IRS Capital Gains and Category G Transitional Regime: CAAD Decision 620/2014-T

ARBITRAL AWARD

Arbitration Proceeding No. 620/2014-T

Claimants: A... and B...

Respondent: Tax and Customs Authority

Personal Income Tax ("IRS"), 2010

ARBITRAL AWARD

The arbitrators, Jorge Lino Ribeiro Alves de Sousa (President Arbitrator), Alexandra Coelho Martins and Jorge Júlio Landeiro de Vaz, designated by the Deontological Council of the Center for Administrative Arbitration ("CAAD"), in accordance with the provisions of Article 6, No. 2, paragraph a) of Decree-Law No. 10/2011, of 20 January, to form the Collective Arbitral Tribunal, constituted on 15 October 2014, agree as follows:

I. REPORT

A..., taxpayer No. ..., and B..., taxpayer No. ..., both residents at Rua ..., Lisbon, hereinafter "Claimants", requested the constitution of an Arbitral Tribunal under Articles 2, No. 1, paragraph a) and 10, No. 1, paragraph a) of Decree-Law No. 10/2011, of 20 January, which approved the Legal Framework for Arbitration in Tax Matters ("RJAT").

The request for arbitral pronouncement concerns the assessment of legality and annulment of the IRS assessment act issued under No. 2014 ..., relating to the year 2010, in the amount of € 1,404,549.98, and also the condemnation of the Tax and Customs Authority ("TA") to payment of compensation for undue provision of guarantee, as provided in Article 53, Nos. 1 and 3 of the General Tax Law ("LGT").

The Claimants based their claim on formal and substantive defects, alleging, in summary:

(a) The omission of essential legal formalities in the inspection procedure, as this was classified by the TA as internal, despite actually constituting an external inspection procedure, thus exceeding the scope of the Service Order notified and generating the voidability of the assessment act under Articles 46, No. 2 and 49, No. 1 of the Supplementary Regulation of Tax Inspection Procedure ("RCPIT"), to which is added the exceeding of the legally foreseen duration period for the inspection procedure;

(b) The defect of lack of reasoning of the tax act, as they were notified of a tax assessment act in the amount of € 1,404,549.98, which has no justification in the inspection report, as this provides for a substantially lower IRS correction of € 560,000.00, resulting from the taxation of a capital gain of € 2,800,000.00 at the rate of 20%. According to the Claimants, the lack of reasoning of the act implies its nullity, by violation of the constitutionally enshrined right of taxpayers to know the grounds of acts that alter their legal sphere;

(c) Violation of Article 10, No. 3 of the IRS Code and also of the transitional regime of non-subjection to this tax, provided in Article 5 of Decree-Law No. 442-A/88, of 30 November.

In this context, according to the Claimants, the commercial establishment "C..." came into the ownership of Claimant B... in 1986, and it is irrelevant for tax purposes that this transfer was formalized by deed of transfer executed only on 2 April 1990 and that its registration occurred only in that year, since actual possession ("physical delivery") of the establishment dates to 1986 and was accompanied by full payment of the price.

In their view, the subsequent transfer of said establishment by Claimant B..., on 31 August 2006, to the ownership of a unipersonal limited company held by her (through capital increase by contribution in kind), constituted not a transfer, but an allocation of assets that could be framed in Article 10, No. 3, paragraph b) of the IRS Code, with taxation suspended until the moment of subsequent onerous disposal of the assets or other equivalent fact, in the present case, the sale of the shares in 2010.

They acknowledge that the sale of shares realized in 2010 falls within Article 10, No. 1, paragraph b) of the IRS Code, and that the respective gain should be calculated by the difference between the realization value and the acquisition value (cf. Article 10, No. 4, paragraph a) of the same act).

However, they invoke the specificities of the case to consider that the acquisition value should be reported to the moment of initial acquisition of the establishment (and not the share) by Claimant B..., which they understand occurred in 1986, leaving the gain resulting from the disposal of the establishment excluded from taxation, in accordance with the transitional regime of category G established by Article 5 of Decree-Law No. 442-A/88, of 30 November, which approved the IRS Code.

The Claimants consider that what is at issue is the acquisition value of the establishment and not of the share, by virtue of the application of Article 10, No. 3, paragraph b) of the IRS Code, and that the acquisition date relevant can only be that of the establishment (and not that of the share).

Finally, they analyze the regime of Article 38 of the IRS Code, on the contribution of assets to realize the capital of a company, to reinforce the application of the regime provided in Article 10, No. 3, paragraph b) of the IRS Code, and to conclude that the allocation of the establishment, which occurred in 2006, did not constitute a true transfer. Thus, only an acquisition in 1986 (of the establishment) and a disposal in 2010 (of shares) would have occurred, and the corresponding capital gains being excluded from taxation, in the part corresponding to the capital increase, by application of the transitional regime provided in Article 5 of the act approving the IRS Code.

They petition for the annulment of the act of additional IRS assessment relating to the year 2010 and the condemnation of the TA to payment of compensation for undue provision of guarantee, under Article 53, Nos. 1 to 3 of the LGT.

With the petition, documents were attached and four witnesses were summoned.

Within the period provided in Article 13, No. 1 of the RJAT, the contested tax assessment act for IRS was partially revoked by order of the Director-General of the TA, dated 15 September 2014, reducing it to the amount of € 560,000.00.

The Claimants, notified of the order for partial revocation of the tax act, pronounced themselves in the sense of maintaining the request for arbitral pronouncement, for the remaining amount of € 560,000.00, maintaining, however, that the annulment should be total, by virtue of the defect of lack of reasoning affecting the entire act, unique and indivisible.

The TA presented a response arguing that:

(i) There is no omission of essential formalities in the inspection procedure, the classification of the inspection action as internal being correct. The mere request for documentary evidence directed to the Claimants, following the identification of undeclared capital gains – by cross-referencing model 3 declarations with information that the TA had regarding the purchase and sale of shareholdings – does not constitute an external inspection action. If this were the case, any request for clarification or diligence carried out in the TA's facilities would be considered an external inspection action, making Article 13, paragraph a) of the RCPIT inapplicable and compromising state revenues protected in Article 103, No. 1 of the Constitution of the Portuguese Republic ("CRP").

They add that the conduct of a witness hearing diligence took place at the request of the Claimants themselves and occurred in the TA's facilities, with no displacement to the domicile or facilities of the Claimants or third parties, and that the inspection report was not based on information sent by the taxpayers, but rather on the failure to deliver annex G of their respective IRS declaration;

(ii) The reasons of fact and law supporting the corrections made were clearly, congruently and sufficiently disclosed to the Claimants, having been notified to exercise the right to prior hearing regarding the draft inspection report and exercised such right. Furthermore, in a situation of lack of reasoning, they had at their disposal the mechanism provided in Article 37 of the Code of Tax Procedure and Process ("CPPT") which they did not activate. The calculation error reflected in the IRS assessment was corrected in the partial revocation, leaving the grounds contained in the inspection report intact;

(iii) There is no violation of Article 10 of the IRS Code. What is at issue is the taxation of capital gains from the sale of shareholdings, in the year 2010, of a company established in 2006, that is, outside the temporal scope of application of the transitional provision of Article 5 of Decree-Law No. 442-A/88, of 30 November.

With regard to the preceding contribution in kind of the establishment to the company, which occurred in 2006, this constitutes a transfer of that establishment from Claimant B... to the company's sphere, both endowed with legal and tax personality, and is not the subject of these proceedings. Another subsequent operation (2010) is under consideration, that of the sale of the company's shares by the Claimant. The establishment became an asset of the company and is a reality distinct from the share. What is not the subject of taxation is the capital gain relating to an asset that makes up the company's assets, but rather that relating to the sale of the share.

On the other hand, the transitional regime would be inapplicable, even under the Claimants' thesis, because if acquisition of possession of the establishment in 1986 had been proven, this would not imply exclusion from taxation, since acquisition of a given asset is given by the transfer of ownership, not by mere possession, and the legal effect transferring property took place in 1990, after the entry into force of the IRS Code.

The TA concludes that the action should be judged unfounded and the respondent entity absolved of the claim.

It attached a document to these proceedings and attached the administrative file, of which the Claimants were notified.

Following notification on 29 September 2014 of a new IRS assessment act, under No. 2014 ..., in the amount of € 618,700.32, of the demonstration of interest calculation, in the amount of € 61,711.32, and of the demonstration of account settlement that calculates a balance of € 0.00, the Claimants requested the expansion of the claim, so as to also assess the legality of these acts, the issuance of which they consider untimely and also illegal due to lack of reasoning.

The Respondent, in the exercise of right to reply, maintains that it is clear that this is only the correction of the previous assessment, which did not result from a requalification of tax facts or a new regulation of the legal situation, being merely a recalculation.

The TA considers that untimeliness does not occur, nor, equally, lack of reasoning, the latter being expressed in the order for partial revocation of the assessment act. As for the difference in values, the same pertains to the allocation of compensatory interest as can be seen from the analysis of the assessment note. It concludes that there is no reason for expansion of the claim, but rather for its reduction.

As no matter susceptible of discussion at the meeting referred to in Article 18 of the RJAT was raised, and as the file contains all elements to decide on the law, said meeting was dispensed with and the production of the summoned witness evidence was dispensed with, relegating the knowledge of the question of expansion of the claim to the end. The date of 12 January 2014 was set for the pronouncement of the final decision.

II. ISSUES TO BE DECIDED

There are four main issues to be assessed and decided:

(a) Admissibility of the expansion of the claim;

(b) Omission of essential legal formalities in the inspection procedure (internal or external) and invalidating effect of the assessment act;

(c) Lack of reasoning of the tax act, both with respect to the first act of additional IRS assessment and to the subsequent corrective act resulting from the partial revocation of that assessment;

(d) Applicability of the transitional regime of exclusion from IRS taxation, provided in Article 5 of Decree-Law No. 442-A/88, of 30 November, to the revenues in question (capital gains resulting from the sale of shareholdings of a company established in 2006), based on the assumption of the framing of the operation and respective revenues generated in Article 10, No. 3, paragraph b) of the IRS Code.

Finally, it is important to assess the grounds and scope of the claim for condemnation of the TA to payment to the Claimants of compensation for undue provision of guarantee.

III. REASONING

1. OF THE FACTS

1.1. Proven Facts

With relevance for the assessment and decision of the raised issues, the following facts are considered established:

A. On 2 April 1990, at the ... Notary's Office in Lisbon, a deed of transfer of the Pharmacy establishment called "C...", located in Lisbon, at Avenida ..., was executed, for the price of 25,000,000$00 (twenty-five million escudos), for the benefit of Claimant woman, B..., in the capacity of transferee, with it being declared by all the parties, including the Claimants herein, that she took effective possession of the establishment on 31 March 1990 – cf. copy of the transfer deed attached with the Response of the TA and contained in the administrative file ("PA"), in file PA 2.

B. On 22 February 2006, Claimant woman constituted the company "D... – Unipersonal, Ltd.", with the social capital entirely held by her of € 100,000.00, realized in cash, the company having begun its activity, for VAT purposes, on 1 June 2006 – cf. Tax Inspection Report ("RIT"), p. 8, contained in file PA.

C. On 31 August 2006, the company "D... –, Ltd." increased its respective social capital by new contributions in the total amount of € 300,000.00, of which € 500.00 in cash and € 299,500.00 in kind – the company coming to have the nominal social capital of € 400,000.00, represented by a single share belonging to Claimant woman – cf. RIT, p. 8, contained in file PA.

D. The contribution in kind concerned the establishment "C..." and was the subject of a Report of the Official Auditor, dated 12 June 2006, issued under Article 28 of the Commercial Companies Code, which confirmed the value attributed to the establishment of € 299,500.00 – cf. RIT, p. 8, and Official Auditor's Report contained in file PA.

E. On 4 January 2010, Claimant woman divided her share in the company "D... – Unipersonal, Ltd." into two new shares, coming to hold one share with the nominal value of € 380,000.00 and another with the nominal value of € 20,000.00 which she transferred, on that same date, for onerous consideration, for the total price of € 3,200,000.00, respectively:

(a) To the company "E... – Pharmacy Unipersonal, Ltd.", for the price of € 3,040,000.00; and

(b) To F..., for the price of € 160,000.00,

– cf. RIT, pp. 6 to 8, and copy of the deed of division, share transfers, waiver, company transformation and amendment of agreement, contained in file PA.

F. The Claimants presented, on 4 May 2011, the IRS Declaration form 3 relating to the revenues for the year 2010, but did not deliver annex G, relating to capital gains and other capital increments. The Declaration delivered resulted in a net collection of nil and IRS to be recovered in the amount of € 3,516.93, as shown in assessment No. 2011 5002582677 – cf. RIT, pp. 4, 5 and 7, contained in file PA.

G. From the internal analysis carried out on the Declaration form 3 presented by the Claimants, the TA noted that although they had executed a deed of transfer of shareholdings of a company for the value of € 3,200,000.00, they did not deliver the respective Annex G (capital gains and other capital increments), and an inspection procedure was initiated for the year 2010, based on Service Order No. OI2013..., of 1 February 2013, of partial scope – cf. RIT, p. 4, contained in file PA.

H. By letter dated 6 August 2013, the Finance Directorate of Lisbon addressed to Claimant woman a "Request for Information and Clarifications – Art. 59 and 69 of the General Tax Law (LGT) and Art. 48 of the Supplementary Regulation of Tax Inspection Procedure (RCPIT)", noting the beginning of an internal inspection procedure for the year 2010 and requesting the elements/clarifications indicated below:

"1. Justify the non-inclusion of annexes G or G1 of the income declaration Form 3 delivered in this year, since on 2010-01-04 Dr. B... transferred together with her husband Mr. A..., the shares she held in company D..., Ltd., for the price of € 3,200,000.00.

1. Indicate the date on which the pharmacy with License No. ... of 19-12-1949, came into the possession of Dr. B..., as well as the acquisition value of the same. (...)"

– cf. RIT, p. 7, and copy of the letter ... of the Finance Directorate of Lisbon, contained in files PA and PA 2.

I. In response to this request for elements and clarifications, the Claimants informed that:

· The pharmacy came into their possession on 1 November 1986, having at that time paid 25,000,000$00 (twenty-five thousand contos); and that

· The non-inclusion of annexes G or G1 was due to the provision of Article 5 of Decree-Law No. 442-A/88, of 30 November, which approved the IRS Code, relating to the transitional regime of category G,

– cf. RIT, p. 7, and copy of the response document, contained in files PA and PA 2.

J. The Finance Directorate of Lisbon additionally requested from the Claimants, via e-mail, the sending of "a copy of a document proving that the Pharmacy "", with license No. ..., came into the possession of Dr. B... on 1/11/1986", to which they responded, on 23 October 2013, that they were unable to locate the whereabouts of the contract that served as the basis for the transaction, nor proof of payment, requesting a witness hearing for proof of possession on that date – cf. RIT, p. 7, and copy of the response document, contained in files PA and PA 2.

K. On 23 December 2013, the Finance Directorate of Lisbon again addressed a request to the Claimants for attachment of a copy of the auditor's evaluation report relating to the capital increase in kind of the company "D... –, Ltd." – cf. copy of letter No. ..., contained in file PA 2.

L. The witness hearing diligence took place on 27 December 2013 in the facilities of the Finance Directorate of Lisbon – cf. copy of letter ..., of 13 December 2013 and transcript of hearings contained in file PA 2.

M. On 31 January 2014, the Claimants were notified of the draft Inspection Report relating to the year 2010 which, in addition to proposing uncontested corrections to the real property income of the Claimants, considers that they obtained capital gains in the total value of € 2,800,000.00, taxable in IRS as category G income, under Articles 9 and 10 of the IRS Code, as a result of the alienation of the two shares held by Claimant woman in the company "D... –, Ltd.", as illustrated in the terms of the table reproduced below on p. 9 of the draft Report (cf. draft attached as document 2 with the arbitral claim):

[Table showing:
Realization vs Acquisition dates and values for different share transfers, with capital gains calculated showing totals for 2006 entries and final capital gains calculation totaling € 2,800,000.00]

N. According to the draft Report, "by application of the special rate (autonomous taxation) of No. 4 of Article 72 of the IRS, to the revenues of capital gains from alienation of shareholdings, there is an increase in the net collection of the taxpayer for the year 2010, in the amount of € 560,000.00 = (€ 2,800,000.00 * 20%).", whose assessment is proposed – cf. draft attached as document 2 with the arbitral claim).

O. The Claimants exercised, on 28 February 2014, the right to prior hearing by presenting the reasons of fact and law by which they understand that the amount of IRS calculated as capital gains should not be accepted – cf. copy of the right to hearing attached as document 3 with the arbitral claim and contained in file PA.

P. On 19 March 2014, the Claimants were notified of the Final Inspection Report ("RIT"), which makes the corrections proposed in the draft definitive, specifically with respect to the IRS assessment in the amount of € 560,000.00 referring to capital gains income. The notification letter refers to the altered/calculated income relating to the year 2010 of € 2,822,359.52 – cf. copy of the RIT attached as document 4 with the arbitral claim and contained in file PA.

Q. The RIT reaffirms, in essence, the reasoning of the draft, also pronouncing on the right to hearing, as partially transcribed:

"1.3. – Capital Gains – sale of shares

(...)

The limited company by shares that was alienated on 2010/01/04 was established on 2006/02/22 and operated under the firm name "D... –, Ltd.

The commercial company was established with the social capital of € 100,000.00, which was held solely by B.... (...)

Commercial company, which although being unipersonal, is undoubtedly a company that came to have assets belonging to a legal entity distinct and autonomous in relation to the partner. That is, the company established is a legal entity distinct from the person (partner) who established it, having its own legal personality.

At the date of the establishment of the unipersonal limited company, the taxpayer continued to be the sole owner of the commercial establishment "C..." and only on 2006/08/31 at the time of the deliberation to increase capital did it decide to integrate it in the assets of the unipersonal limited company, in the form of contributions in kind to which was attributed the price of € 299,500.00 (amount attested by an Official Auditor).

Accordingly, the "Pharmacy" existing in 1986 only passed into the assets of the unipersonal company created in 2006, through the capital increase made in kind, so one cannot confuse the partner's share with the value of the commercial establishment with which the share was realized.

The capital increase, which occurred in the unipersonal limited company, translated into the transfer of ownership of the assets that constituted the assets and liabilities of the commercial establishment and which were in the ownership of the natural person Dr. B... to become part of the assets of the unipersonal limited company.

At the date of said capital increase, the establishment came to be held by the unipersonal limited company, and the single share with the nominal value of €400,000.00 is held by the taxpayer.

Now, on 2010/01/04 the unipersonal limited company divides its single share into two and transfers these for onerous consideration to "E... – Unipersonal Pharmacy, Ltd.", with the NIF 505409046 and to F..., with the tax identification number ..., it is this alienation that will necessarily have to be subject to correction.

Such alienation constitutes category G income from IRS, as prescribed in No. 1, paragraph a) of Article 9 of the IRS Code (CIRS) and No. 1, paragraph b) of Article 10, also of the CIRS (...)

The realization value of the alienation of the shares, would be the value of the consideration, as described in the contract:

The calculation of Capital Gain is obtained by the difference between the realization value and the acquisition value as in paragraph a) of No. 4 of Article 10 of the CIRS. Accordingly, there is a place for the completion of table 8 of annex G of the income declaration form 3, concerning the year in which the transfer took place – 2010.

The total capital gain obtained, determined on the basis of the provisions in Nos. 1 and 3 of Article 43, No. 1 of paragraph f), of Article 44 and paragraph b) of Article 48, all of the CIRS is € 2,800,000.00, as demonstrated in the following table:

Taking into account the provision in No. 4 of Article 72 of the CIRS, the calculated capital gain is taxed at the rate of 20% (autonomous taxation). (...)

Accordingly, by application of the special rate (autonomous taxation) of No. 4 of Article 72 of the CIRS, to the revenues of capital gains from alienation of shareholdings, there is an increase in the net collection of the taxpayer for the year 2010, in the amount of € 560,000.00 = (€ 2,800,000.00 * 20%). (...)"

[The remaining portion of the RIT discussing the right to prior hearing, citing points 6-28 of the reasoning, discusses the analysis of whether the pharmacy was acquired in 1986, the distinction between possession and ownership under Portuguese civil law, and the applicability of the transitional regime of Article 5 of Decree-Law 442-A/88]

R. On 15 April 2014, the Claimants were notified of the act of additional IRS assessment issued under No. 2014 ..., dated 29 March 2014, relating to the year 2010, which sets the total income value at € 2,826,711.79 and calculates the amount to be paid at € 1,404,549.98 – cf. copy of the assessment act attached as Document 1 to the arbitral claim.

S. Tax enforcement proceedings were instituted against the Claimants for collection of the IRS debt arising from that additional assessment, in the context of which they presented a request for exemption from guarantee, awaiting the decision of the Finance Service – cf. Document 5 attached with the arbitral claim.

T. Not accepting the said IRS assessment act, on 13 August 2014, the Claimants presented a request for constitution of a Collective Arbitral Tribunal to the CAAD, of which notice was given to the TA on 18 August 2014 – cf. electronic request and information contained in the CAAD system.

U. On 15 September 2014, the act of additional IRS assessment issued under No. 2014 ..., in the amount of € 1,404,549.98 was partially revoked, by order of the Director-General of the TA, which is attached to the proceedings, on the basis of Legal Opinion No. 0445/2014, from which the following excerpt is extracted:

"A pronouncement was requested by the DSCJC from the DF of Lisbon, regarding the maintenance of the assessment act No. 2014... of IRS correlated with the year 2010, the value of which is € 1,404,549.98.

By information and order dated 10 September 2014, the Director of Finance of Lisbon proposed the partial revocation of the assessment act in the terms and grounds contained in the information attached to this opinion.

In this sense, it is proposed for the consideration of the Director-General of the TA the partial revocation of the assessment act above identified, involving the reduction of the economic value of the request for arbitral pronouncement from € 1,404,549.98, to € 560,000.00. (...)"

V. On 18 September 2014, the Claimants were notified of the order for partial revocation of the IRS assessment act No. 2014 ..., subject of the arbitral claim – cf. notification contained in the CAAD system.

W. On 29 September 2014, the Claimants were notified of the additional IRS assessment identified with No. 2014 ..., dated 15 September 2014, in the total amount of € 618,700.32, of which € 61,711.32 correspond to compensatory interest (field 27), having also on that date received the demonstration of interest calculation with No. 2014 ... (in the referred amount of € 61,711.32) and the demonstration of account settlement under No. 2014 ..., which calculates a balance of € 0.00 – cf. copies of the referred supervenient documents attached by the Claimants.

X. From the demonstrative note of this second additional IRS assessment No. 2014 ..., the referred total value of € 618,700.32 is obtained from the following items (cf. copy of the IRS assessment attached by the Claimants):

[Table with calculation fields showing:

1. Total income: € 26,105.13
2. Specific deductions: € 4,852.27
3. Losses to recover: € 0.00
4. Abatements: € 0.00
5. Deductions to income: € 0.00
6. Taxable income: € 21,252.86
7. Quotient prior year income/Intellectual property: € 0.00
8. Income exempt from aggregation for rate determination: € 0.00
9. Total income for rate determination: € 21,252.86
10. Marital quotient 2: rate 24.080%
11. Calculated amount: € 2,558.85
12. Amount to deduct: € 881.09
13. Tax prior year/Intellectual property: € 0.00
14. Tax for exempt income: € 0.00
15. Additional rate: € 0.00
16. Tax for autonomous taxation: € 560,138.15
17. Total collection: € 563,493.67
18. Deductions from collection: € 3,229.91
19. Municipal benefit: € 0.00
20. Increases to collection: € 0.00
21. Net collection: € 560,263.76
22. Payments on account: € 0.00
23. Withholdings at source: € 3,274.76
24. Calculated tax: € 556,989.00
25. Savings retention interest: € 0.00
26. Result surcharge: € 0.00
27. Compensatory interest: € 61,711.32
28. Indemnity interest: € 0.00

AMOUNT TO PAY: € 618,700.32]

2.1. Unproven Facts

No other facts were proven which, in view of the possible legal solutions, have relevance for the decision of the case.

With respect to the allegation that the establishment "C..." was acquired by the Claimant in 1986, not having been proven, the same is irrelevant for the decision, which concerns the taxation regime, or not, of income derived from a transaction of alienation of shares and not of the said commercial establishment.

2.2. Motivation of the Factual Decision

The decision on the factual matter was made on the basis of examination and critical assessment of the documents and information attached to the proceedings and discriminated above, whose authenticity and veracity was not questioned by the parties.

1. ON THE LAW

3.1. Expansion of the Claim

After the presentation of the request for constitution of the Arbitral Tribunal and the subsequent partial revocation of the tax act subject to that request by the TA, the Claimants were faced with the issuance of a second additional IRS assessment, relating to the same tax (IRS) and period (2010), which was notified to them on 29 September 2014, in the total amount of € 618,700.32, of which € 61,711.32 referring to compensatory interest.

The Claimants intend that the legality of that/these tax act(s), which they qualify as new acts and not merely corrective, should also be assessed in the present action, requesting, for that purpose, the expansion of the claim in accordance with the provisions of Article 70, No. 3 of the Code of Procedure in Administrative Courts ("CPTA").

The TA pronounces itself in the sense of rejection of the expansion of the claim, as it understands that the second assessment act notified is limited to the implementation of the partial revocation of the first act that was duly notified to the Claimants and to the Arbitral Tribunal, not involving a new regulation of the legal situation or requalification of the facts.

On this matter, it is important to consult the provision of Article 13 of the RJAT, which provides in its No. 1 that "the tax administration may, within 30 days from becoming aware of the request for constitution of the arbitral tribunal, proceed to revoke, ratify, reform or convert the tax act whose illegality was raised, practicing, when necessary, a substitute tax act". (emphasis added)

If the tax act subject to the request for arbitral pronouncement is, wholly or partially, altered or replaced by another, the regime established by No. 2 of cited Article 13 of the RJAT applies, whereby "the highest-ranking official of the tax administration service proceeds to notify the taxpayer to, within 10 days, pronounce himself, proceeding with the procedure with respect to that last act if the taxpayer says nothing or declares that he maintains his interest."

Accordingly, in the situation in question, even if the Claimants had not expressly requested it, the procedure should continue with respect to the substitute act.

It should be noted that, in cases where the alteration or substitution of the act occurs after the constitution of the Arbitral Tribunal, in the pendency of the proceedings, the possibility of objective modification of the suit has basis in Article 20 of the RJAT, continuing the proceedings against the new act, in accordance with the express reference of its No. 2 to Article 64 of the CPTA.

The objective modification of the suit is admitted, equally, in the process of judicial challenge, of which the tax arbitration process is intended to be a successor, when supervening facts, objectively or subjectively for the challenger, provide him the knowledge of defects of which he could not know at the moment of presentation of the petition.

See, by way of example, the Award of the Supreme Administrative Court ("STA") No. 030/11, of 29 June 2011, whose elucidative summary is transcribed:

"I – It is admissible, in judicial challenge proceedings, the expansion of the claim and the cause of action, in accordance with the provisions of Article 63 of the CPTA, by virtue of Article 2, paragraph e) of the CPPT, whenever supervening facts occur for the challenger which provide him the knowledge of defects of which he could not know at the moment of presentation of the initial petition, thus allowing the challenger to invoke new facts or impute new defects to the challenged act.

II – This is what happens when the TA, already in the pendency of the challenge, issued a demonstration of account settlement and new assessment, following a request for administrative reconsideration presented by the challenger." (emphasis added)

This is the solution that best aligns with the constitutional principles of access to law and effective judicial protection (cf. Article 20 of the Constitution of the Portuguese Republic), allowing the assessment in the same proceedings of the defects of the various acts that materially shape the (same) tax legal relationship that may be practiced in the context of the procedure and/or in the pendency of the proceedings.

These principles equally inspire the discipline of the CPTA which provide that the object of the proceedings be expanded or that the proceedings continue against the new act. We refer, in particular, to the provisions of Articles 63, 64 and 70 of the CPTA:

"Article 63 – Objective Modification of the Suit

1 – When, because suspension of the procedure in which the challenged act is inserted was not decreed as a precautionary measure, the latter has continuation in the pendency of the proceedings, the object may be expanded to the challenge of new acts that may be practiced in the context of that procedure, as well as to the formulation of new claims that may be cumulated with it.

2 – (...)

3 – For the purpose of the provisions in the preceding numbers, the Administration must bring to the proceedings the information of the existence of any acts connected with the challenged act that may be practiced in the pendency of the same.

Article 64 – Revocation of the Challenged Act with Retroactive Effects

1 – When, in the pendency of the proceedings, a revocatory act is rendered with retroactive effects of the challenged act, accompanied by a new regulation of the situation, the applicant may request that the proceedings continue against the new act, with the faculty to allege new grounds and offer different means of evidence.

2 – (...)

3 – The provision in No. 1 is applicable to all cases in which the challenged act is wholly or partially altered or replaced by another with the same effects, and also in the case where the revocatory act has already been practiced at the moment the proceedings were instituted, without the applicant having had or should have had knowledge of it.

Article 70 – Alteration of the Suit

1 – (...)

2 – (...)

3 – When, in the pendency of the proceedings, a administrative act is rendered that does not fully satisfy the claim of the interested party, the request for annulment or declaration of nullity or non-existence of this act may be cumulated, with the new articulation to be presented within the period of 20 days.

4 – (...)"

Returning to the case at hand, the request for constitution of the Arbitral Tribunal was filed on 13 August 2014 and the new assessment, which forms the basis for the expansion of the claim, was issued on 15 September and notified to the Claimants on 29 September.

The new tax act is, accordingly, unequivocally supervening to the arbitral claim. And there is no doubt that this new IRS assessment has the same subjective scope (the Claimants), concerns the same tax and the same year as the tax act that constitutes the subject of the initial arbitral claim, therefore, altering or replacing it.

The conditions of Article 13, Nos. 1 and 2 of the RJAT are accordingly met, the procedure for constitution of the arbitral tribunal should continue in a way that also covers the new tax act, regardless of whether this reduces, maintains or increases the value of the altered or replaced assessment.

It should be added that acts that are merely corrective and not innovative may have their own exclusive defects, particularly formal ones, in addition to those that affect the corrected act, justifying the expansion of the claim so as to be covered by the jurisdictional pronouncement.

In summary, the requested "expansion of the claim" is not only admissible, but required by law (cf. Article 13, Nos. 1 and 2 of the RJAT), being appropriate for the assessment of the new tax acts, so as to enable a jurisdictional decision on the merits that globally and definitively defines the underlying material tax relationship, which is why it is granted.

3.2. Untimeliness and Inadmissibility of the Second IRS Assessment No. 2014 ...

The Claimants raise the untimeliness of the second IRS assessment act for breach of the 30-day period provided in Article 13, No. 1 of the RJAT, counted from when the TA became aware of the request for constitution of the arbitral tribunal.

It should be noted that we are in a phase that precedes the constitution of the Tribunal and, for that reason, the period in question has a procedural nature and not a processual one, following the rule of counting periods contained in Article 72, No. 1 of the CPA, of subsidiary application, given the provision of Article 29, No. 1, paragraphs a) and d) of the RJAT and Article 2, paragraph d) of the CPPT, being suspended on Saturdays, Sundays and public holidays.

In this context, the following sequence of events results from the factual matter:

ü From the request for constitution of the Arbitral Tribunal, filed on 13 August 2014, a message was sent to the TA, via electronic means, on 18 August 2014;

ü The order for partial revocation of the assessment act subject to the arbitral claim and the second IRS assessment were both issued on 15 September 2014;

ü On 18 September 2014 the Claimants were notified of the order for partial revocation of the (first) assessment act;

ü On 29 September 2014 the Claimants were notified of the second IRS assessment.

To the extent that the message was sent to the TA on 18 August 2014, discounting Saturdays, Sundays and public holidays, the last day of the 30-day period would be precisely 29 September 2014, whereby not only was the second assessment issued but also notified within the legal period for that purpose[1].

Accordingly, the defect of untimeliness raised by the Claimants with respect to the notification of the second assessment does not exist.

The Claimants further allude to the fact that the second IRS assessment does not fit within Article 13, No. 1 of the RJAT (which only contemplates the possibility of revocation, ratification, reform or conversion of the tax act), by constituting a new act and not merely corrective in relation to the replaced tax act, which if occurring would have to be based on new facts that would justify its issuance.

They add that, even in the hypothesis of the second assessment constituting a corrective act, since the first IRS assessment act suffers from nullity due to lack of reasoning, the same cannot be cured in view of the precept of Article 137, No. 1 of the CPA.

We cannot agree with the Claimants. This second IRS assessment act implements and follows from the order for partial revocation of the first assessment which was notified to them (moreover, the partial revocation and the second assessment date from the same day, 15 September 2014), which reduced and set the value of the IRS assessment at € 560,000.00.

We agree with the TA on this point, the second assessment constituting only a corrective act that does not contemplate a new regulation or configuration of the tax legal relationship. This new assessment did not result from a requalification of the tax facts, being merely a correction/recalculation of the previous assessment.

With respect to the impossibility of curing or correction, due to alleged nullity of the first IRS assessment act, we anticipate from now that the defect of lack of reasoning is not sanctioned with nullity, but with voidability, as follows from the comparison of Articles 133 and 135 of the CPA and is recognized by the case law of our superior courts and by doctrine, as discussed further below. We are, accordingly, outside the field of application of Article 137 of the CPA to the contrary of what the Claimants maintain.

Finally, the Claimants raise the defect of lack of reasoning of the second tax act, which is analyzed together with that alleged for the first assessment.

3.3. Omission of Essential Legal Formalities in the Inspection Procedure

According to the Claimants, the inspection procedure that led to the additional IRS assessment was an external inspection procedure and not internal as the TA classified it. Starting from that premise, that is, that the tax act derived from an inspection action of external character, the Claimants point out multiple defects in its processing and, in consequence, deem the additional IRS assessment invalid due to the illegality of the procedure.

On this point, it is fundamental to start by analyzing the distinction between internal and external inspection, as the two types of procedures have important regime differences. The provision in this matter is made by Article 13 of the RCPIT:

"Article 13 – Place of the Inspection Procedure

As to the place of conduct, the procedure may be classified as:

a) Internal, when the inspection acts are conducted exclusively in the offices of the tax administration through formal analysis and coherence of documents;

b) External, when the inspection acts are conducted, wholly or partially, in installations or dependencies of the taxpayers or other tax-obligated parties, of third parties with whom they maintain economic relations or in any other place to which the administration has access." (emphasis added)

The distinctive criterion of the two types of procedure is, accordingly, the place of its conduct, with the differences in regime essentially depending on the potentially invasive character of external procedures and their level of disruption and interference in the sphere of taxpayers, which does not occur with internal procedures (see, in this sense, Diogo Leite de Campos, Benjamim Silva Rodrigues and Jorge Lopes de Sousa, General Tax Law Commented and Annotated, 4th edition, Encontro da Escrita, 2012, p. 271, and António Lima Guerreiro, General Tax Law Annotated, Rei dos Livros, 2001, p. 293).

These regime differences are linked, on the one hand, with the suspension of the statute of limitations for the right to assessment found in Article 46, No. 1 of the LGT, a suspension that does not occur in cases of internal inspection – cf. Nuno de Oliveira Garcia, Rita Carvalho Nunes, "External Tax Inspection and the Relevance of Material Inspection Acts", in Journal of Public Finances and Tax Law, Year IV, No. 1, March 2011, p. 249-268. On the other hand, the limitation of the succession of procedures embodied in the principle of non-repetition of inspections, contained in Article 63, No. 4 of the LGT, "is applicable only to external inspections, thus not including internal inspections which may be repeated as many times as necessary"[2] – cf. António Lima Guerreiro, General Tax Law Annotated, Rei dos Livros, 2001, p. 293.

This solution is understandable, as the main objective of the precept delimiting the powers of tax inspection of the TA is to prevent "a same taxpayer or tax-obligated party from being burdened with the inconveniences that external inspection actions are liable to cause them", as emphasized by Diogo Leite de Campos, Benjamim Silva Rodrigues and Jorge Lopes de Sousa, General Tax Law Commented and Annotated, 4th edition, Encontro da Escrita, 2012, p. 271, in line with the principle of proportionality expressly adopted by Articles 5 and 7 of the RCPIT.

In internal inspection action, the TA does not move to the installations or domicile of the taxpayer and the inspection acts are conducted through formal analysis and coherence of documents, namely the cross-referencing of information available in its databases with the tax declarations of taxpayers.

Analyzing the concrete situation, it is found that the first condition of paragraph a) of Article 13 of the RCPIT is met, that the inspection acts resulted exclusively in the offices of the TA.

The question that arises is, accordingly, whether the inspection acts were conducted through formal analysis and coherence of documents, or whether the fact that the TA directed requests for information and clarifications to the Claimants, exceeds the scope of formal analysis and coherence of documents and characterizes the inspection action as an external procedure.

We understand that in the concrete case this does not occur. Indeed, the TA identified by its sole initiative and by its own means, without any intervention by the Claimants and by mere cross-referencing of the data it had, the declarative omission, on the part of the latter, of capital gains resulting from the alienation of shares.

The subsequent clarifications requested by the TA from the Claimants had a complementary nature and performed the meritorious function of interposing a stage of right to reply before the issuance of the Draft Corrections, without such representing the transformation of the inspection into external.

It should be emphasized that in the first request for clarifications the TA reveals in the notification addressed to the Claimants the beginning of an internal inspection procedure for the year 2010 in which incongruities were detected, the justification of which is requested, relating to the non-inclusion of the annexes of the capital gains in the Annual Income Declaration for the year 2010, capital gains which originated in the transfer of shares of the company "D..., Ltd." for the price of € 3,200,000.00.

Accordingly, the main elements of the preconized correction were already materialized and were transparently communicated by the TA to the Claimants.

On the other hand, the conduct of a witness hearing diligence stemmed from the initiative of the Claimants, to which the TA agreed, having been conducted in its facilities.

It appears that the merely complementary character of the request for clarifications directed to the Claimants and the fact that no inspection acts occurred outside the offices of the TA militate in the sense of the materially internal nature of the procedure, in line with the formal classification attributed to it by the TA, whereby it does not exceed Article 13, paragraph a) of the RCPIT or the Internal Service Order.

The Claimants invoke in support of the intended requalification of the inspection action into an external procedure the Award of the Central Administrative Court South ("TCA South"), No. 04371/10, of 20 March 2012, from which the following elucidatory excerpts are transcribed:

"II – Resulting from the content of the report and the grounds that served as the basis for the corrections made that the procedure did not aim merely at the collection of information, before it can be stated that it was much more than that, since it was in that information that the entire inspection action was based, we are faced with a materially external inspection. The said "internal" inspection did not result from a mere inspection of analysis on the formal correctness of the documents delivered and their coherence with the presented declarations.

III – It is that, with a sequence of inspection initiated with the procedure of 10/11 December 2007, which was oriented to the identification of possible infractions and analysis of the accounting of the challenger so that corrections to the taxable matter could result, it is necessary to conclude that that procedure was not merely information gathering, before having initiated the inspection conducted to the taxpayer, which had external character.

IV – And since it was not notified to the taxpayer and continued for a period exceeding the period provided in the law (Article 36 No. 2 RCPIT), without any order for extension, such constitutes a defect generating voidability of the assessments based on such procedure (Article 135 of the CPA)."

However, the situation sub iudice is completely different. In that judgment, the TA had initiated the inspection by conducting various information gathering diligences in the installations of the taxpayer, information gathered in the installations of the company, in which the entire inspection action was based.

Differently, in the case of the present proceedings, not only were the determining elements of the corrections – the identification of the failure to report capital gains in an operation of transfer of shares of € 3,200,000.00 – obtained through cross-referencing of data from the TA itself and not from the taxpayers, but there occurred no surveying or gathering of information in the installations or domicile of the latter.

Once the classification of the procedure as internal is established, it is important to note that its beginning does not require notification.

Indeed, the obligation of notification applies only to external inspection. It is provided in this respect by Article 49, No. 1 of the RCPIT that "The external inspection procedure must be notified to the taxpayer or tax-obligated party with a minimum advance of five days with respect to its beginning" and Article 51, No. 2 of the RCPIT that "The taxpayer or tax-obligated party or its representative must sign the service order indicating the date of notification, which, for all purposes, determines the beginning of the external inspection procedure".

As notification is not owed, neither is its signature. In this point there is no irregularity to point out.

The Claimants allege that the maximum duration period legally foreseen for the inspection procedure was exceeded in accordance with Article 36, Nos. 2 and 3 of the RCPIT, which determines that this is continuous and must be concluded within the maximum period of six months from the notification of its beginning, which may be extended for two further periods of three months, corresponding, accordingly, to an absolute maximum period of one year.

However, the applicability of this regime is circumscribed to the external inspection procedure, given its potential for harmfulness. This conclusion is reinforced by the systematic insertion of Article 36 of the RCPIT in Chapter II - Place, hours of inspection acts and duration of the procedure which, obviously, can only refer to external procedures (in the sense that Article 36 of the RCPIT refers to the external procedure, see Arbitral Award, No. 14/2012-T, of 29 June 2012).

It should be noted that even in the field of application of Article 36, Nos. 2 and 3 of the RCPIT (that is, in external procedures) the case law of the STA understands, without exception, that the excess duration of the inspection procedure does not invalidate the assessment act. The consequence of the exceeding of the period is that of Article 46, No. 1 of the LGT: the statute of limitations, which was suspended, ceases that effect, being counted from its beginning (Awards of the STA, No. 695/06, of 29 November 2006, and No. 0955/07, of 27 February 2008). And nothing more.

Position that the Constitutional Court came to uphold in Award No. 457/08, published in the Official Gazette No. 209, Series II, of 2008-10-28, declaring the constitutional conformity of the interpretative normative of Articles 46, No. 1 of the LGT and 36, Nos. 1 and 2 of the RCPIT, according to which disrespect for the six-month period defined therein for the conduct of tax inspection only bears on the context of the institute of statute of limitations.

Additionally, it should be noted that the counting of this period made by the Claimants is not correct. Indeed, if we were in the context of an external inspection (which we are not) and it were to invoke the period limitation of Article 36 of the RCPIT, the beginning thereof would not be reported to the date of the Service Order (on 1 February 2013), but to the moment of notification of the beginning of the inspection.

Now, the first interaction that the TA had with the Claimants, notifying them of the internal inspection and requesting clarifications, was on 6 August 2013, whereby this would be the date equivalent to that of notification of the beginning of inspection. The absolute maximum period (1 year) would not be exceeded, given the fact that the notification of the RIT, which concludes the inspection procedure in accordance with Article 62 of the RCPIT, occurred on 19 March 2014.

Without prejudice to the foregoing, even if defects were to be found in the procedure, it would not be concluded without more that the illegality of the procedure would project itself in the consequent lack of value and invalidity of the tax assessment act.

The inspection procedure is distinct from that of assessment, although, in accordance with Article 11 of the RCPIT, it has a "merely preparatory or accessory character of tax acts or in tax matters". As a result of this preparatory or accessory character attributed to the inspection procedure, the rule is that illegalities committed therein may project themselves in the assessment, the act defining the tax situation of the taxpayer, but this does not always occur.

Indeed, it constitutes consolidated case law of the STA that procedural defects do not necessarily generate the invalidity of the tax assessment act, whereby even if the position of the Claimant were to be upheld (which it is not), the raised defects might not produce the invalidating effect of the tax assessment act (cf. among others, the following Awards of the STA: proceeding No. 0955/07, of 27 February 2008; proceeding No. 080/08, of 10 December 2008; proceeding No. 0102/08, of 10 December 2008; and proceeding No. 103/08, of 4 June 2008).

This is what occurs when the law provides for other legal consequences, for example, in the cases cited above of Articles 46 and 63 of the LGT; or the essential formalities are degraded to non-essential because the interests that the procedural norms aimed to protect are safeguarded; or it is a matter of invoking the principle of act preservation.

In view of the foregoing, the defect of omission of essential legal formalities in the inspection procedure is not verified, with the Claimants not being right on this point.

3.4. Lack of Reasoning

According to the Claimants, the Inspection Report does not constitute reasoning for the IRS assessment act, because that concludes that there is no lack of IRS assessment in the amount of € 560,000.00 and the latter was issued in the amount of € 1,404,549.98. This discrepancy in values is, for the Claimants, incomprehensible and constitutes gross error by the services, the assessment act suffering, for that reason, from the defect of lack of reasoning which determines its nullity.

They also allege that, with respect to the second assessment act (which, as we have seen, has a corrective nature of the first act), the same is devoid of any reference to the first tax act, making it impossible to decipher the calculation of the values.

Let us examine this.

The challenged tax act (we refer to the first additional IRS assessment) constitutes the outcome of an inspection procedure, in which the Claimants were heard, having been notified both of the draft corrections and, after exercising the right to prior hearing, of the Final Inspection Report.

From a reading of the Final Report, it results clearly that the additional IRS assessment is the corollary of the taxation of capital gains, quantified at € 2,800,000.00, obtained as a result of the sale of shares of the company "D... –, Ltd.", which the Claimants had not declared and for which they had not duly paid the corresponding tax obligation, resulting from the application of the autonomous taxation rate provided in Article 72, No. 4 of the IRS Code, at the time of 20%, totaling the value of IRS owed of € 560,000.00.

There remain no doubts as to the clarity, congruence and sufficiency of the reasoning and the cognitive and evaluative itinerary thereof, the Report mentioning the relevant facts – origin, nature and value of income – and the legal framework that is at the origin of IRS incidence: Articles 9, No. 1, paragraph a); 10, No. 1, paragraph b); 43, Nos. 1 and 3; 44, No. 1, paragraph f); 48, paragraph b) and 72, No. 4, all of the IRS Code.

The decision of the procedure is, accordingly, reasoned as to the amount of IRS of € 560,000.00, meeting the parameters of Article 77, Nos. 1 and 2 of the LGT.

The definitive Report was notified on 19 March 2014 and preceded the act of additional IRS assessment, this dated 29 March 2014 and notified to the Claimants on 15 April 2014.

It is true that the assessment act does not contain an express reference to the reasoning of the definitive Report (the said decision of the procedure). However, not only does that reasoning exist, but it is prior to the assessment act and had already been notified to the Claimants, whereby it would be redundant to notify them of it again with the assessment. The assessment act in question represents the culmination of an inspection procedure of which the Claimants had knowledge, having participated therein and having been notified of the final decision of that procedure.

Moreover, the Claimants, if any doubt subsisted, had at their disposal the mechanism of Article 37 of the CPPT. Jorge Lopes de Sousa distinguishes on this point the act of notification and the notified act, teaching that Article 37 of the CPPT concerns only the notification of acts, aiming to establish the consequences of deficiencies in notifications and not the regime of defects of notified acts.

Now, in the present situation the reasoning existed and if the notification of the assessment act omitted it, the failure to use the faculty provided in this Article 37 has as consequence that the recipient lost the right to be notified of that reasoning – cf. Code of Tax Procedure and Process Annotated and Commented, Volume I, 6th edition, 2011, pp. 349-351.

The question that truly arises here is whether the discrepancy in values between the provision of IRS calculated in the assessment act and that which the Inspection Report that constitutes its basis preconized, more than double the amount of tax that should be assessed, should be qualified as lack of reasoning that invalidates in toto the tax act in question, considered unique and indivisible, or whether that act is divisible and valid in the part quantified that is covered by the decision of the procedure expressed in the Inspection Report (€ 560,000.00).

Put differently, the question raised concerns the assessment of the possibility of partial annulment of the assessment act.

Let us recall the facts. The Inspection Report concluded for the value of IRS to be paid of € 560,000.00 and the setting of an altered income value for the year 2010 of € 2,822,359.52. The IRS assessment was issued for a much higher amount to be paid, of € 1,404,549.98, including compensatory interest, calculated on the total income of € 2,826,711.79.

We accompany the Claimants in the qualification of this discrepancy in values as gross error by the services (with possible consequences in terms of civil liability that is not to be explored here).

At its genesis is a calculation error, evident in the assessment act, by not having been calculated the tax based on the special autonomous rate of 20% then applicable to capital gains (under Article 72, No. 4 of the IRS Code), but rather as if it were an income subject to aggregation (total income) applying the general rates.

Following the case law of the STA, assessment acts, by defining an amount, are naturally divisible, being also legally so, as the law provides for the possibility of partial annulment of such acts in Article 100 of the LGT (see, for example, and more recent, the Awards of the Tax Dispute Section No. 583/10, of 12 November 2011; No. 1374/12, of 30 November 2012, No. 121/13, of 10 July 2013, and of the Plenary, No. 298/12, of 30 April 2013, all in www.dgsi.pt).

The cited Plenary Award states that the "criterion for determining whether the act should be wholly or partially annulled passes by determining whether the illegality affects the tax act in its entirety, in which case the act should be wholly annulled or only in part, in which case partial annulment is justified." In the case of illegality correctable by mere arithmetic operation that expunges the unjustified value "there will be place to partial annulment only of the challenged act, which is not to its total annulment".

In the situation under analysis, it appears that the error that affects the IRS assessment act is correctable by mere arithmetic operation, and the lack of reasoning of the remaining value (in the part exceeding € 560,000.00) does not contaminate the entire IRS assessment. What has been said is applicable, both to the first and to the second IRS assessment.

Having the TA itself noted the error committed, it corrected the initial assessment, within the period provided in Article 13, No. 1 of the RJAT, and issued a new IRS assessment. The reasoning of this new IRS assessment is contained in the order for partial revocation of the first, duly notified to the Claimants, which preceded the notification of the second assessment act.

This order makes explicit that it intends the reduction of the value of € 1,404,549.98, to € 560,000.00, thereby adjusting the excess value of the initial tax act to the amount that the same should present, that is, IRS in the amount of € 560,000.00.

The Claimants argue that, even as to this second act, they cannot decipher the calculation of the values contained in the assessments. Although we recognize some complexity and difficulty in understanding the various stages and algebraic operations for determining tax contained in the IRS assessment acts, derived largely from the way these are presented and the markedly synthetic character of the information they contain, we do not agree with the "indecipherable" character that is attributed to this second IRS assessment act.

Indeed, this new corrective assessment (which did not result from a requalification of the tax facts, being a correction of the calculations of the previous assessment) presents an amount to be paid of € 618,700.32 that results, in addition to the consideration of the income that had already been declared by the Claimants in their Declaration Form 3, adjusted from the corrections made to the real property income that were accepted by them (field 1, € 26,105.13) and from the specific deductions (field 2, € 4,852.27):

(a) From the increase of the value of € 560,138.15 of "tax relating to autonomous taxation" (field 16);

(b) From the increase of compensatory interest in the amount of € 61,711.32 (field 27);

(c) From the subtraction of deductions from the collection of € 3,229.91 (field 18); and

(d) From the subtraction of withholdings at source borne by the Claimants, in the value of € 3,274.76 (field 23).

Contrary to the Claimants, we do not evaluate that the arithmetic of this assessment act is indecipherable. We only do not find an explanation for the (immaterial, it should be noted) value of € 138.15 that appears, in paragraph (a) above, to increase the corrected value of the IRS of € 560,000.00 provided in the Inspection Report.

The reason for the issuance of this second IRS assessment act is perceptible, based on the order for partial revocation that corrected the first act subject to the arbitral claim, and there are no doubts as to its nature as merely corrective of the recalculation of the values owed and not innovative. It is, accordingly, to maintain the conclusion that the same is reasoned as to the value of IRS of € 560,000.00, regardless of whether one agrees with that reasoning.

The defect of lack of reasoning occurs only "when it is not possible for a normal recipient to perceive the reasons why the one who decided took the decision they took and not when the understanding adopted is wrong, since in the latter case, if the error indeed occurs, one is faced with the defect of error in the factual premises or error in the legal premises" – cf. Award rendered in arbitration proceeding No. 86/2012-T CAAD, of 16 November 2012.

The conclusion reached regarding the reasoning of the IRS assessment, however, is not extensible to the component of compensatory interest liquidated, the reasoning of which is omitted.

In fact, neither the decision of the procedure, nor the tax assessment act for IRS contain any reasoning for compensatory interest. The Inspection Report is completely silent on the matter of interest, and the first notification of the IRS assessment is limited to stating "Compensatory interest € 140,094.71.", being devoid of justification for its liquidation and not explaining its basis and method of calculation.

Compensatory interest is owed "when, due to a fact attributable to the taxpayer, the liquidation of part or all of the tax owed or the delivery of tax to be paid in advance, withheld or to be withheld in the context of tax substitution is delayed" and form an integral part of the tax debt itself, with which they are jointly assessed, being covered by the duty to reason, as to the reasons for their existence and the method of calculation, as expressly provided in Article 35, Nos. 1 and 9 of the LGT and follows from the general rules contained in Article 77 of the LGT and Article 125 of the CPA.

Even if, in the case of compensatory interest, one adheres to a theory of minimalist reasoning, the minimum content of the statement giving reasons must contain the reference to the amount of tax on which the interest was liquidated, the applicable rate and the period of time for which it is owed, mentions which as noted above, are not found in the RIT nor in the tax assessment act for IRS. We agree here with the Award of the STA, No. 0619/11, of 30 November 2011, to which reference is made.

Such deficiencies cannot be cured later.

In the second assessment, merely corrective of the first, the compensatory interest is reduced to the value of € 61,711.32 and accompanied by a demonstration of interest calculation, which already discriminates the essential elements for its calculation (base value, calculation period and applicable rate).

However, this reasoning, if deemed sufficient, is posterior to the tax act that is intended to be corrected, it not being admissible in our legal system for reasoning to be posterior or successive, but only the mere communication of the grounds omitted in the notification of the decision, in accordance with the law (Article 37 of the CPPT). The reasoning must, accordingly, be contemporaneous with the act and figure, directly or by reference, in the same formal instrument of decision, and must also be expressed.

Accordingly, it is necessary to conclude for the verification of a defect of lack of reasoning only as to the compensatory interest liquidated in the first assessment act.

This defect cannot be deemed cured in the second assessment by the mere presentation of a demonstrative note, as the requisite of contemporaneity with the original act is not met.

In this specific component, the defect of lack of reasoning is to be upheld, affecting the compensatory interest liquidated in the first assessment. However, this defect will only determine the annulment of the compensatory interest portion and not the entire assessment, the latter being divisible, as stated above.

Consequently, as to the first assessment, the following is concluded:

• The component of IRS proper (€ 560,000.00) is reasoned and valid;
• The component of compensatory interest (€ 140,094.71) suffers from lack of reasoning and is therefore voidable.

As to the second assessment, which is corrective in nature, it maintains a reasonable connection to the first through the order for partial revocation that preceded it and which constitutes its foundation. To the extent that this second assessment maintains the IRS component in the corrected amount of € 560,000.00 and reduces compensatory interest to € 61,711.32, with a corresponding demonstrative statement, the defect of lack of reasoning concerning compensatory interest is not reproduced in the second assessment, provided that this demonstrative note meets the minimum requirements identified above.

However, we note that the second assessment introduces an immaterial increase of € 138.15 in the IRS component (from € 560,000.00 to € 560,138.15) without explanation. This lack of explanation, although immaterial from a quantitative standpoint, technically represents a defect of reasoning for this additional component.

In conclusion, both assessments are deemed valid as to their core IRS component (€ 560,000.00), and the second assessment corrects the defect of lack of reasoning in the compensatory interest portion through the accompanying demonstrative note. The second assessment introduces a new defect of lack of reasoning in the amount of € 138.15, which is immaterial but technically present.

3.5. Validity of Assessments and Compensatory Interest

Based on the above analysis:

The first assessment act, insofar as it established € 1,404,549.98 as the amount due, is partially voidable due to:
(a) Lack of proper reasoning as to compensatory interest liquidated;
(b) A calculation error in the determination of the amount of IRS due (double taxation application instead of autonomous taxation).

The component of IRS in the amount of € 560,000.00 remains valid and well-reasoned.

The second assessment act of € 618,700.32, insofar as it represents the correction of the first and maintains the IRS at € 560,000.00 with corrected interest of € 61,711.32, is deemed valid, notwithstanding the introduction of an immaterial increase of € 138.15 whose origin is unexplained.

These conclusions lead to the annulment of the portion of the first assessment that exceeded € 560,000.00, specifically the excessive compensatory interest component.

The second assessment, as corrective of the first, properly implements the correction and should be maintained.

However, the compensatory interest component of € 61,711.32 in the second assessment, while accompanied by calculation detail, represents interest accrued on an overstated principal and therefore its amount requires verification against the correct principal of € 560,000.00.

3.6. Application of the Transitional Regime of Article 5 of Decree-Law No. 442-A/88

The Claimants argue that the transitional regime established in Article 5 of Decree-Law No. 442-A/88, of 30 November, which approved the IRS Code, should be applied, providing for the exclusion from taxation of capital gains relating to assets acquired prior to the entry into force of that Code (1 January 1989), provided that said assets were not previously subject to the capital gains tax.

The crux of the Claimants' argument is that:

(1) The pharmacy establishment was acquired by Claimant B... in 1986 (though documentary proof was not presented);

(2) The acquisition in 2006 of the establishment by the company constitutes not a transfer but an allocation of assets under Article 10, No. 3, paragraph b) of the IRS Code;

(3) Consequently, the acquisition date for purposes of the transitional regime is 1986 (when the establishment was acquired), not 2006 or 2010;

(4) Therefore, the capital gains are excluded from taxation under the transitional regime.

The TA's position is that:

(1) The relevant acquisition for tax purposes occurred in 1990, when the deed of transfer was executed and property was transferred;

(2) What matters is the acquisition of the shares, not the establishment, since the sale in question was of shares;

(3) The company itself was established in 2006, after the effective date of the IRS Code, and therefore outside the temporal scope of the transitional regime;

(4) The contribution of the establishment to the company in 2006 constitutes a transfer between distinct legal entities, not an allocation preserving the original acquisition date.

Analysis:

The evidence establishes that:

• Effective possession of the establishment occurred on 31 March 1990 (or 1 November 1986, per the Claimants' unproven assertion);
• The deed of transfer was executed on 2 April 1990;
• The company was established on 22 February 2006;
• The establishment was contributed to the company on 31 August 2006;
• The shares were sold on 4 January 2010.

The relevant legal provisions are:

Article 5 of Decree-Law No. 442-A/88 provides that capital gains not previously subject to capital gains tax are excluded from IRS if the acquisition of the related assets occurred prior to 1 January 1989.

Article 10, No. 3, paragraph b) of the IRS Code provides that the allocation of assets to a company in the form of a capital contribution may suspend taxation until subsequent disposal.

The question is whether the acquisition date for transitional regime purposes is:
(a) 1986 (possession, per the Claimants), or
(b) 1990 (transfer of ownership), or
(c) 2006 (contribution to company)?

Under Portuguese law, as the Inspection Report correctly notes, ownership (domínio) is distinct from possession. Mere possession does not establish ownership without formal transfer. The deed of transfer in 1990 is the operative act transferring ownership.

While Article 5 of Decree-Law No. 442-A/88 may be interpreted to include assets held through possession, the Claimants failed to prove possession in 1986. The only documented date is the deed of transfer in 1990, which is after the entry into force of the IRS Code on 1 January 1989.

Furthermore, what is being taxed is not the capital gain on the establishment itself (which would be measured from 1990 to 2006), but the capital gain on shares sold in 2010. The shares represent ownership interests in a company established in 2006. The company itself came into existence in 2006, after the temporal cutoff of the transitional regime.

Article 10, No. 3, paragraph b) of the IRS Code addresses contributions to companies and provides for suspension of taxation. However, this provision does not extend the transitional regime backwards in time to cover assets acquired after 1 January 1989 merely because they were later contributed to a company.

The proper analysis is:

• Establishment acquired (transferred): 1990 (after IRS Code entry into force) – outside transitional regime;
• Company established: 2006 (after IRS Code entry into force) – shares in such company outside transitional regime;
• Sales transaction: 2010 – subject to IRS on capital gains.

Conclusion on transitional regime:

The transitional regime of Article 5 of Decree-Law No. 442-A/88 does not apply. The Claimants are not entitled to the exclusion from taxation they seek.

The capital gains are properly subject to taxation under Article 10, No. 1, paragraph b) of the IRS Code at the autonomous tax rate of Article 72, No. 4 of the IRS Code (20%).

The amount of € 560,000.00 of IRS is correct as to the determination of the tax obligation, notwithstanding the procedural defects identified regarding compensatory interest.

3.7. Compensatory Interest and Indemnification

Compensatory interest was properly liquidated in the second assessment at € 61,711.32, as shown in the accompanying calculation note.

However, the absence of reasoning in the first assessment as to compensatory interest is noted.

Regarding the Claimants' request for indemnification for "undue provision of guarantee" under Article 53 of the LGT:

The Claimants requested exemption from guarantee in the tax enforcement proceedings. This request is typically granted when the taxpayer demonstrates lack of means or when the tax assessment is questionable. The facts do not indicate that the request was granted; rather, the enforcement proceeded, leading to the present arbitration.

Article 53 of the LGT provides for compensation when a guarantee is demanded but later found to have been unjustified (e.g., when the assessment is completely annulled).

Given that the assessment is being reduced but not entirely annulled (€ 560,000.00 remains due), and only the procedural defect regarding compensatory interest reasoning is being remedied through the second assessment's explanatory note, the grounds for compensation under Article 53 are not clearly established.

The Claimants' claim for compensation is therefore not upheld.

1. OPERATIVE PART

For the reasons stated above:

1. The expansion of the claim is ADMITTED;

2. The second IRS assessment of € 618,700.32 is found to be ADMISSIBLE and NOT UNTIMELY;

3. The classification of the inspection procedure as internal is CONFIRMED;

4. Regarding the IRS assessment proper (€ 560,000.00), it is VALID and REASONED;

5. Regarding the compensatory interest component:

   • In the first assessment: LACKS REASONING and is VOIDABLE in the amount of € 140,094.71;
   • In the second assessment: PROPERLY REASONED in the amount of € 61,711.32, with defect cured through accompanying demonstrative note;

6. The application of the transitional regime of Article 5 of Decree-Law No. 442-A/88 is REJECTED;

7. The IRS assessment in the amount of € 560,000.00 (autonomous taxation of capital gains at 20% on € 2,800,000.00) is CONFIRMED;

8. The compensatory interest shall be recalculated based on the correct principal of € 560,000.00 from the date of the first assessment notification to the date of payment;

9. The claim for indemnification under Article 53 of the LGT is DENIED;

10. The first assessment as to the portion exceeding € 560,000.00 is ANNULLED; the second assessment as corrective of the first is CONFIRMED subject to the recalculation of compensatory interest as stated above.

Thus it is decided.