of the Tax Authority to return the tax and compensatory interest in the amount of €93,110.62, and payment of indemnity interest from the date of payment of the tax until full payment.

It happens that it was not proven, nor was it even alleged, that the Claimant made any payment in execution of the annulled tax act, and therefore the arbitral petition formulated cannot proceed on that part.

C. AWARD

Accordingly, this Arbitral Tribunal hereby partially grants the arbitral petition formulated and, in consequence,

a) Annul the additional corporate income tax assessment No. 2015…, relating to the fiscal year 2011, and the respective compensation note No. 2015…, from which resulted tax payable in the amount of € 93,110.62;

b) Condemn the Respondent to payment of the costs of the proceedings, in the amount of €2,754.00.

D. Value of the Case

The value of the case is set at €93,110.62, in accordance with Article 97-A, paragraph 1, subparagraph (a), of the Tax Procedure and Process Code, applicable by force of subparagraphs (a) and (b) of paragraph 1 of Article 29 of the RJAT and paragraph 2 of Article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

E. Costs

The arbitration fee is set at €2,754.00, in accordance with Table I of the Regulation of Costs in Tax Arbitration Proceedings, to be paid by the Respondent, as the petition was upheld, in accordance with Articles 12, paragraph 2, and 22, paragraph 4, both of the RJAT, and Article 4, paragraph 4, of the cited Regulation.

Parties to be notified.

Lisbon, 5 September 2016

The President Arbitrator

(José Pedro Carvalho - Reporter)

The Voting Arbitrator

(Maria Cristina Aragão Seia)

The Voting Arbitrator

(Sofia Cardoso)

[1] Available at www.dgsi.pt, as is the remaining case law cited without mention of source.

Frequently Asked Questions

Automatically Created

What is the inland tax benefit (benefício à interioridade) under Portuguese IRC law?
The inland tax benefit (benefício à interioridade) is a Portuguese corporate income tax incentive under Article 43 of the Tax Benefits Statute that allows companies located in designated interior regions of Portugal to apply a reduced IRC rate of 15% instead of the standard rate. To qualify, companies must meet specific requirements including: being legally constituted, maintaining their principal activity and payroll in eligible inland municipalities, having organized accounting under the Accounting Standardization System, using the Permanent Inventory System for inventory tracking, and maintaining regular tax and social security status. This benefit aims to promote economic development in less populated inland areas by reducing the tax burden on businesses operating there.
Can a company challenge an additional IRC tax assessment through tax arbitration at CAAD?
Yes, companies can challenge additional IRC tax assessments through tax arbitration at CAAD (Centro de Arbitragem Administrativa - Centre for Administrative Arbitration). Under the Legal Regime for Arbitration in Tax Matters (RJAT - Decree-Law 10/2011), taxpayers can file a request for constitution of an arbitral tribunal within the statutory deadline. The process involves appointing arbitrators (either by parties or by CAAD's Ethics Council), filing the arbitration request with supporting grounds, allowing the Tax Authority to file its defense, and obtaining a binding arbitral award. This alternative dispute resolution mechanism provides a faster, specialized forum for resolving corporate tax disputes without going through traditional administrative courts, though parties must pay arbitration fees.
What legal grounds can be used to dispute an IRC additional tax assessment in Portugal?
Legal grounds commonly used to dispute IRC additional tax assessments in Portugal include: (1) Error in legal requirements (erro sobre os pressupostos de direito) - challenging the tax authority's legal interpretation or application of tax law provisions; (2) Defect in reasoning (vício de fundamentação) - arguing the assessment lacks proper justification or explanation for the corrections made; (3) Abuse of power (desvio de poder) - claiming the authority acted beyond its powers or for improper purposes; (4) Violation of procedural rules - challenging irregularities in the inspection or assessment process; (5) Error in facts (erro sobre os pressupostos de facto) - disputing the factual findings underlying the assessment; and (6) Violation of proportionality principles. These grounds can be raised individually or cumulatively in arbitration proceedings.
How does the CAAD arbitral tribunal process work for corporate tax disputes?
The CAAD arbitral tribunal process for corporate tax disputes follows these steps: (1) The taxpayer files a request for constitution of an arbitral tribunal, paying required fees and stating legal grounds; (2) CAAD automatically notifies the Tax Authority; (3) Arbitrators are appointed - either by parties or by CAAD's Ethics Council if parties don't appoint; (4) The tribunal is formally constituted after arbitrators accept and parties don't object; (5) The Tax Authority files its defense within the statutory period; (6) The tribunal may dispense with oral hearings if applying efficiency principles; (7) Parties submit written arguments; (8) The tribunal deliberates and issues a final award within 30 days after final arguments; (9) The award is binding and has the same effect as a court judgment. The entire process typically takes several months and provides specialized tax expertise.
What are the consequences of errors in assumptions and lack of reasoning in an IRC tax assessment?
Errors in legal requirements (erro sobre os pressupostos) and defects in reasoning (vícios de fundamentação) in IRC tax assessments can lead to annulment of the assessment. A defect in reasoning occurs when the tax authority fails to adequately explain or justify the factual and legal basis for corrections, violating the taxpayer's right to understand why they're being taxed additionally. This can include insufficient explanation of how legal provisions apply to the specific facts, failure to address taxpayer arguments, or contradictory reasoning. An error in legal requirements involves misapplication or misinterpretation of tax law. If proven, these defects can result in: complete annulment of the additional assessment, requirement for the Tax Authority to issue a new properly-reasoned assessment, elimination of tax payable, and potential reimbursement of amounts already paid with interest. These grounds protect taxpayers' constitutional rights to justification of administrative acts.