Process: 701/2018-T

Date: September 2, 2019

Tax Type: IRS

Source: Original CAAD Decision

Summary

This CAAD arbitral decision (Case 701/2018-T) addresses whether IRS Category F rental income losses can be carried forward without opting for income aggregation (englobamento). The married taxpayers filed a joint 2017 IRS return showing €76,798.11 in rental property losses for one spouse and €39,689.97 in gains for the other. They chose the autonomous 28% tax rate rather than aggregation with progressive rates. The Tax Authority denied carry-forward of losses, arguing that without choosing englobamento, Category F results cannot be carried forward to subsequent years. The taxpayers contended that the right to deduct conservation and maintenance expenses from rental properties does not depend on choosing aggregation, as these are deductions from gross income under Article 41 of the IRS Code, not from aggregated income. They argued that Article 55(1)(b) of the IRS Code permits carry-forward of Category F losses regardless of the aggregation option. The case presents a fundamental question about the interaction between the optional aggregation regime for rental income and the statutory right to carry forward losses, with significant implications for taxpayers incurring substantial property maintenance costs that exceed rental income in a given year. The decision would clarify whether the separate taxation regime at 28% precludes loss carry-forward benefits or whether this right exists independently of the aggregation choice.

Full Decision

TAX ARBITRATION JURISPRUDENCE

Case No. 701/2018-T

Date of Decision: 2019-09-02

IRS

Value of Claim: € 76,798.11

Subject Matter: IRS - Real Property Income – Deductions - Aggregation.

ARBITRAL DECISION

The arbitral tribunal agrees as follows:

I – Report

  1. A..., taxpayer no. ..., resident at Street ..., ..., ..., ..., and B..., taxpayer no. ..., resident at ... ..., ..., ...-..., hereby request, jointly, the constitution of an arbitral tribunal, pursuant to the provisions of Articles 2, No. 1, paragraph a), and 10 of Decree-Law No. 10/2011, of 20 January, to assess the legality of the IRS assessment act relating to 2017, as well as the decision denying the administrative appeal against it, whereby the carry-forward to subsequent years of losses determined in Category F during that fiscal year was not admitted.

The request is founded on the following grounds.

In the fiscal year 2017, the Requesters incurred various expenses relating to real property from which they obtain rental income, such as expenses relating to conservation and maintenance works, condominium fees and taxes, which they itemized in Model Declaration 3, presented jointly, in which they did not opt for the aggregation of their real property income (Category F).

In that declaration, losses in Category F in the amount of € 76,798.11 were declared with respect to Requester A..., and gains in the amount of € 39,689.97 with respect to Requester B....

The losses of Requester A... were not deducted from the real property income of Requester B..., with tax being assessed in the amount of € 11,113.19 corresponding to the rate of 28% on the net real property income earned by the latter.

The said Declaration resulted in the assessment act now being challenged, which disregards the losses determined in Category F by Requester A..., which should have been carried forward to the six following fiscal years.

The Requesters filed an administrative appeal against the assessment act, which was denied on the ground that, as the interested parties had not opted for aggregation of income, the net result of category F cannot be indicated in the assessment note nor considered in the assessments of subsequent years, whereby the expenses borne and paid relating to conservation and maintenance works do not constitute losses to be carried forward.

However, the interpretation conveyed by the Tax Administration has no legal support and is marred by errors in both factual and legal grounds, because, as is the settled understanding, the right to deduct maintenance and conservation expenses relating to real property that is the subject of a lease does not depend on the exercise by the taxpayer of the option for aggregation of real property income and its subjection to the general progressive rates of IRS, particularly since we are dealing with a rule that permits the deduction of expenses from gross income and not from aggregated income.

It thus follows that aggregation is not legally required for a particular taxpayer to be able to carry forward losses incurred in category F, whereby the IRS assessment act in question, which is based on this understanding, is unlawful and should be annulled and replaced by another that admits the carry-forward of losses incurred in Category F during the fiscal year 2017 to subsequent years, in accordance with Article 55, No. 1, paragraph b), of the IRS Code.

The Tax Authority, in its response, contends that the Requesters filed a joint IRS declaration but did not opt in Annex F for the aggregation of the real property income earned by them.

Gross real property income, after deduction of eligible expenses for the purposes of what is established in Article 41 of the IRS Code, are taxed at an autonomous tax rate of 28%, in accordance with Article 72, No. 1, paragraph e), of the IRS Code, and the taxpayer may opt for aggregation in accordance with Articles 72, No. 8, and 22, No. 2, paragraph b), and No. 5 of the IRS Code, and must indicate this option in Annex F.

Having opted for non-aggregation of real property income, the Requesters preferred to tax separately the income of category F through the application of a fixed liberatory rate on that gross income, which is provided for real property income in Article 72, No. 1, paragraph e).

And being thus, the tax to be determined corresponds to the product of the special rate of 28% on the gains earned, in the amount of € 39,689.97, amounting to € 11,113.19, incurred on the net value recorded in favor of Requester B... of € 39,689.97.

It concludes in favour of dismissal of the request.

  1. Following the proceedings, the meeting referred to in Article 18 of the Arbitration Regulation was waived and the proceedings were ordered to continue for submissions by successive deadlines.

The parties submitted no arguments.

  1. The request for constitution of the arbitral tribunal was accepted by the President of CAAD and notified to the Tax and Customs Authority in accordance with regulatory requirements.

In accordance with the provisions of paragraph a) of No. 2 of Article 6 and paragraph b) of No. 1 of Article 11 of the Arbitration Regulation, in the wording introduced by Article 228 of Law No. 66-B/2012, of 31 December, the Deontological Council designated as arbitrators of the collective arbitral tribunal the undersigned, who communicated acceptance of the appointment within the applicable deadline.

The parties were timely and properly notified of this designation and did not manifest any wish to refuse it, in accordance with the combined provisions of Article 11, No. 1, paragraphs a) and b), of the Arbitration Regulation and Articles 6 and 7 of the Deontological Code.

Thus, in accordance with the provisions of paragraph c) of No. 1 of Article 11 of the Arbitration Regulation, in the wording introduced by Article 228 of Law No. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 7 March 2019.

The arbitral tribunal was regularly constituted and is materially competent in light of the provisions of Articles 2, No. 1, paragraph a), and 30, No. 1, of Decree-Law No. 10/2011, of 20 January.

The parties have legal personality and capacity, are legitimate and are represented (Articles 4 and 10, No. 2, of the same decree and 1 of Regulation No. 112-A/2011, of 22 March).

The proceedings are not affected by nullities and no exceptions were raised.

It is incumbent upon us to assess and decide.

II – Reasoning

Factual Matters
  1. The relevant facts for the decision of the case that may be considered as established are as follows:

a) The Requesters have residence in Portuguese territory;

b) In the year 2017, the Requesters obtained income resulting from the lease of real property that is their property and in relation to which they incurred expenses for conservation and maintenance works, condominium fees and taxes;

c) In that year, they presented a joint Model 3 IRS declaration, in which they recorded losses in Category F, in the amount of € 76,798.11 in relation to Requester A..., and gains in the amount of € 39,689.97 with respect to Requester B...;

d) The Requesters opted for non-aggregation of the declared real property income;

e) The income declaration resulted in assessment act No. 2018 ... and the assessment schedule No. 2018 ..., which disregards the losses to be carried forward to the six following fiscal years resulting from the negative net value determined in relation to Requester A...;

f) On 7 August 2018, the Requesters filed an administrative appeal against the assessment act, seeking to include the amount of € 76,798.11 in the total of losses to be carried forward;

g) The administrative appeal was denied by decision of 5 November 2018, by the Head of the Finance Service of Sintra ..., and notified to the Requesters by official letters No. ... and No. ..., of 6 November 2018;

h) The decision to deny was based on the understanding that, as the interested parties had not opted for aggregation of income in Category F, the expenses borne do not constitute losses to be carried forward.

The Tribunal formed its conviction regarding the established facts based on the documents attached to the petition and in the administrative file attached by the Tax Authority with its response and on the assertion of facts not questioned.

Matters of Law
  1. The sole issue in debate consists of determining whether the deductions specific to real property income depends on prior aggregation of income.

The Tax Authority contends, in essence, that real property income is taxed autonomously at the rate of 28%, in accordance with Article 72, No. 1, paragraph e), of the IRS Code, although, in accordance with the provision in No. 8 of that article, such income may be aggregated at the option of their respective holders resident in Portuguese territory.

In the present case, the taxpayers did not opt for aggregation and, thus, preferred to tax separately the income of category F through the application of a fixed liberatory rate on the gross income, which is provided for real property income in Article 72, No. 1, paragraph e).

And being thus, the tax to be determined corresponds to the product of the special rate of 28% on the gains earned, in the amount of € 39,689.97, amounting to € 11,113.19, with the consequent exclusion of the possibility of carrying forward losses to subsequent years, since the carry-forward of losses is a downstream operation that presupposes prior election to aggregate income.

The Requesters counter that Article 55, No. 1, paragraph b), of the IRS Code permits the negative result determined in a particular year in category F to be carried forward to the six following years without making the deduction dependent on the option to aggregate income.

The provisions that are relevant to clarify the issue raised are those of Articles 22, 41, 55 and 72 of the IRS Code.

Article 22 is the one that permits the aggregation of income from the various categories earned in each year, after deductions and allowances have been made, for the purpose of determining the aggregate income in IRS, aiming to determine the global net income by adding the net income of the various categories.

However, aggregation does not apply to all types of taxpayers nor to all types of income earned by them. In the IRS taxation system, an aggregation scheme coexists with a system of taxation at liberatory rates and at special autonomous taxation rates, with income earned by taxpayers not resident in Portuguese territory not being aggregated (Article 22, No. 3, paragraph a)), whose taxation is carried out through the application of liberatory rates or special rates, nor income earned by taxpayers resident in Portuguese territory that are subject to the liberatory rates or special rates of Articles 71 and 72. These latter income categories may, however, be subject to optional aggregation as provided for in No. 8 of Article 72.

Real property income is mentioned in Article 72, No. 1, paragraph e), as being subject to taxation at the autonomous rate of 28%, and although excluded from mandatory aggregation (Article 22, No. 3, paragraph b)), may be aggregated at the option of their respective holders resident in Portuguese territory (Article 72, No. 8).

Article 41, on the other hand, refers to the specific deductions applicable to real property income, prescribing, to the extent relevant to consider, as follows:

1 – From the gross income referred to in Article 8 shall be deducted, in relation to each property or part of property, all expenses effectively borne and paid by the taxpayer to obtain or secure such income, with the exception of expenses of a financial nature, those relating to depreciations and those relating to furniture, household appliances and items of comfort or decoration, as well as the additional real property transfer tax.

2 – In the case of an autonomous fraction of property under a horizontal property scheme, other charges are deductible, in relation to each fraction or part of fraction, which, in accordance with law, the co-owner must necessarily bear and which are effectively paid by the taxpayer.

(...)

5 – The real property transfer tax and stamp duty, paid in a particular year, are only deductible when they relate to property or part of property whose income is subject to taxation in that fiscal year.

The Requesters counter that Article 55, No. 1, paragraph b), of the IRS Code permits the negative result determined in a particular year in category F to be carried forward to the six following years without making the deduction dependent on the option to aggregate income.

The provisions that are relevant to clarify the issue raised are those of Articles 22, 41, 55 and 72 of the IRS Code.

Article 22 is the one that permits the aggregation of income from the various categories earned in each year, after deductions and allowances have been made, for the purpose of determining the aggregate income in IRS, aiming to determine the global net income by adding the net income of the various categories.

However, aggregation does not apply to all types of taxpayers nor to all types of income earned by them. In the IRS taxation system, an aggregation scheme coexists with a system of taxation at liberatory rates and at special autonomous taxation rates, with income earned by taxpayers not resident in Portuguese territory not being aggregated (Article 22, No. 3, paragraph a)), whose taxation is carried out through the application of liberatory rates or special rates, nor income earned by taxpayers resident in Portuguese territory that are subject to the liberatory rates or special rates of Articles 71 and 72. These income categories may, however, be subject to optional aggregation as provided for in No. 8 of Article 72.

Real property income is mentioned in Article 72, No. 1, paragraph e), as being subject to taxation at the autonomous rate of 28%, and although excluded from mandatory aggregation (Article 22, No. 3, paragraph b)), may be aggregated at the option of their respective holders resident in Portuguese territory (Article 72, No. 8).

Article 41, on the other hand, refers to the specific deductions applicable to real property income, prescribing, to the extent relevant to consider, as follows:

3 – From the gross income referred to in Article 8 shall be deducted, in relation to each property or part of property, all expenses effectively borne and paid by the taxpayer to obtain or secure such income, with the exception of expenses of a financial nature, those relating to depreciations and those relating to furniture, household appliances and items of comfort or decoration, as well as the additional real property transfer tax.

4 – In the case of an autonomous fraction of property under a horizontal property scheme, other charges are deductible, in relation to each fraction or part of fraction, which, in accordance with law, the co-owner must necessarily bear and which are effectively paid by the taxpayer.

(...)

6 – The real property transfer tax and stamp duty, paid in a particular year, are only deductible when they relate to property or part of property whose income is subject to taxation in that fiscal year.

(...)

7 – Expenses borne and paid in the 24 months prior to the commencement of the lease relating to conservation and maintenance works on the property may also be deducted, provided that the property has not in the meantime been used for any purpose other than leasing.

8 – The expenses referred to in the preceding numbers must be documented.

Article 55, however, establishes certain limitations on loss deductions, providing, with respect to real property income, that "the negative net result determined in a particular year in category F can only be carried forward to the six years following that to which it relates" (Article 55, No. 1, paragraph b)). As regards the deduction of losses relating to income from category G, relating to certain capital gains on moveable property, the provision determines that the negative balance determined in a particular year "can be carried forward to the five years following when the taxpayer opts for aggregation" (Article 55, No. 1, paragraph d)), thus establishing a clear distinction as to the carry-forward of losses between income from category F and category G. That is, the carry-forward of losses relating to income from category G depends on prior aggregation of income, whereas this requirement is not imposed with respect to income from category F.

In light of this legal framework, nothing appears to justify the understanding formulated by the Tax Authority whereby, in the case of non-election by taxpayers of aggregation, with respect to real property income, such income would be taxed separately at the special rate of 28% without any possibility of loss deduction. In fact, as we have seen, the deduction of the determined negative net result can be deducted from the positive net results in accordance with the provisions of Article 55, No. 1, paragraph b), of the IRS Code, without any dependence on the option to aggregate income.

It is important to note, on the other hand, that Article 41 establishes a rule of tax deductibility of "all expenses effectively borne and paid by the taxpayer to obtain or secure such income," which corresponds to the implementation, in the IRS field, of the principle of contributory capacity, or more properly the principle of taxation of net income, which is in line with the legislative purpose manifested in the preamble to the IRS Code in which it is declared that "in the field of real property income (category F), included is the income actually earned from leased property, both urban and rural, and not, as was the case under the property contribution system, the rental value or land rent of unleased properties, since the aim is to tax only the income actually earned" (point 11).

It is true that Article 41 excludes certain types of expenses and Article 55 establishes certain limitations on loss deductions, especially in terms of time. But nothing permits the conclusion that loss deductions are dependent on the option of taxpayers to aggregate income. The only exception established on this point is that which refers to the deduction of losses relating to income from category G.

Furthermore – as PAULA ROSADO PEREIRA notes – "the impossibility of expense deductions – if it were to occur – would remove much of the tax attractiveness and efficiency from the system of taxation of real property income through special autonomous taxation rates. Which would not make sense if we consider the legislative intention in creating the system in question. The subjection of real property income to an autonomous taxation scheme, through the application of a special rate and the exclusion of the mandatory requirement for aggregation, was intended, precisely, to make the system of taxation of real property income more attractive to investors. Which would be totally unworkable if the autonomous taxation scheme excluded the deductibility of expenses borne to obtain or secure real property income" (IRS Manual, 2nd edition, Coimbra, p. 172).

The right to deduct expenses relating to real property that is the subject of a lease does not, therefore, depend on the exercise by the taxpayer of the option to aggregate real property income and its subjection to the general progressive rates of IRS.

And in this sense, arbitral decisions have already been rendered in Proceedings Nos. 96/2015-T, 338/2016-T, 399/2017-T, 481/2017-T, 360/2017-T and 314/2017-T.

III – Decision

Accordingly, it is decided to grant the arbitral request and annul the assessment act No. 2018 ... and the assessment schedule No. 2018 ..., as well as the decision denying the administrative appeal against it.

Value of the Case

The Requester indicated as the value of the case the amount of € 76,798.11, which was not contested by the Respondent and corresponds to the value of the assessment sought to be challenged, whereby the value of the case is fixed at that amount.

Costs

In accordance with Articles 12, No. 2, and 24, No. 4, of the Arbitration Regulation, and 3, No. 2, of the Costs Regulation in Tax Arbitration Proceedings and Table I attached to that Regulation, the amount of costs is fixed at € 2,448.00, which is charged to the Respondent.

Notify accordingly.

Lisbon, 2 September 2019

The President of the Arbitral Tribunal

Carlos Fernandes Cadilha

The Arbitrator Member

Mariana Vargas

The Arbitrator Member

José Nunes Barata

Frequently Asked Questions

Automatically Created

Can rental income losses (Category F) be carried forward to future tax years without opting for englobamento in Portuguese IRS?
According to the Tax Authority's position in this case, rental income losses (Category F) cannot be carried forward to future tax years without opting for englobamento. When taxpayers choose the autonomous 28% tax rate on rental income instead of aggregation with other income, the Tax Authority argues that negative results cannot be indicated in assessment notes or considered in subsequent years. However, taxpayers argue this interpretation lacks legal basis, as Article 55(1)(b) of the IRS Code permits loss carry-forward regardless of the aggregation option, since conservation and maintenance expense deductions apply to gross income under Article 41, not aggregated income.
What deductions are allowed for property rental income under IRS Category F in Portugal?
Under IRS Category F in Portugal, taxpayers can deduct conservation and maintenance expenses, condominium fees, and property taxes from rental income according to Article 41 of the IRS Code. These deductions apply to gross rental income before determining net taxable income. When expenses exceed rental income, creating losses, the treatment depends on whether the taxpayer opts for englobamento (aggregation with progressive rates) or the autonomous 28% rate. The Tax Authority's position is that loss carry-forward under Article 55(1)(b) requires choosing aggregation, though this interpretation is contested by taxpayers who argue the deduction right exists independently of the taxation method chosen.
How does the Portuguese Tax Authority treat conservation and maintenance expenses that exceed rental income in Category F?
The Portuguese Tax Authority treats conservation and maintenance expenses exceeding rental income in Category F differently depending on the taxation option chosen. When taxpayers opt for the autonomous 28% rate without englobamento, the Tax Authority disregards losses and does not permit carry-forward to subsequent years, assessing tax only on positive rental income at 28%. In this case, one spouse's €76,798.11 loss was not offset against the other spouse's €39,689.97 gain, resulting in €11,113.19 tax on the gain alone. The Tax Authority argues that choosing separate taxation at a fixed rate means preferring simplicity over loss utilization. Taxpayers counter that Article 41 expense deductions and Article 55(1)(b) loss carry-forward rights apply regardless of aggregation choice.
Can spouses in joint IRS declarations offset one spouse's Category F losses against the other spouse's rental income?
In joint IRS declarations, the Portuguese Tax Authority does not permit spouses to offset one spouse's Category F losses against the other spouse's rental income when they choose the autonomous 28% tax rate without englobamento. In this case, despite filing jointly, the husband's €76,798.11 rental loss was not deducted from the wife's €39,689.97 rental gain. Each spouse's Category F income is taxed separately at 28% when aggregation is not chosen. The Tax Authority assessed €11,113.19 tax (28% of €39,689.97) on only the positive income. Taxpayers argue this interpretation is legally flawed because expense deductions under Article 41 should apply to gross income regardless of aggregation, and joint filing should permit offsetting within the same income category between spouses.
What is the legal basis for reporting Category F losses over the following six tax years under Portuguese tax law?
Article 55(1)(b) of the IRS Code provides the legal basis for carrying forward Category F losses over the following six tax years in Portuguese law. This provision allows negative net income from rental properties to be deducted in subsequent years. However, the Tax Authority's interpretation restricts this right to situations where taxpayers opt for englobamento under Articles 72(8) and 22(2)(b) and (5) of the IRS Code, aggregating rental income with other income and subjecting it to progressive rates. The dispute centers on whether Article 55(1)(b) applies independently or only when aggregation is chosen. Taxpayers argue the loss carry-forward right exists regardless of taxation method, as it relates to determining net Category F income under Article 41 expense deductions, not to the subsequent choice of how that net income is taxed.