Process: 617/2017-T

Date: June 22, 2018

Tax Type: IRS

Source: Original CAAD Decision

Summary

This arbitral decision (Process 617/2017-T) addresses the taxation of capital gains from Portuguese property sales by Spanish tax residents. The case involved a married couple who sold Portuguese real estate acquired in 2001, realizing capital gains of €87,625.74 each in 2016. The Portuguese Tax Authority applied the standard 28% rate to the entire capital gain without applying the 50% exclusion available to Portuguese residents under Article 43(2) of the IRS Code. The applicants argued this constituted unlawful discrimination violating the EU's free movement of capital principle under Article 63 TFUE, citing the CJEU Hollmann case (C-443/06). The Tax Authority defended its position based on the principle of legality, arguing the applicants had chosen the general non-resident regime and could have opted for equalization under Article 72 of the IRS Code. The tribunal rejected the Authority's procedural argument, finding the core issue was substantive compatibility with EU law. The decision examines whether denying non-resident EU citizens the 50% capital gains exclusion available to Portuguese residents breaches fundamental EU freedoms, even when an alternative equalization regime exists. This case is significant for establishing parameters around discriminatory taxation of non-residents and the application of EU fundamental freedoms to domestic tax provisions, particularly regarding real property capital gains taxation for cross-border investors within the European Union.

Full Decision

ARBITRAL DECISION

The arbitrator Miguel Durham Agrellos, appointed by the Ethics Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 7 February 2018, decides as follows:

ARBITRAL DECISION

Report

The APPLICANTS A..., holder of tax identification number ... and B..., holder of tax identification number..., resident in ..., no. ... ..., Spain, have, pursuant to paragraph a) of article 2(1), in conjunction with article 10 of Decree-Law no. 10/2011 of 20 January ("RJAT") and article 2 of Ordinance no. 112-A/2011 of 22 March, requested the constitution of a Singular Arbitral Tribunal to pronounce on the partial illegality of the tax assessment acts for Personal Income Tax (IRS) numbers 2017 ... and 2017 ..., respectively in the amounts of EUR 27,253.00 and EUR 27,445.93, requesting the reimbursement of the amount of tax unduly assessed and paid in the sum of EUR 24,535.20. They further request the condemnation of the Tax and Customs Authority to the payment of compensatory interest at the legal rate of 4%, calculated from the date of undue payment until full reimbursement to the Applicants of the tax unduly paid.

The Tax and Customs Authority is hereby RESPONDENT.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Applicants and to the Respondent on 27 November 2017.

Pursuant to article 6(1) and paragraph b) of article 11(1) of RJAT, the Ethics Council appointed the undersigned as arbitrator of the singular arbitral tribunal, who communicated acceptance of the assignment within the applicable period.

On 18 January 2018, the parties were duly notified of this appointment and did not manifest any wish to refuse the arbitrator's appointment, in accordance with the combined provisions of article 11(1) paragraphs a) and b) of RJAT and articles 6 and 7 of the Code of Ethics.

Thus, in accordance with the provisions of paragraph c) of article 11(1) of RJAT, the singular arbitral tribunal was constituted on 7 February 2018.

On 20 March 2018, the Respondent filed a Reply in which it argued that the claim should be judged unfounded and that the Applicants should be condemned to costs. The Respondent also submitted the Administrative File.

By order of 10 April 2018, the meeting provided for in article 18 of RJAT was waived and it was decided that proceedings continue with written submissions.

The parties argued by largely referring to the Request for Arbitral Pronouncement and the Reply.

The arbitral tribunal was regularly constituted pursuant to the provisions of articles 2(1) paragraph a) and 10(1), both of RJAT.

The parties are duly represented, enjoy legal personality and capacity, and possess standing.

The proceedings are not vitiated by any nullities.

Statement of Facts

Proven Facts

  • The Applicants are married to each other and have tax residence in Spain.

  • In 2016, the Applicants obtained capital gains in Portugal relating to real property acquired in 2001.

  • Also in 2016, the Applicants obtained rental income, in the amount of €13,200.00 each.

  • The Applicants submitted their respective Personal Income Tax (IRS) declarations using Form 3.

  • Applicant A... was notified in June 2017 of assessment number 2017 ... in the amount of €27,253.00.

  • Applicant B... was notified in June 2017 of assessment number 2017 ..., in the amount of €27,445.93.

  • The Respondent considered that each of the Applicants obtained a real property capital gain in the amount of €87,625.74, as follows:

Acquisition Correction Coefficient Corrected Value Sale Expenses Capital Gain
€54,867.76 1.29 €70,779.41 €162,500.00 €4,094.85 €87,625.74
  • In quantifying the taxable capital gain, the Respondent considered the capital gain in full, without consideration of the 50% taxation exclusion regime provided for in article 43(2) of the Personal Income Tax Code.

Unproven Facts

With relevance to the arbitral decision, there are no facts that should be considered as unproven.

Substantiation of the Statement of Facts

The proven facts are based on documents submitted by the Applicants and contained in the Administrative File. The Respondent does not contest the facts presented by the Applicants.

Statement of Law

Position of the Parties

The Applicants contend that the wording of article 43(2) of the Personal Income Tax Code violates European Union Law, in particular the freedom of movement of capital (articles 63 et seq. of the Treaty on the Functioning of the European Union (TFEU)), constituting unjustified discrimination. For this purpose, they rely on the Hollmann case law, of 11.10.2007 (C-443/06), as well as on the manner in which such case law was received by Portuguese courts, namely by the Supreme Administrative Court, in the Judgment of 16.01.2008 (Case no. 0439/06).

According to the Applicants, "the courts in question concluded, therefore, in both decisions, that the establishment of a special regime for residents in Portugal with the exclusion of residents in other Member States of the European Union would lead to negative discrimination against the latter compared with taxpayers resident in Portugal, which would have as a direct consequence an aggravation of the tax burden of the former not tolerated by community rules insofar as it frontally violates the freedom of movement of capital."

The Applicants further argue that the current equalization regime provided for in article 72 of the Personal Income Tax Code does not eliminate the discriminatory character of article 43(2) of the Personal Income Tax Code, and that the taxpayer cannot find himself in the circumstance of having to choose between two regimes, one legal and another illegal. For this, the Applicants cite the Judgment of the CJEU Gielen, of 18.03.2010 (C-440/08), in particular in paragraphs 50 to 54, as well as the approach adopted by arbitral tribunals operating with CAAD, in cases no. 748/2015-T and 89/2017-T.

The Respondent contends that, in accordance with the principle of legality, it may only act under the conditions authorized by law, and therefore, since the Applicants opted for taxation according to the "general regime" for non-residents, the rate of 28% applies to the entire capital gain realized. The Respondent therefore contends that the issue at hand is of an adjective nature: "the Applicants, who did not exercise the option made in due time and place, in order to be taxed as they now claim to invoke, so the Tax Authority made no alteration to what was declared by the taxpayers, merely proceeding to assess the tax in accordance with the elements they provided."

Issue to be Decided

The issue to be decided is essentially concerned with the compatibility with European Union Law (in particular, the freedom of movement of capital, established in article 63 of the TFEU) of the non-application of the 50% real property capital gain taxation exclusion regime, as provided for in article 43(2) of the Personal Income Tax Code, to tax residents of another Member State of the European Union. It being certain, however, that the current wording of article 72(8) to (10) of the Personal Income Tax Code grants to residents of another Member State the right to opt for a regime equating taxation to the regime applicable to tax residents in Portugal.

The Tribunal accordingly rejects the understanding defended by the Respondent that the issue to be decided is of an adjective nature. In fact, the Applicants opted to be taxed in accordance with the regime applicable to non-residents. They only contend that this regime is discriminatory insofar as, at the level of rules of application, the provisions for determining capital gains applicable to tax residents are more favorable than those applicable to non-residents, in that in the case of the former, 50% of real property capital gains are excluded from taxation.

Principle of Legality and Internal Norms Contrary to European Union Law

The Respondent argues that, "in accordance with the principle of legality, established from the outset in article 266(2) of the Constitution of the Portuguese Republic, the Tax Authority may only act under the conditions authorized by law." From this, the Respondent concludes that the assessment acts were issued on the basis of income declarations presented by the Applicants, in accordance with the provisions of the Personal Income Tax Code, and therefore it merely applied the law.

It is important to note, however, that the principle of fiscal legality extends beyond internal legal norms. The problem presented here is thus one of a possible conflict between an internal norm and a European Union Law norm, and the former should be disapplied if contrary to the latter, in accordance with the Principle of Primacy (Costa/ENEL Judgment). Furthermore, the Respondent is obliged to disapply the internal norm when it violates European Union Law (cf., for example, Fratelli Constanzo Judgment (103/88)).

Incompatibility of Current Article 43(2) of the Personal Income Tax Code with European Union Law (Freedom of Movement of Capital)

The legal issue raised here has already been subject to decision by arbitral tribunals operating with CAAD, namely in cases nos. 45/2012-T, 127/2012-T, 748/2015-T, and 89/2017-T, all to the effect of finding article 43(2) of the Personal Income Tax Code incompatible with European Union Law, even taking into account the current optional equalization regime.

The tribunal expressly adheres to the grounds set forth in those arbitral decisions, in particular in Case no. 45/2012-T which, for ease of reference, are transcribed below:

"In the Hollmann case law, the CJEU concludes that the national provision in question [no. 2 of article 43 of the Personal Income Tax Code] violates article 63 of the Treaty on the Functioning of the European Union, as it is of a discriminatory (less favorable) character for non-residents and is consequently restrictive of the freedom of movement of capital between Member States.

This conclusion rests on the following main arguments:

An operation of liquidation of a real property investment constitutes a movement of capital, the Treaty providing for a specific provision prohibiting all restrictions on movements of capital;

In the case of sale of real property situated in Portugal, where capital gains are realized, non-residents are subject to a higher tax burden than that applied to residents, and are therefore in a less favorable position than the latter;

Indeed, while a non-resident is subject to a rate of 25% on the entire capital gains realized, the consideration of only half of the taxable matter corresponding to capital gains realized by a resident allows such resident to systematically benefit, on this count, from a lower tax burden, whatever the rate of taxation applicable to all his income, given that the taxation of resident income is subject to a table of progressive rates with a highest bracket of 42%;

This regime makes the transfer of capital less attractive for non-residents and constitutes a restriction on movements of capital prohibited by the Treaty;

The discrimination of the national provision is not justifiable by the objective of avoiding penalizing residents (who are subject to a table of progressive rates that may be much higher and are taxed on a world-wide basis, unlike non-residents, who are taxed at the proportional rate of 25%, with no aggregation occurring), because, as noted above, with the highest bracket being 42%, this always leads, in the same circumstances, to heavier taxation of the non-resident, taking into account the reduction to 50% of the resident's taxable income, there being, objectively, no difference that would justify this unequal treatment with respect to taxation of capital gains between the two categories of taxpayers.

We are therefore faced with a discriminatory regime incompatible with Community Law, by violation of article 63 of the Treaty on the Functioning of the European Union.

It remains to be determined whether the equalization option, introduced into the Portuguese tax system following the Hollmann Judgment, contained in nos. 8 and 9 of article 72 of the Personal Income Tax Code, and in force at the date of the facts sub judice, makes it possible to avoid the CJEU's discrimination finding with regard to the restrictive provision of no. 2 of article 43 of the Personal Income Tax Code to tax residents.

Beyond the fact that, as the Applicants rightly point out, the provision of this optional regime imposes an additional burden on non-residents, compared to residents, the equalization option is not, in our view, capable of excluding the discrimination in question.

The CJEU pronounced itself in this sense in the Judgment of 18 March 2010, delivered in case C-440/08 (Gielen Judgment) in a situation that presents manifest parallelism, with the only difference being that in that case the violation was of article 49 and not article 63 of the Treaty on the Functioning of the European Union.

That judicial body emphasizes that "the equalization option allows a non-resident taxpayer, (…) to choose between a discriminatory tax regime and another regime supposedly non-discriminatory," stressing that such choice is not capable of excluding the discriminatory effects of the first of these two tax regimes.

And that court continues by revealing the paradox: "recognition of such an effect to that choice would have the consequence of (…) validating a tax regime which would continue, in itself, to violate article 49 TFEU on account of its discriminatory character."

The CJEU concludes that the Treaty "precludes a national provision that discriminates against non-resident taxpayers in the grant of a tax benefit (…) even though those taxpayers may opt, as regards that benefit, for the regime applicable to resident taxpayers."

It is acknowledged that the consequences drawn here from the above-mentioned community case law, in particular from the Hollmann Judgment, provide for more favorable taxation of real property capital gains earned by non-residents in Portugal who reside in the European Union than by residents, since, in addition to benefiting equally from the 50% reduction of the Personal Income Tax taxable base, they are subject to a single rate of 25%, which will, in most cases, be lower than the progressive rates for residents, in accordance with the table provided for in article 68(1) of the Personal Income Tax Code, plus the fact that the latter must aggregate all their income.

However, at the current stage of Community Law, no principle or provision is discernible that prevents positive discrimination of non-residents as against residents, with direct taxation being a matter within the competence of the Member States.

It should further be noted that, as may be understood from the case law of the Supreme Administrative Court, in the Judgment of 22 March 2011, case no. 1031/10, it was the Tax Authority that, "before the declaration of the taxpayers, assessed against them the tax it considered due (as indeed always happens with Personal Income Tax): at the rate provided for non-residents (25%, in accordance with article 72 no. 1 of the Personal Income Tax Code) and on the total amount of the capital gain realized and not merely on 50% of this value (article 43 no. 2 of the Personal Income Tax Code), thus ignoring the community case law and that of this Supreme Court which accepted it (cfr. the Judgment of 16 January 2008, appeal no. 439/06) as to the incompatibility of that legal provision, as thus applied, with the (then) article 56 of the TFCE (current article 63 of the Treaty on the Functioning of the European Union), thus subjecting, as was to occur, to see annulled in that part the disputed assessment, given the primacy of community law."

In this manner, given what has been stated above, the alleged defect of violation of law claimed by the Applicants is well-founded, due to incompatibility of no. 2 of article 43 with article 63 of the TFEU, insofar as it restricts the 50% real property capital gain taxation exclusion regime to tax residents in Portugal, with the consequent partial annulment of the tax assessment acts subject to arbitral pronouncement.

Right to Compensatory Interest

The Applicants are entitled to reimbursement of the sum of €12,267.60 each (totaling €24,535.20) and the illegalities of the assessments are attributable to the Respondent, as it issued them on its own initiative with erroneous application of the Law.

Consequently, the Applicants are entitled to compensatory interest, pursuant to article 43(1) of the General Tax Law and article 61 of the Tax Procedure Code, with respect to the amount to be reimbursed.

The compensatory interest shall be paid from the date the Applicants paid each of the illegal assessments until full payment of the amount to be reimbursed, at the legal supplementary rate of 4%, in accordance with articles 43(4) and 35(10) of the General Tax Law, article 61 of the Tax Procedure Code, article 559 of the Civil Code, and Ordinance no. 291/2003 of 8 April.

Decision

In these terms, the Arbitral Tribunal decides:

  1. To partially annul the assessments at issue, in the part corresponding to the increase in taxation resulting from the full consideration of the real property capital gain.

  2. To condemn the Respondent to reimburse each of the Applicants the amount of tax unduly paid, in the sum of €12,267.60.

  3. To condemn the Respondent to the payment of compensatory interest, at the rate of 4%, from the date the Applicants paid each of the illegal assessments until full payment of the amount to be reimbursed.

Case Value

€24,535.20 (in accordance with the provisions of article 305(2) of the Code of Civil Procedure and 97-A(1) paragraph a) of the Tax Procedure Code and 3(2) of the Regulations on Costs in Tax Arbitration Proceedings).

Costs

Pursuant to article 22(4) of RJAT, the amount of costs is set at €1,530.00, in accordance with Table I annexed to the Regulations on Costs in Tax Arbitration Proceedings, at the expense of the Respondent.

Porto, 22 June 2018

The Arbitrator,

(Miguel Durham Agrellos)

Frequently Asked Questions

Automatically Created

How are capital gains from property sales taxed for non-residents under Portuguese IRS rules?
Under Portuguese IRS rules, capital gains from property sales by non-residents are generally taxed at a flat rate of 28% on the entire gain. Non-residents are subject to a different regime than Portuguese tax residents, who benefit from a 50% exclusion on real property capital gains under Article 43(2) of the IRS Code. However, non-residents from EU Member States may opt for equalization treatment under Article 72(8)-(10) of the IRS Code, which allows them to be taxed under conditions similar to Portuguese residents, potentially accessing the more favorable 50% exclusion regime.
What does Article 43(2) of the Portuguese IRS Code say about the 50% exclusion for capital gains?
Article 43(2) of the Portuguese IRS Code establishes a 50% exclusion for capital gains arising from the sale of real property held by Portuguese tax residents. This means that only 50% of the capital gain is subject to taxation. However, this provision by its literal wording applies exclusively to tax residents in Portugal, creating a distinction between resident and non-resident taxpayers. This differential treatment became the central issue in this arbitration, as the Spanish resident applicants argued the exclusion of non-residents from this beneficial regime constituted discriminatory treatment incompatible with EU law.
Can non-residents in the EU claim the same capital gains tax treatment as Portuguese residents under EU law?
Yes, non-residents in the EU can claim the same capital gains tax treatment as Portuguese residents under EU law principles, specifically the free movement of capital guaranteed by Article 63 TFUE. The CJEU's Hollmann case (C-443/06) established that discriminatory tax treatment between residents and non-residents of EU Member States violates fundamental EU freedoms. Portuguese courts, including the Supreme Administrative Court, have recognized this principle. While Article 72 of the IRS Code now provides an equalization option, the existence of this alternative regime does not automatically eliminate the discriminatory character of provisions that grant more favorable treatment exclusively to residents, as confirmed by CJEU jurisprudence such as the Gielen case (C-440/08).
How does the free movement of capital under Article 63 TFUE affect taxation of non-resident capital gains in Portugal?
The free movement of capital under Article 63 TFUE prohibits restrictions on capital movements between Member States and between Member States and third countries. This fundamental freedom directly affects the taxation of non-resident capital gains in Portugal by preventing discriminatory tax measures that disadvantage non-residents compared to Portuguese tax residents. Tax provisions that impose heavier burdens on non-residents, such as denying them access to the 50% capital gains exclusion available to residents, constitute restrictions on capital movement that are incompatible with EU law unless objectively justified. The TFUE requires Member States to ensure tax neutrality between cross-border and domestic investments, meaning non-residents selling Portuguese property cannot be subjected to systematically less favorable tax treatment solely based on their residence status.
What compensation and indemnity interest can non-residents claim when overcharged on Portuguese capital gains tax?
When overcharged on Portuguese capital gains tax, non-residents can claim reimbursement of the tax unduly assessed and paid, plus compensatory interest (juros indemnizatórios). In this case, the applicants requested reimbursement of €24,535.20 in overpaid tax plus compensatory interest at the legal rate of 4%, calculated from the date of undue payment until full reimbursement. Compensatory interest serves to compensate taxpayers for the State's undue retention of funds and is automatically due when tax assessments are annulled or reduced. The interest rate and calculation method are established by Portuguese tax law, ensuring taxpayers are made whole for both the principal amount incorrectly collected and the time value of money during the period the tax authority improperly retained their funds.