Process: 617/2018-T

Date: August 19, 2019

Tax Type: IRC

Source: Original CAAD Decision

Summary

CAAD arbitration process 617/2018-T addressed the deductibility of property-related expenses under Article 23 of the Portuguese IRC Code. The claimant, A... Ltd., a company primarily engaged in real property leasing (CAE 68200) and secondarily in hotel accommodation and wholesale trade, challenged IRC assessments for tax years 2014-2016 totaling €67,312.76, seeking partial annulment of €45,333.07. The Portuguese Tax Authority (AT) disallowed expenses related to three properties in Lisbon, Leiria, and Coimbra, arguing they lacked business purpose and were not intended to obtain or guarantee IRC-taxable income. The claimant contended these properties were legitimately used for statutory business activities, including property leasing and local accommodation services. Key arguments included: the Lisbon property was acquired for future rental income and subsequently leased in 2018; the Leiria property suffered fire damage after brief commercial operation, delaying income generation; and the Coimbra property served multiple business purposes including corporate headquarters, partial leasing to the company B... and partners, and local accommodation activity. The claimant asserted that expense deductibility under Article 23 IRC does not require simultaneous taxable income in the same period, but rather a genuine business connection. The dispute centered on whether properties awaiting full commercial exploitation or experiencing temporary interruptions qualify for expense deduction, challenging AT's narrow interpretation of business purpose and its allegation of personal use by partners.

Full Decision

ARBITRAL DECISION

I. REPORT

On 6 December 2018, A..., Ltd., with the NIPC ... and with registered address at Rua ..., no. ..., ..., ...-... Coimbra, came, pursuant to the provisions of articles 2, no. 1, subparagraph a) and 10, of Decree-Law no. 10/2011, of 20 January, which approved the Legal Framework for Tax Arbitration (RJAT) and articles 1 and 2 of Order no. 112-A/2011, of 22 March (Binding Order), to request the constitution of an Arbitral Tribunal, in which the Tax and Customs Authority (hereinafter AT or Respondent) is the Respondent, informing that it does not intend to use the power to designate an arbitrator.

The request for constitution of the arbitral tribunal was accepted by His Excellency the President of CAAD and automatically notified to the AT, and, pursuant to the provisions of no. 1 of article 6 and subparagraph b) of no. 1 of article 11 of the RJAT, in the wording introduced by article 228 of Law no. 66-B/2012, of 31 December, the Deontological Council designated the undersigned as arbitrator of the singular arbitral tribunal, a duty accepted within the applicable period, without opposition from the Parties.

A. Subject matter of the request:

The Claimant seeks a declaration of illegality of the Corporate Income Tax (IRC) assessments no. 2018..., no. 2018... and no. 2018...; of the statements of account reconciliation no. 2018..., no. 2018... and no. 2018...; and of interest assessments no. 2018..., no. 2018..., no. 2018... and no. 2018..., referring to the taxation periods of 2014, 2015 and 2016, in the total amount of € 67,312.76, requesting its partial annulment in the sum of € 45,333.07 (forty-five thousand, three hundred and thirty-three euros and seven cents), the economic value attributed to the request.

B. Summary of the Positions of the Parties

a. Of the Claimant:

The Claimant, which engages primarily in the activity of leasing real property (CAE 68200) and, secondarily, in activities related to accommodation in hotel establishments with restaurants and short-term accommodation (CAE 55119 and 55204, respectively), as well as non-specialized wholesale trade (CAE 46900), alleges, in summary, that the adjustments to taxable profit for the fiscal years 2014, 2015 and 2016, underlying the disputed IRC assessments, lack legal foundation, arising from erroneous interpretation and application of article 23 of the IRC Code.

These adjustments, with which the Claimant does not comply, relate to the non-acceptance by the Respondent of expenses related to three real properties owned by it, located in Lisbon, Leiria and Coimbra, respectively, acquired with the intention to derive income from them, expenses which the AT considers as non-deductible, as allegedly not intended to obtain or guarantee income subject to IRC.

Furthermore, the Claimant imputes to the inspection procedure the defect of violation of procedural duties of collaboration and performance according to the rules of good faith, as an autonomous defect of violation of law, which it considers evident from the reading of various excerpts from the Tax Inspection Report, "through the attempt to force, without any evidentiary support, artificial connections between unrelated events or the unjustifiably attributed emphasis to irrelevant situations" (...) "which the present Arbitral Tribunal cannot ignore, in the assessment of the case sub judice".

The Claimant alleges that the aforementioned expenses should be accepted for tax purposes, under the rules in force in the IRC Code, as they respect real properties used by it with a business purpose and as a means of pursuing its statutory goals, "even in cases and time periods in which a certain real property (in whole or in part) did not generate income subject to taxation in the IRC context, such assets are actually relevant for the pursuit of its commercial and economic activity", since the tax acceptance of a given expense is not conditioned by the existence, in the same taxation period, of taxable income in the IRC context.

As regards the Lisbon property, the AT alleges that it did not have business use nor registered any income, having been indicated as the residence of one of the Claimant's partners; however, it ignores that this property was acquired with the purpose of being leased for housing, within the context of the "real property leasing" activity carried out by the Claimant, being an asset apt to generate income in the future, depending on the plans and business strategies that the Claimant wished to establish and pursue.

Having considered its sale in a context of rising prices in the real estate market, this Lisbon property ultimately became the subject of a residential lease agreement, executed on 19.03.2018 and which continues to the present day.

Nor was the aforementioned property used as a residence of the Claimant's partner mentioned in the Report, as this person has resided for many years in London, a residence through which the AT has established contact with that citizen via mail.

The Leiria property, consisting of ground floor, first and second floors, has the last floor leased to B..., with the first two having been assigned to C..., for the latter to develop an art gallery and support bar project therein. For this purpose, the first two floors were entirely rehabilitated and adapted by the Claimant, in the expectation of being able to obtain income therefrom.

The art gallery and support bar began to be commercially operated by C... in December 2011, an operation interrupted by the fire that occurred on 06.01.2012, which significantly damaged the property as a whole, with its recovery being undertaken in accordance with the Claimant's economic capacity.

For this reason, it is not surprising that, with respect to the ground floor and first floor of this property, no income was recorded in the Claimant's accounting nor that, given the brief period of operation by C..., any lease agreement between the two companies was ever formalized, since the latter was prevented from conducting its activity there and generating its own income.

With regard to the Coimbra property, the AT understood that "it is not credible that the monthly € 500.00 could be the consideration for the use by the parent-partners of the Coimbra residence as their principal residence, an isolated dwelling (Type T7) with swimming pool, in a noble residential area and scenically privileged, inserted in a lot with 1,500 m² and with a gross building area of approximately 720 m², also including electricity, water and maintenance of the pool, garden and air conditioning, when, on the other hand, the sp receives/charges B..., for the lease of an apartment (ground floor) T3 in Lisbon, € 600.00 monthly".

However, this property, consisting of three floors, has been used by the Claimant, in the context of its economic activity, to enter into contracts with distinct legal persons and in the context of equally distinct purposes.

Part of this property was leased to B... between 2012 and 2016, for it to use in the context of its own activity; the same property has been partially leased (approximately 2/3), since 2012, to partners D... and E..., for residential purposes; the Claimant's registered office has been located there since 2015 and, since July 2018, it has been partially used by the Claimant in the context of local accommodation activity.

Therefore, the Claimant understands that this property is effectively used for the pursuit of its statutory goals (which include the leasing of real properties) and for obtaining income subject to taxation in the IRC context, and cannot be considered as lacking a business purpose for such lease.

The Claimant understands that the non-acceptance of expenses related to the aforementioned properties contradicts the view of doctrine and case law on the notion of "expense" or "cost", as "expenditure with a business purpose, which does not mean an immediate and directly profitable purpose, but rather that it has, in its origin and cause, a business purpose." (Saldanha Sanches), since "there clearly prevails in the Portuguese legal system a general principle of acceptance of all expenses and losses incurred by the taxpayer" (António Martins), and "subjective judgments by the public controller about the wisdom of the management undertaken" are not admissible (António Moura Portugal).

Thus, "An indispensable cost does not have to be a cost that directly entails the obtaining of income. There are various costs that only mediately fulfill that function and which are nonetheless considered indispensable, in accordance with article 23 of the IRC Code." (Superior Administrative Court Decision, of 07.05.2015, case no. 07287/14).

According to the Claimant, the fact that the real properties of which it is the owner "did not generate, in full and at all times, income subject to taxation in the IRC context will not legally prevent, in light of the provisions of article 23 of the IRC Code, the deduction of expenses incurred with the same", as such expenses are framed within the company's activity and undertaken in its interest.

All the more so because, regarding the Coimbra property, although appearing to disregard the effects of the existing residential lease agreement between the Claimant and its partners, under the "substance over form principle", the AT does not expressly invoke the application of the general anti-abuse clause referred to in no. 2 of article 38 of the General Tax Law (LGT), nor follows the procedural formality appropriate to the use of that clause, as per article 63 of the Code of Tax and Customs Procedure (CPPT).

And, although appearing to disagree with the manner in which the Claimant has been establishing and maintaining commercial and economic relations with entities with which it maintains special relationships, at no time does the AT invoke the provisions of article 63 of the IRC Code, nor does it follow from the Report that the Claimant has breached the arm's length principle, and there is no justification for the disregard of certain expenses incurred by it in the context of its economic activity, under article 23 of the IRC Code.

The Claimant concludes that the adjustments to taxable profit for the periods 2014, 2015 and 2016 have no legal foundation and, consequently, the subsequent IRC assessments, compensatory interest and account reconciliation statements must necessarily be annulled in the respective proportion, as illegal.

b. Of the Respondent:

Notified in accordance with the terms and for the purposes provided in article 17 of the RJAT, the AT presented a response and attached the administrative file (hereinafter PA), in which it came to defend the legality and maintenance of the assessment acts subject to the present request for arbitral pronouncement, stating that:

The Claimant is a family limited liability company, established by parents and children in 1998, whose management has been exercised since then by the mother-partner and which "has not declared income derived from the exercise of the activities listed in its tax registration for quite some time (although it continues to declare in the various annual statements that its income comes exclusively from non-specialized wholesale trade)" and whose declared income has declined since 2011, with a slight reversal of the downward trend in 2014 and 2015, resumed in 2016.

It is not possible to discern the income and pricing policy followed by the Claimant towards company B..., with which it maintains uninterrupted special relationships and from which it obtains income almost exclusively.

With regard to the Lisbon property, it was impossible to discern any business use or any income generated by its lease and, according to available Commercial Registry data, it was always indicated as the residence of the partner-son between 2009 and 2015, so the effects intended to be derived from documents 12 and 13 attached to the request for arbitral pronouncement (ppa) are disputed, as they do not constitute full and complete proof that he resided, in the indicated years, in London.

The only lease agreement exhibited by the Claimant regarding said property dates from 18.03.2018; however, even before that lease, the property recorded water and electricity consumption that indicated regular and frequent use of such services.

It not being proven that the partner-son had, between 2014 and 2017, his residence in London, it is concluded that said property was used by him frequently, and the Claimant incurred and deducted costs that did not contribute to the exercise of its commercial activity.

With regard to the Leiria property, it is found that its first two floors did not generate income, as there is no lease agreement for that space, since 2008 the registered office of company C..., Ltd., of which the "parent-partners" are partners and managers, and whose statutory activity consists of "Bar and Art Gallery".

This company began operating the space in December 2011 and, on 06.01.2012, a fire apparently occurred at the property, which is not conclusive in view of the documentary evidence attached to the ppa, which is disputed, making no sense that the Claimant would not have entered into a lease agreement at the beginning of C...'s activity, "if its purpose was not, pure and simply, not to charge rent at all for the assignment of the space".

It is unknown whether the bar and gallery, operated by company C..., continued or did not continue in full operation after the disaster, since, according to images from the Google Maps information platform, from 2014, the property in question is rehabilitated and apt to generate income.

It should therefore be concluded that the Claimant incurred and deducted expenses incurred by another company, unrelated to its economic interests, as they did not contribute to the realization of its social purpose.

The Coimbra property has been used as office and warehouse of the Claimant and, especially, as principal residence of the parent-partners, for a monthly rent of € 500.00, from 2017 onwards, having been previously partially leased to B....

The lease to the partners was not considered by the Tax Inspection, "under the substance over form principle", maintaining the situation recorded in the previous year, of lease to B..., for € 500.00 monthly, "and maintenance of the allocation to non-business purposes of the residential area used by the partners and family".

The Respondent concludes that, in view of the provisions of article 23 of the IRC Code, "the values deducted as expenses in the years 2014, 2015 and 2016 cannot be accepted for tax purposes, of € 59,125.02, € 63,798.71 and € 62,658.68, respectively".

According to the AT, the alleged violation of the principles of collaboration and cooperation is "inappropriate", due to lack of proof, stemming from bad faith litigation and having the sole purpose of annulling the inspection procedure.

The AT concludes by requesting dispensation from questioning the witnesses listed by the Claimant, considering the documentary evidence produced sufficient for proper judgment of the case, and arguing for the non-approval of the request for arbitral pronouncement, as not proven, with the consequent absolution of the Respondent from all claims.

On 15 May 2019, the meeting referred to in article 18 of the RJAT took place at CAAD, in which witness testimony was produced with the examination of Mr. F..., resident in Coimbra and certified accountant of the Claimant since its inception, with the Claimant waiving the testimony of the other witness it had listed.

At the same meeting, various evidentiary documents were admitted by agreement of the Parties, and the latter were notified at that time to submit written pleadings, for the successive period of 15 days commencing with the Claimant and with the Respondent's right to review the subsequent documents, in the same period.

15 July 2019 was designated as the date for rendering the final decision, with the Claimant being warned that, by that date, it should comply with the provisions of no. 3 of article 4 of the Regulation of Costs in Tax Arbitration Proceedings (RCPAT).

The Claimant submitted written pleadings within the designated period, in which it reiterated the arguments raised in the request for arbitral pronouncement. The Respondent did not submit pleadings nor did it comment on the new evidentiary documents offered by the Claimant on 15 May 2019.

By arbitral order of 4 July 2019, the Parties were notified of the postponement of the final decision until the end of the period referred to in no. 1 of article 21 of the RJAT.

II. PRELIMINARY RULING

  1. The singular arbitral tribunal is competent and was regularly constituted on 18 February 2019, in accordance with the provisions 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.

  2. 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 Order no. 112-A/2011, of 22 March.

  3. No exceptions worthy of consideration and decision have been raised.

  4. The proceedings do not suffer from defects that would render them invalid.

  5. The joinder of claims is admissible, in accordance with the provisions of no. 1 of article 3 of the RJAT, insofar as the request for arbitral pronouncement formulated, and its success, depend on the assessment of the same circumstances of fact and the interpretation and application of the same principles or rules of law, in the concrete case, of article 23 of the IRC Code.

III. REASONING

III.1 FACTUAL MATTERS

In the judgment, the judge shall distinguish between proven and unproven facts, substantiating his decisions (article 123, no. 2, of the Code of Tax and Customs Procedure [CPPT], subsidiarily applicable to tax arbitration proceedings, pursuant to article 29, no. 1, subparagraph a), of the RJAT), under penalty of nullity, provided for in no. 1 of article 125 of the same CPPT.

The factual matters relevant to the understanding and decision of the case, after critical examination of the documentary evidence attached to the request for arbitral pronouncement and to the administrative file, as well as the testimonial evidence produced, are set forth as follows:

A – PROVEN FACTS

  1. The Claimant is a family limited liability company (parents and children) established in 1998, initially with headquarters in Leiria and, since February 2015, at Rua ..., no. ...- ..., in Coimbra, which at the time of the inspection action was engaged primarily in the activity of non-specialized wholesale trade, with CAE 46900 and, secondarily, in the activities of real property leasing, CAE 68200, and accommodation in hotel establishments with restaurants, with CAE 55119 (cf. page 4 of the Tax Inspection Report – RIT);

  2. Currently, the Claimant is engaged primarily in the activity with CAE 68200 and, secondarily, in the activities of accommodation in hotel establishments with restaurants and short-term accommodation, with CAE 55119 and 55204, respectively, as well as non-specialized wholesale trade, with CAE 46900 (cf. copy of the permanent certificate issued on 12.07.2017, attached to the PA as document no. 1);

  3. The Claimant is the owner of various properties that it operates through the execution of lease agreements for non-residential and residential purposes, among which, with relevance to these proceedings, (i) an apartment located at Rua ..., no. ... –... Esq.º – Lisbon; (ii) an urban property located at ..., nos. ... and ...– Leiria and, (iii) an urban property located at Rua ..., no. ...- ..., in Coimbra (PA and RIT);

  4. Through service orders OI2017..., of 26.11.2017, OI2018..., of 10.01.2018, OI2018... and OI2018..., both of 04.04.2018, the Claimant was subject to an external tax inspection procedure, initially of limited scope, by reference to VAT for the period 16.12T, which was to be transformed into a polivalent external procedure, covering the IRC for the fiscal years 2014 to 2016, of which the Claimant was notified, as well as of the extension of the procedure period provided for by OI2017... (cf. RIT, page 4);

  5. The Claimant is classified under the normal regime for determining taxable profit, in the IRC context, and under the normal quarterly regime, in the VAT context (cf. PA and RIT);

  6. Most of the income obtained by the Claimant during the inspection period relates to rents charged to company B..., Ltd., with NIPC..., with registered address in Leiria, with which the Claimant is in a situation of special relationships, in accordance with article 63, no. 4, subparagraphs b) and d), of the IRC Code;

  7. In the IRC context, technical adjustments were made to the taxable matter for the fiscal years 2014, 2015 and 2016, by the amounts shown in the table below, concerning expenses not accepted for tax purposes, "as their occurrence is not intended to obtain or guarantee income subject to IRC, as provided in article 23 of the IRC Code", relating to A.1. Properties; A.2. Allowances; A.3. Rents in Italy; A.4. Insurance; B. Depreciation on the value of the land of properties and C. Tangible Fixed Assets considered as Supplies and External Services (pages 12 to 14 of the RIT):

  8. The justification for the adjustments to the Claimant's expenses in the fiscal years 2014, 2015 and 2016, by reference to the properties identified above (point 3), in the total amount of € 185,582.41, as per the table above, is contained in pages 10/12 of the RIT:

"1. Following the analysis carried out on the activity developed by sp (through the charges and income recorded in the years under analysis), in which it was concluded that there was provision of services relating to real properties, it was also found that some of sp's properties or parts thereof are not being used for its business purposes, as follows:

1.1. The apartment in ... in Lisbon (...) in addition to making it impossible to discern any business use and not registering any income, according to available Commercial Registry data, was indicated in 2009 and in 2015, as the residence of partner-son G...;

1.2. The so-called "... building" (... in Leiria) since at least 2013, its first floors have not been leased to B..., taking into account on the one hand, the value of the lease registered annually since that year (€ 1,000.00), and on the other, the amendment to the lease agreement with B..., in which it is referred that only the 2nd floor is in lease, a situation of partial lease of the building, also visible in the table of rents provided by sp – see Annex 6 to pages 2 and 7 to 9. Thus those two first floors, in addition to not generating any income, according to available Commercial Registry data, have been since 2008, the registered office of company C..., Ltd. with NIPC..., of which the "parent-partners" are partners and managers, and whose statutory activity consists precisely of Bar and Art Gallery:

1.3. The three-floor dwelling in Coimbra, which in addition to having part (approximately 70% of the area, to believe the information provided to the inspection – see Annex 8, pages 9 to 11) of the lower floor used as office and warehouse of the company (and also as an office branch of B..., for the preparation of medical reports, as previously mentioned in III.1.A.2), has been used, especially by the parent-partners, as their principal residence.

(...)

  1. Given that the "... building" in Leiria and the dwelling in Coimbra are only partially not being used for business purposes, and with a view to calculating the percentage of properties not utilized, the tax graduation of the various areas was taken into account for the purposes of tax property assessment given by the formula of article 40 of the Real Estate Tax Code, namely the difference between the gross private area and the gross dependent area, also provided therein. Thus:

a) For the Coimbra dwelling, from the combination of the assessment form contained in the respective property matrix, with the floor plans provided by sp, it was possible to conclude that the area allocated to business purposes located on the 1st floor was considered for tax purposes as a gross dependent area (thus enjoying, for tax purposes -in the assessment of a 70% reduction - only 30% of that area is considered), thus obtaining a percentage of non-utilization of the property for business purposes of 89%-see calculations in Annex 8, page 8;

b) For the "... building" in Leiria, the areas of the legends for the various divisions of that floor (the 2nd floor - attic in the plan) contained in the architectural plan that is an integral part of the respective property matrix were considered, thus obtaining a percentage of non-utilization of the property for business purposes of 75% -see calculation in Annex 8, page 1.";

  1. In quantitative terms, the expenses not accepted for tax purposes and contested by the Claimant in the PA, "relating to properties (or parts thereof) not used for business purposes", were, according to the RIT (annex 12), as follows:

  2. The Lisbon property was acquired and rehabilitated by the Claimant with the objective of obtaining income from it, through its lease for housing; however, no opportunity arose that would justify its lease until March 2018, and its sale was even considered with the rise in prices in the real estate market (witness testimony and docs. 10 and 11 attached to the PA);

  3. Partner G... has resided in London since 2010, having changed his address registration to the United Kingdom with the AT in 2014 (witness testimony, docs. 12 to 14 attached to the PA and subsequent documents, dated 2010 to 2017);

  4. On 6 January 2012, a fire broke out on the second floor of the Leiria property, leased to company B..., which, according to the incident report prepared by the Municipal Fire Department of ..., "(…) occurred in a section of the building, which was completely destroyed inside. Other sections were also affected by smoke and gases, from combustion", from which "(…) as a result of damages, the complete destruction of the chimney, partial destruction of the roof and floors resulted", as per the statement of the Volunteer Fire Department of ... (Doc. 20 attached to the PA);

  5. The ground floor and first floor of the building were, at the date of the fire, made available by the Claimant to company C..., for it to develop an art gallery and support bar project therein, entirely rehabilitated and adapted by the Claimant for this purpose, without any lease or operation assignment agreement having been executed between the companies (Pages 7/8 of the RIT, witness testimony and Doc. 16 attached to the PA);

  6. The art gallery and support bar began to be commercially operated by C... in December 2011 (Docs. 17 and 18 attached to the PA and witness testimony);

  7. The fire incident was reported by B..., as the tenant of the 2nd floor of the building, to insurance company H... (line 0316, policy ...), on 12 January 2012 (Doc. 20 attached to the PA and witness testimony);

  8. Company C..., although inactive, did not cease operations and maintains its registered office in the Leiria building (witness testimony);

  9. The exterior of the Leiria property, located in the historic center of that city, is restored (Doc. 2 attached to the PA);

  10. The Coimbra property (i) was the subject of a residential lease agreement executed on 1 May 2012 between the Claimant and the parent-partners, D... and E...; (ii) approximately 70% of the area of the lower floor was used as office and warehouse of the Claimant; (iii) was partially leased to B...; (iv) the Claimant's registered office was transferred there, in February 2015; (v) was the subject of a new residential lease agreement with the parent-partners, on 1 January 2016, with clause 3 thereof stating that "The property is intended for housing, making available all common areas of the house (rooms and WC) for the holding of meetings, encounters and events of the companies" (RIT and Annex 6 to the RIT, witness testimony);

  11. In the leased properties, supplies are generically provided by the Claimant to the respective tenants "electrical power and/or water and/or other services – namely pest control in the Leiria properties (…) – page 7 of the RIT and annexes 7 and 13 to the RIT;

  12. On 5 June 2018, the Claimant exercised the right to a hearing on the draft Tax Inspection Report (Doc. 6 attached to the PA);

  13. The final Report was notified to the Claimant on 29 June 2018, with the proposed adjustments being maintained (doc. 7 attached to the PA);

  14. In July 2018, the Claimant was notified of the IRC assessments no. 2018 ..., no. 2018 ... and no. 2018 ...; of interest assessments no. 2018 ..., no. 2018 ..., no. 2018 ... and no. 2018 ..., and of statements of account reconciliation no. 2018 ... (IRC and compensatory interest for 2014, of the amounts of € 20,357.11 and € 2,845.24, respectively), no. 2018 ... (IRC and compensatory interest for 2015, of € 24,264.52 and € 1,985.20, respectively) and no. 2018 ... (IRC for 2016, in the respective amounts of € 17,486.73 and € 733.96), in a total amount payable of € 67,312.76 (Doc. 8 attached to the PA);

  15. The Claimant made a partial payment of the IRC assessments and compensatory interest, in the amount of € 11,405.54 (IRC and compensatory interest for 2014 and 2016), on 07.09.2018 and € 10,574.15 (IRC and compensatory interest for 2015), on 10.09.2018 (Doc. 9 attached to the PA).

B – UNPROVEN FACTS

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

C – Reasoning of the Proven and Unproven Factual Matters

With respect to factual matters, the Tribunal does not have to pronounce on everything alleged by the parties, and should select and delineate the facts relevant to the judgment of the case based on their legal relevance, in view of the plausible solutions to legal questions, in accordance with the combined application of articles 123, no. 2, of the CPPT, 596, no. 1 and 607, no. 3 of the Code of Civil Procedure (CPC), applicable pursuant to article 29, no. 1, subparagraphs a) and e) of the RJAT.

Given the positions of the Parties in their respective pleadings, the critical analysis of the documentary evidence attached to the file and the witness testimony produced, the facts set forth above are deemed proven.

III.2 LEGAL MATTERS

  1. Questions to be decided.

As the cause of action, the Claimant invokes various defects, both of a formal nature and of a substantive nature, capable of determining the annulment of the tax acts that it contests.

From the formal perspective, the Claimant argues the illegality of the tax inspection procedure, for violation of the principles of cooperation referred to in article 9 of the Complementary Regime of the Tax and Customs Inspection Procedure (RCPITA) and of mutual collaboration, provided for in article 59 of the General Tax Law (LGT).

From the material perspective, the Claimant considers that the adjustments made by the AT to taxable profit for the fiscal years 2014, 2015 and 2016, underlying the IRC assessments and compensatory interest subject to the request for arbitral pronouncement, suffer from error regarding the legal assumptions, due to error in the interpretation and application of no. 1 of article 23 of the IRC Code.

We shall proceed to the assessment of the said defects, in the order in which they are invoked by the Claimant.

1.1. On the illegality of the tax inspection procedure

The Claimant invokes the illegality of the tax inspection procedure, imputing to the Respondent the violation of the principles of cooperation and mutual collaboration, evident in various passages of the RIT, "through the attempt to force, without any evidentiary support, artificial connections between unrelated events or unjustifiably attributed emphasis to irrelevant situations"

The tax inspection procedure, regulated by the Complementary Regime of the Tax and Customs Inspection Procedure (RCPITA), approved by Decree-Law no. 413/98, of 31 December, aims at the observation of tax realities, the verification of compliance with tax obligations and the prevention of tax offences (article 2, no. 1, of the RCPITA), being governed, among others, by the principles of material truth, proportionality, contradiction and cooperation (articles 5 to 10 of the RCPITA).

The principle of material truth is enshrined in article 6 of the RCPITA, and requires that the Tax Administration, in the context of the inspection procedure, seek to gather evidentiary elements that allow substantiation of the tax act.

To this end, AT officials have the powers set forth in article 29 of the RCPITA, specifically those to "examine any elements of taxpayers that are capable of revealing their tax situation, in particular those related to their activity, or of third parties with whom they maintain economic relationships and to request or make, specifically on magnetic media, copies or extracts considered indispensable or useful" and to "take statements from taxpayers, members of corporate bodies, certified official accountants, official external auditors or any other persons, whenever their testimony is of interest to the determination of tax facts".

The principle of cooperation or mutual collaboration between tax inspection officials and taxpayers and other tax obligated parties, presumes good faith on the part of the participants in the procedure, and it is the duty of the former, among others, to listen to the interested parties for "clarification of doubts regarding their statements or documents" and the collaboration of taxpayers consisting of "providing the clarifications that [AT] requests from them regarding their tax situation, as well as regarding the economic relationships they maintain with third parties" (article 59, no. 3, subparagraph d) and no. 4, of the LGT).

In the situation under analysis, we believe that the inspection report shows that the principles guiding material truth, contradiction and cooperation have been observed, with the Claimant having been afforded the right to a hearing and participation in the formation of AT decisions within the scope of the inspection procedure, having always been notified of the decisions rendered therein.

From the content of the inspection report, despite the divergence of views on the Claimant's tax reality, it reveals no persecutory intent, appearing to derive from difficulties in apprehending the management model pursued, taking into account, namely, the accounting lapses acknowledged by the Claimant in the course of the right to a hearing, whose period was extended at the request of the taxpayer, or the irregularities detected regarding compliance with certain tax obligations, as results from the analysis of real property lease agreements (Annex 6 of the RIT), in which it was found that "each one of them is signed by the same person as representative of each one of the parties, that the agreements were not communicated to the AT, as provided for in article 60 of the Stamp Tax Code – CIS, and that they do not have a note of the respective Stamp Tax having been assessed, as provided for in no. 6 of article 23 of the CIS (...)".

It does not appear, however, that the administrative action is violative of the principles of good faith and collaboration or any other principles governing the tax procedure (article 55 of the LGT), nor that the powers conferred on the AT in the scope of the tax inspection procedure have been exceeded (article 63 of the LGT and RCPITA).

For the reasons set forth, since no invalidating defect can be attributed to the inspection report that would render the subsequent tax acts voidable, the request for arbitral pronouncement is denied in this respect.

1.2. On the merits of the IRC assessments and compensatory interest

No. 1 of article 23 of the IRC Code, in the wording prior to that given to it by Law no. 2/2014, of 16 January, contained a general clause for the deductibility of expenses, subordinated to their indispensability "for the realization of income subject to tax or for the maintenance of the source producing it", indispensability which both doctrine and case law have come to consider that "cannot be understood as a necessary causal relationship between a concrete expense and the consequent income" (cf. the Superior Administrative Court Decision, of 21/02/2018, Case: 0791/13), and should rather take into account the connection of costs with the taxpayer's activity, that is, "in the operations resulting from the use of its assets, in particular its assets (...) in the manner in which its management will utilize the assets within the scope of the various operations (productive, commercial, investment and disinvestment, general financing, acquisition of financial participations and others) which, as a whole, allow the entity in question to fulfill its economic purpose: the pursuit (immediate or on a deferred basis) of an economic surplus (profit)."

The current wording of no. 1 of article 23 of the IRC Code, following what has been advocated by case law and doctrine, abandoned the concept of indispensability, coming to enshrine, as a general principle, the deductibility of expenses related to the taxpayer's activity, by providing that:

"Article 23 - Expenses and Losses

1 - For the determination of taxable profit, all expenses and losses incurred or borne by the taxpayer to obtain or guarantee income subject to IRC are deductible."

One of the activities pursued by the Claimant during the inspection period and which continues to be maintained consists of the leasing of real property, with CAE 68200, with a view to the exercise of which it has acquired and is the owner of various properties, which constitute its assets, in accordance with the definition given by the System of Accounting Normalization (SNC), according to which an asset "is a resource controlled by the entity as a result of past events and from which it is expected that economic benefits will flow to the entity" (§ 49 of the Conceptual Framework).

Now, it is not the fact that a given asset is not being used, wholly or partially, in a given fiscal year, not generating income in that fiscal year, that can remove from it the character of an asset, capable of generating future economic benefits for the company that holds it, thus preventing the deduction of expenses associated with its maintenance and conservation or the reintegration of invested capital, as this will be an option adopted by the respective corporate bodies within their freedom of management, and it is not the responsibility of the AT to substitute itself for them in the formulation of judgments of a business nature, as "whether or not it corresponds to the most effective defense of the company's interests is a question that cannot be resolved by granting the State a power of intervention".

In this way, the AT may only disregard expenses that do not fall within the scope of the taxpayer's activity and were incurred, not in the interest of the latter, but for the pursuit of objectives alien to the social purpose (theory of the abnormal act of management, that is, the one which "although legitimate, was not guided by the corporate interest").

This is because, unlike what happens in the VAT context, in which the right to deduct the tax borne by companies in their inputs requires, in order to guarantee the neutrality of the tax, the allocation of goods or services to an activity actually taxed, the deductibility of expenses in the IRC context does not depend on the realization of income in a given fiscal year, or the existence of a direct correlation between gains and expenses, even if these relate to assets not used in the fiscal year in question, as such non-use is merely a matter of management choice, which, if not proven to result in abnormal acts, the AT cannot scrutinize.

Having stated this, we shall proceed to analyze the adjustments contested by the Claimant in the request for arbitral pronouncement, relating to "costs and expenses relating to properties (or parts thereof) not used for business purposes" – depreciation, electricity, water, insurance, condominium and other expenses, in the fiscal years 2014 (€ 59,125.02), 2015 (€ 63,798.71) and 2016 (€ 62,658.68), in the total amount of € 185,582.41, referred to in the RIT (page 12 and annex 12).

With respect to the apartment located at ..., in Lisbon, which did not generate income in the fiscal years to which the inspection action applies, the AT alleges that, having constituted the residence of partner G..., the expenses incurred by the Claimant cannot be accepted for tax purposes, as they do not have a business cause.

However, as it has been proven that the said partner resided in London in the indicated years and the non-integration of the property into the Claimant's operational activity, in the fiscal years in question, being incapable of altering its nature as an asset of the company, nor having the AT succeeded in proving, as was its responsibility, that such expenses (depreciation, electricity, water, insurance, condominium, in the amounts of € 7,316.51, in 2014; € 7,678.21, in 2015 and € 8,805.31, in 2016) were not incurred in the interest of the taxpayer, the same should be accepted in their entirety.

As regards the Leiria property, consisting of ground floor, 1st floor and 2nd floor, the latter leased to B..., and in which a fire occurred on 6 January 2012, the AT considers that, as the two first floors of this building were assigned by the Claimant to C..., a company inactive in the period to which the inspection action applies, and regarding which the Respondent states that "it is unknown, since there is no need to know, whether the bar and gallery, operated by company C..., continued or did not continue in full operation after the fire" (article 51 of the response), only the expenses corresponding to the part leased to that first entity would be tax deductible.

Thus, as regards this property, which, according to the calculations contained in the RIT (page 12 and annex 8), is only allocated to the Claimant's business activity in the percentage of 25%, expenses resulting from depreciation were disregarded (€ 21,199.54, in 2014; € 21,989.03, in 2015 and € 21,989.03, in 2016), as well as expenses relating to water consumption (€ 96.99, in 2015 and € 296.64, in 2016, although in the RIT – page 21 – it is stated that "it is also noted that there are in the years under analysis water consumption in the building borne by sp, and it is certain that the water and electricity installations are common to the 3 floors") and other expenses (€ 3,186.64, in 2015, an amount which includes pest control – page 7 of the RIT).

It is true that it was not proven that the prolonged inactivity of company C..., recorded in the period to which the inspection applies, was due to the occurrence of the fire at the Leiria building on 6 January 2012, nor do the documentary or witness evidence produced allow ascertaining which damages, in concrete terms, affected the facilities of that company.

However, the AT cannot assert ignorance regarding the exercise (or not) of C...'s activity, in order to draw the conclusion that this company (still) occupies the ground floor and first floor of the building in which its registered office is located, and that, as they do not generate income for the Claimant, the same is not, in its totality, allocated to business purposes. Such conclusion is forbidden to it by the principle of inquisitorial power (article 58 of the LGT), which requires the AT to perform "all necessary steps to satisfy the public interest and discovery of material truth, not being subordinated to the initiative of the party making the request", a principle that is upstream of the rules on the burden of proof referred to in article 74 of the LGT.

The AT having failed to prove, as was its responsibility (article 74, no. 1, of the LGT), that the expenses borne by the Claimant with respect to the Leiria property were incurred for the benefit of third parties, as they relate mostly to charges inherent to the ownership of that asset (such as in the case of depreciation – articles 23, no. 2, subparagraph g), 29 and following of the IRC Code and Decree-Regulation no. 25/2009, of 14 September) or to supplies of water and other expenses borne for the benefit of the sole tenant, possibly included in the value of the rents, since, with respect to properties "with collected income, supplies of electrical power and/or water and/or other services are also generically provided to the tenant", as is acknowledged on page 7 of the RIT, the same should be accepted in their entirety.

Finally, with regard to the Coimbra dwelling, only partially allocated to the Claimant's activity (page 12 of the RIT and annex 8), the AT disregarded in 89% the expenses declared in the fiscal years under analysis, relating to depreciation (€ 20,680.27, in 2014; € 20,680.27, in 2015 and € 20,680.27, in 2016), electricity (€ 3,996.81, in 2014; € 6,200.99, in 2015 and € 4,796.61, in 2016), water (€ 2,094.53, in 2014; € 2,153.63, in 2015 and € 2,328.60, in 2016), insurance (€ 1,167.48, in 2014; € 1,126.22, in 2015 and € 1,099.59 in 2016), condominium – which is apparently a lapse by the AT (€ 89.00, in 2015) and other expenses (€ 2,669.87, in 2014; € 597.73, in 2015 and € 2,662.63, in 2016).

The justification given by the AT for these adjustments was that: (i) "From 2014 onwards it is recognized in the results of the fiscal year the use by B..., of the company office in the Coimbra dwelling" – page 5 of the RIT; (ii) "in February 2015, the registered office [of the Claimant] moves to Coimbra, to Rua ..., no...., a residential dwelling (...), which is also the residence of the parent-partners and family address"; (iii) "The three-floor dwelling in Coimbra, which in addition to having part (approximately 70% of the area, to believe the information provided to the inspection – see annex 8, pages 9 to 11) of the lower floor used as office and warehouse of the company (and also as a branch office of B..., for the preparation of medical reports, as previously mentioned in III.1.A.2) has been used especially by the parent-partners, as their principal residence" – page 10 of the RIT and, (iv) "it was found that only the contracts for the alleged lease of the dwelling to the parent-partner were presented, one dated 2012.05.01 and another dated 2016.01.01, although as of April 2017, there was no invoice issued to the parent-partner, those issued, and only from 2014 onwards, until that date regarding this property were to B...(…)" – page 25 of the RIT and annex 5, pages 19 and 20.

As already mentioned above, it is not the fact that a given asset of a company is not being used, wholly or partially, for business purposes, in a given fiscal year, that can remove from it the character of an asset, capable of generating future economic benefits for the company that holds it, so as to prevent the deduction of expenses associated with its maintenance and conservation or the reintegration of invested capital.

However, it is necessary to distinguish between expenses for such function, which cannot fail to be considered as incurred in the corporate interest, such as in the case of depreciation or insurance, from those which, not serving the business purpose, are incurred for the benefit of third parties.

Having regard to the foregoing and, the Claimant having failed to prove receipt of any rents relating to the part of the property assigned to the partners, they cannot be accepted as tax deductible, in the percentage ascertained by the AT, the charges relating to supplies of electricity, water and other expenses with respect to that part, in the global amounts of € 8,761.21 (2014), € 8,952.35 (2015) and € 9,787.84 (2016), the corresponding adjustments to taxable profit for the mentioned fiscal years being maintained.

For the reasons set forth regarding the identified properties, the assessments should be annulled in the part corresponding to the adjustments improperly made, due to erroneous interpretation and application of article 23 of the IRC Code, in the amounts of € 50,363.80 (2014), € 54,846.36 (2015) and € 52,870.85 (2016), with the further legal consequences.

  1. Questions whose determination is prejudiced

In the judgment, the judge must pronounce on all questions that he should assess, refraining from pronouncing on questions that he should not know about (final part of no. 1 of article 125 of the CPPT), and the questions on which the tribunal's powers of cognition fall are, according to no. 2 of article 608 of the Code of Civil Procedure (CPC), subsidiarily applicable to the tax arbitration proceedings, by referral of article 29, no. 1, subparagraph e), of the RJAT, "the questions which the parties have submitted for its assessment, except those whose decision is prejudiced by the solution given to others (...)".

Given the foregoing, the determination of the questions addressed by the Claimant, relating to transfer pricing referred to in article 63 of the IRC Code, and to the application of the general anti-abuse clause, provided for in no. 2 of article 38 of the LGT, is prejudiced.

As to the first of those questions, since it aims to ensure the arm's length principle in commercial operations between related entities, namely through the "comparable market price method", which the AT manifestly did not use in the adjustments to taxable profit for the fiscal years under analysis, accepting the values of the rents contained in the Claimant's accounting elements.

With respect to the second question, regarding the lease of the Coimbra dwelling to the Claimant's partners in the fiscal years 2014, 2015 and 2016, we believe that the same relates to the application of the rules on the burden of proof: having the AT proven, on the basis of the Claimant's accounting, that despite lease agreements for the dwelling to the partner having been presented, one dated 2012.05.01 and another dated 2016.01.01, until April 2017, no invoice had been issued in his name, it was incumbent upon the Claimant to provide counter-proof of the alleged, which it failed to do.

IV. DECISION

Based on the factual and legal grounds set forth above, this decision is rendered, finding the present request for arbitral pronouncement partially well-founded:

a. To declare the partial illegality of IRC assessments no. 2018..., of 27.07.2018 and compensatory interest no. 2018..., as well as the statement of account reconciliation no. 2018..., relating to the fiscal year 2014, determining their annulment in the part corresponding to taxable matter of € 50,363.80;

b. To declare the partial illegality of IRC assessments no. 2018..., of 02.08.2018 and compensatory interest no. 2018... and no. 2018..., as well as the statement of account reconciliation no. 2018..., relating to the fiscal year 2015, determining their annulment in the part corresponding to taxable matter of € 54,846.36;

c. To declare the partial illegality of IRC assessments no. 2018..., of 02.08.2018 and compensatory interest no. 2018..., as well as the statement of account reconciliation no. 2018..., relating to the fiscal year 2016, determining their annulment in the part corresponding to taxable matter of € 52,870.85.

VALUE OF PROCEEDINGS: In accordance with the provisions of article 306, nos. 1 and 2, of the CPC, 97-A, no. 1, subparagraph a), of the CPPT and no. 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceedings is fixed at € 45,333.07 (forty-five thousand, three hundred and thirty-three euros and seven cents).

COSTS: Calculated in accordance with article 4 of the Regulation of Costs in Tax Arbitration Proceedings and Table I attached thereto, in the amount of € 2,142.00 (two thousand, one hundred and forty-two euros), to be apportioned in the proportion of 14.82% against the Claimant and 85.18% against the Respondent.

Let notice be given.

Lisbon, 19 August 2019.

The Arbitrator,

Mariana Vargas

Text produced by computer, in accordance with no. 5 of article 131 of the CPC, applicable by referral of subparagraph e) of no. 1 of article 29 of Decree-Law 10/2011, of 20 January.

The wording of this decision is governed by the 1990 spelling agreement.

Frequently Asked Questions

Automatically Created

What are the conditions for deducting expenses (gastos) under Article 23 of the Portuguese IRC Code?
Under Article 23 of the Portuguese IRC Code, expenses are deductible when they are incurred to obtain or guarantee taxable income, documented, recorded in accounts, and comply with business purpose requirements. The expense must have a genuine business connection, though Portuguese tax jurisprudence recognizes that deductibility is not necessarily conditioned on generating immediate taxable income in the same taxation period. The business purpose test examines whether the expenditure relates to the company's statutory activities and economic objectives, rather than requiring direct profitability in each fiscal year.
Can property-related costs be deducted as business expenses for IRC purposes when the company operates in real estate leasing?
Property-related costs can be deducted as business expenses for IRC purposes when the company operates in real estate leasing, provided the properties are held for business purposes within the company's statutory activities. In CAAD process 617/2018-T, the claimant argued that properties acquired for future rental income, properties undergoing rehabilitation, or properties temporarily not generating income due to external factors (such as fire damage) maintain their business character. The deductibility depends on demonstrating that properties constitute business assets intended to generate taxable income, even if income realization is deferred due to market conditions, strategic planning, or unforeseen circumstances.
What was the outcome of CAAD arbitration process 617/2018-T regarding IRC expense deductibility?
The complete outcome of CAAD arbitration process 617/2018-T is not provided in the excerpt, which contains only the initial sections of the arbitral decision. The case involved IRC assessments for 2014-2016 regarding three properties where the Tax Authority challenged €45,333.07 in deductions. The claimant contested the AT's rejection of property expenses, arguing violation of good faith duties in the inspection procedure and incorrect application of Article 23 IRC Code. The arbitral tribunal was constituted as a singular arbitration under the Legal Framework for Tax Arbitration (RJAT), with the decision addressing fundamental questions about expense deductibility, business purpose requirements, and the temporal connection between expenses and income generation.
How does the Portuguese Tax Authority (AT) assess the deductibility of costs associated with multiple properties for IRC?
The Portuguese Tax Authority (AT) assesses the deductibility of costs associated with multiple properties for IRC by examining whether each property demonstrates genuine business use and income-generation potential. In process 617/2018-T, the AT scrutinized: evidence of actual rental income; formal lease agreements; relationship between property use and declared business activities; and potential personal use by partners or shareholders. The AT questioned properties showing no recorded income, those allegedly used as partners' residences, and rental arrangements with below-market rates to related parties. The authority applied a restrictive interpretation requiring contemporaneous income correlation, while the taxpayer advocated for recognizing properties held for future exploitation or experiencing temporary non-use as legitimate business assets qualifying for expense deduction under Article 23 IRC Code.
What is the procedure for challenging IRC tax assessments through CAAD tax arbitration in Portugal?
Challenging IRC tax assessments through CAAD tax arbitration in Portugal follows the procedure established in Decree-Law 10/2011 (RJAT - Legal Framework for Tax Arbitration). Taxpayers submit a request for constitution of an arbitral tribunal to CAAD, identifying the contested assessments and specifying the economic value at stake. The request must comply with Articles 2 and 10 RJAT and Order 112-A/2011. The CAAD President accepts the request and notifies the Tax Authority. Under Article 11 RJAT, the Deontological Council designates an arbitrator for singular tribunals (or arbitrators for collective tribunals), unless parties exercise their designation rights. Both parties may present arguments, with the claimant bearing the burden of demonstrating assessment illegality. The process provides an alternative to judicial courts, offering specialized tax dispute resolution with binding decisions on matters including IRC expense deductibility, transfer pricing, and procedural irregularities in tax inspections.