Process: 703/2018-T

Date: August 30, 2019

Tax Type: IRS

Source: Original CAAD Decision

Summary

CAAD arbitration decision 703/2018-T addressed whether the 50% capital gains exclusion under Article 43(3) and (4) of the Portuguese IRS Code applies to shares in non-resident companies. The taxpayer, a French national residing in Portugal under the Non-Habitual Resident regime, sold shares in a French micro-enterprise (B... SARL) in 2016, generating capital gains of €519,256.80. She applied the 50% exclusion in her tax return, but the Tax Authority rejected this treatment, assessing €138,878.10 in tax. The central legal question was whether the beneficial regime for micro and small enterprises applies only to Portuguese companies or extends to foreign entities meeting the same criteria. The taxpayer argued for equal treatment of EU-established companies, while the Tax Authority maintained a restrictive interpretation limiting the benefit to Portuguese-resident entities. This case illustrates the tension between domestic tax provisions and EU principles of free movement and non-discrimination. The decision has significant implications for Portuguese tax residents holding shares in foreign small and medium enterprises, particularly those from other EU member states, and affects tax planning for cross-border investments. The case also demonstrates the CAAD arbitration process for challenging IRS assessments, including the automatic constitution of arbitral tribunals and the procedural framework under RJAT.

Full Decision

ARBITRAL DECISION

I – REPORT

  1. On 28 December 2018, A..., TIN..., with fiscal domicile at Rua ..., ..., ..., ...-... Cascais, filed a request for constitution of an arbitral tribunal, pursuant to the combined provisions of Articles 2 and 10 of Decree-Law No. 10/2011, of 20 January, which approved the Legal Regime for Arbitration in Tax Matters, as amended by Article 228 of Law No. 66-B/2012, of 31 December (hereinafter, abbreviated as RJAT), seeking the declaration of illegality of the assessment act for Personal Income Tax (IRS) No. 2017..., made by reference to the fiscal year 2016, in the amount of € 138,878.10, as well as of the decision on the administrative complaint that had such assessment as its subject matter.

  2. To support her request, the Applicant alleges, in summary, that the regime provided for in Articles 43(3) and (4) of the Personal Income Tax Code (CIRS) is applicable in situations where capital gains arise from the alienation of equity interests in entities that do not have their seat and/or effective place of management in Portugal.

  3. On 31-12-2018, the request for constitution of the arbitral tribunal was accepted and automatically notified to the Tax Authority.

  4. The Applicant did not proceed with the appointment of an arbitrator, wherefore, pursuant to the provisions of Article 6(2)(a) and Article 11(1)(a) of the RJAT, the President of the CAAD Deontological Board designated the undersigned as arbitrators of the collective arbitral tribunal, who communicated acceptance of the charge within the applicable time period.

  5. On 15-02-2019, the parties were notified of these designations, and did not manifest any intention to challenge any of them.

  6. In accordance with the provision of Article 11(1)(c) of the RJAT, the collective Arbitral Tribunal was constituted on 07-03-2019.

  7. On 08-04-2019, the Respondent, duly notified for this purpose, submitted its response defending itself by way of objection.

  8. Pursuant to the provisions of Articles 16(c) and (e) and Article 29(2), both of the RJAT, the holding of the meeting referred to in Article 18 of the RJAT was dispensed with.

  9. Having been granted a time period for submission of written submissions, the parties refrained from doing so.

  10. It was indicated that the final decision would be notified by the end of the time period provided for in Article 21(1) of the RJAT.

  11. The Arbitral Tribunal is materially competent and is regularly constituted, pursuant to Articles 2(1)(a), 5 and 6(2)(a) of the RJAT.

The parties have legal personality and capacity, are legitimate, and are legally represented, pursuant to Articles 4 and 10 of the RJAT and Article 1 of Ordinance No. 112-A/2011, of 22 March.

The proceedings do not suffer from any nullities.

Thus, there is no obstacle to the consideration of the case.

All things considered, it is necessary to issue:

II. DECISION

A. MATTER OF FACT

A.1. Facts established as proven

  1. The Applicant is a retired person and has French nationality.

  2. In the context of economic activities previously pursued, the Applicant held an equity interest in a company governed by French law denominated B... SARL.

  3. In 2014 the Applicant decided to change her residence to Portugal.

  4. The Applicant registered with the Tax and Customs Authority as a resident for tax purposes.

  5. For the purposes of taxation under Personal Income Tax (IRS), the Applicant was classified under the regime applicable to non-habitual residents.

  6. On 30 June 2017 the Applicant submitted her IRS declaration – Form 3 for 2016, in the status of "single, divorced or judicially separated", without dependents, together with Annexes J and L.

  7. In the aforementioned income declaration, the Applicant – in line "951" of Sub-table A of Table 9.2 of Annex "J" – recorded a capital gain arising from the alienation of equity interests in the amount of € 519,256.80 and expenses in the amount of € 3,203.00.

  8. In August 2017, the Applicant was notified of the assessment act No. 2017..., of 2017-07-29, which is the subject matter of the present arbitral action, which resulted in the amount payable of € 138,878.10.

  9. Of the aforementioned amount, € 138,423.02 corresponds to autonomous taxation, related to the capital gain realized.

  10. The Applicant, in a timely manner, submitted an administrative complaint concerning the aforementioned assessment.

  11. Subsequently, the Applicant was notified of the draft decision of rejection, and exercised the corresponding right to be heard thereon.

  12. The Applicant was notified of the order rejecting the administrative complaint, issued by the Division Head, issued in the exercise of subdelegated powers, dated 26 September 2018.

  13. The company B... SARL had, by reference to the year 2016, its seat in France and a total balance sheet and turnover of less than € 10,000,000.00, and a number of employees of less than 50.

A.2. Facts established as not proven

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

A.3. Grounds for the proven and not proven matter of fact

With respect to the matter of fact, the Tribunal does not have to pronounce on everything that was alleged by the parties, but rather has the duty to select the facts that matter for the decision and distinguish the proven from the not proven matter (cf. Article 123(2) of the CPPT and Article 607(3) of the CPC, applicable ex vi Article 29(1)(a) and (e) of the RJAT).

In this way, the facts relevant to the judgment of the case are chosen and determined according to their legal relevance, which is established in light of the various plausible solutions to the legal question(s) (cf. previous Article 511(1) of the CPC, corresponding to current Article 596, applicable ex vi Article 29(1)(e) of the RJAT).

Thus, taking into account the positions assumed by the parties, in light of Article 110(7) of the CPPT, the documentary evidence and the file attached to the proceedings, the facts listed above were considered proven, with relevance to the decision, taking into account that, as was written in the Judgment of the TCA-South of 26-06-2014, issued in case 07148/13, "the probative value of the tax inspection report (...) may have probative force if the assertions contained therein are not challenged".

Specifically, and with respect to the fact established as proven in point 13, it takes into account the content of document 6 submitted by the Applicant, which was not challenged by the Respondent, from which it appears that in 2016 the company in question had a turnover of €4,828,229.19, a balance sheet of €6,087,916.80 and a total of 5 salaried employees (cf. p. 27).

No assertions made by the parties were considered as either proven or not proven, when presented as facts consisting of strictly conclusive statements, incapable of proof and whose truthfulness must be assessed in relation to the specific matter of fact consolidated above.

B. ON THE LAW

As is consensual between the parties, the question that arises is whether the regime provided for in Articles 43(3) and (4) of the Personal Income Tax Code (CIRS) is or is not applicable in situations where capital gains arise from the alienation of equity interests in entities that do not have their seat and/or effective place of management in Portugal.

The following is the wording of the aforementioned provision:

"1 - The value of income qualified as capital gains is the corresponding balance determined between capital gains and capital losses realized in the same year, determined in accordance with the following articles. (...)

3 - The balance referred to in paragraph 1, relating to the operations provided for in Article 10(1)(b), concerning micro and small enterprises not listed on the regulated or unregulated markets of the stock exchange, when positive, is equally considered at 50% of its value.

4 - For the purposes of the preceding paragraph, micro and small enterprises shall be understood as the entities defined, pursuant to the annex to Decree-Law No. 372/2007, of 6 November."

For its part, Article 2(2) of the annex to Decree-Law No. 372/2007, of 6 November, to which the aforementioned CIRS provision refers, provides that:

"In the category of SMEs, a small enterprise is defined as an enterprise that employs fewer than 50 persons and whose annual turnover or total annual balance sheet does not exceed 10 million euros."

In light of this provision and the facts established as proven, it is verified that the company whose equity interests generated the capital gains taxed in the assessment that is the subject matter of the present arbitral action qualifies as a small enterprise.

Thus, it is only necessary to assess whether the circumstance that the company in question is a non-resident entity (without seat or effective place of management in national territory) contends with, or not, the application of the aforementioned provision of Articles 43(3) and (4) of the applicable CIRS.

On this point, the Respondent argues that "Decree-Law No. 372/2007, of 6 November applies to companies whose seat or effective direction are located in Portugal, since that is the scope of territorial sovereignty of the Portuguese State, as described in the preamble of the aforementioned legislation".

With respect to this question, it should be said, from the outset, that Articles 43(3) and (4) of the applicable CIRS do not presuppose the application of Decree-Law No. 372/2007, of 6 November, but merely refer to the definition made by that legislation of what constitutes micro and small enterprises.

Moreover, if the DL in question applies only "to companies whose seat or effective direction are located in Portugal", this will not occur by virtue of the definition of micro and small enterprises formulated therein, but rather by virtue of the general rules governing the application of laws, related to their territoriality, to which Article 43(3) and (4) of the CIRS does not refer.

What is not at issue, therefore, is "the Portuguese State considering itself competent to define the concept of micro and small enterprises located outside the limits of its jurisdiction, and as such, subject to the sovereignty of another State." Indeed, the Portuguese State defines what is a micro and small enterprise for itself (and must do so, as will be seen below, respecting the Community obligations to which it is bound, relating to the freedom of movement of capital), and not what is a micro and small enterprise for other States.

Nor is at issue, contrary to what the Respondent appears to suggest, the recognition of enterprises with seat or effective direction abroad, in accordance with Decree-Law No. 372/2007, since, as has been recognized in case law, the reference made by the CIRS to that DL is a material reference, not presupposing that the enterprises in question formally enjoy the qualification of micro or small enterprise recognized pursuant to that same DL.

Hence, the consideration raised by the Respondent that the company, in this case, generating capital gains is situated "outside the scope of certification of IAPMEI - Agency for Competitiveness and Innovation" is also considered irrelevant, given that such certification is, pursuant to the aforementioned case law, irrelevant for the operation of the provisions in question.

Following on, the Respondent further states that "The benefit, concretized in the taxation of only 50% of the positive balance between capital gains and losses obtained from the alienation of equity interests, provided for in paragraphs 3 and 4 of Article 43 of the CIRS, introduced by Law 15/2010, of 26 July, was intended to benefit, encourage and develop Portuguese micro and small enterprises."

Although this may be true, the question that arises, and will be addressed immediately hereafter, is whether such discrimination of Portuguese enterprises is, or is not, in accordance with Community law, namely regarding the freedom of movement of capital and what the repercussions of the judgment arising therefrom are on the interpretation of the provisions of Articles 43(3) and (4) of the CIRS.

Here we arrive at the fundamental question that arises, namely to verify, in the first instance, whether the regime of Articles 43(3) and (4) of the CIRS discriminates, or does not discriminate, between capital gains arising from the alienation of equity interests in micro and small enterprises with seat and effective direction within national territory, and capital gains arising from micro and small enterprises with seat and effective direction outside national territory, as the Tax Authority contends.

Once the literal element is verified, it will be inescapable to conclude that no discrimination is enshrined.

Indeed, unlike, for example, what happens with the analogous situation of capital gains from real property, in which the legislator, in Article 10(5)(a) of the CIRS, which already expressly referred at that time to the possibility of the real property referred to therein being situated "in Portuguese territory or in the territory of another Member State of the European Union or of the European Economic Area", and which, until the entry into force of Decree-Law 361/2007, of 2 November, was restricted to real property situated "in Portuguese Territory", the provisions that regulate capital gains arising from the alienation of equity interests make no mention whatsoever of the location of the entity whose equity interests generate the capital gains.

In this manner, it is not possible to extract from the legislative text any geographic limitation to the location of the seat or effective direction of the entities whose equity interests generate the capital gains.

Given this, it remains to assess whether from the remaining elements of interpretation any limitation in that direction can be derived.

As the Respondent points out, the historical element could, indeed, point in the direction that the application of paragraphs 3 and 4 of Article 43 of the CIRS in question is restricted to capital gains arising from the alienation of equity interests in micro and small enterprises with seat or effective direction within Portuguese territory, taking into account that the bill of law that originated the provision in question has its origin in Bill No. 257/XI, whose preamble justified it in the following terms: "Finally, because it is important on this occasion to indicate the urgency of the financial recovery of enterprises, in particular small and medium-sized national enterprises, many of them of a family character, a more favorable tax regime is recommended for capital gains generated from the onerous alienation of equity interests, in the terms defined in Article 10(1)(b) of the IRS Code".

Notwithstanding, the historical element is not essential, nor even one of the main elements of legal interpretation, having, as is well known, primacy the rational or teleological element.

Thus, within the scope of such interpretative canons, it will be necessary to weigh the intentionality of the regulatory regime to be interpreted, in light of its effectiveness, in the framework of the legal order in general, in which it is inserted.

Now, from this point of view, it will be inescapable that in the enactment of the legal solutions that are posited, the legislator could not have failed to have, insofar as the case is concerned, its international obligations, and in particular Community obligations, namely at the level of its obligation to respect and ensure the freedom of movement of capital.

On this point, the CJEU has already established, in settled case law, that it is not permitted for Member States, in violation of the freedom of movement of capital, to grant more favorable taxation conditions to capital income arising from companies with seat or effective direction in those same Member States, in relation to capital income arising from companies with seat or effective direction in other Member States.

It is true that the known case law of the CJEU on the subject relates to situations of taxation of dividends, and not to capital gains.

However, as was written, for example, in the "Report of the Draft Reform" of the Corporate Income Tax, "the realization of capital gains and the distribution of dividends are two alternative forms of contribution of value to shareholders, being conceived as close substitutes, according to their inherent relative substitutability. In these terms, it is considered that a disparate tax treatment between these two forms of realization of income is susceptible to influencing the fundamental decision regarding the retention of capital in enterprises, thereby modifying the "natural" behavior of economic agents, or, in other words, creating inefficiencies."

Hence, without doubt, the distribution of dividends and the realization of capital gains must be considered analogous, from the point of view of taxation and the freedom of movement of capital, being therefore entirely transposable to the taxation of the latter, the considerations of the CJEU regarding the taxation of the former, such as, for example, that:

"69 According to the case law of the Court of Justice, restrictions on movements of capital involving an establishment or direct investments within the meaning of Article 64(1) TFEU include not only national measures which, when applied to movements of capital to or from third countries, restrict the establishment or investments but also those which restrict the payments of dividends resulting therefrom (Judgment of 24 November 2016, SECIL, C‑464/14, EU:C:2016:896, no. 77 and case law cited therein).

70 It follows that a restriction on movements of capital, such as less favorable tax treatment of dividends of foreign origin, is covered by Article 64(1) TFEU, to the extent that it concerns shareholdings acquired in order to create or maintain lasting direct economic links between the shareholder and the company in question, enabling the shareholder to participate effectively in the management of that company or in its control (Judgment of 24 November 2016, SECIL, C‑464/14, EU:C:2016:896, no. 78 and case law cited therein).

71 In this regard, the Court of Justice stated that the fact that national legislation restricting movements of capital involving direct investments may be applied to other situations is not capable of preventing the applicability of Article 64(1) TFEU in the circumstances it provides for (Judgment of 15 February 2017, X, C‑317/15, EU:C:2017:119, no. 21)."

Now, given that the solution now advocated by the Respondent, of restricting the regime of paragraphs 3 and 4 of Article 43 of the applicable CIRS to capital gains generated by micro and small enterprises with seat or effective direction within national territory is directly contrary to the freedom of movement of capital, as crystallinely defined by the CJEU, to the extent that it would unjustifiably restrict investment in micro and small enterprises with seat or effective direction in other Member States (in this case, in France), it cannot be considered, in light of the rational and teleological elements of interpretation, that the legislator intended to enshrine a solution so flagrantly violating its Community commitments.

Moreover, and returning to the regime of taxation under IRS of capital gains from real property, one cannot fail to note that it must have been the necessity of respecting the aforementioned commitments that led the legislator to amend the provision of Article 10(5)(a) of the CIRS, through Decree-Law 361/2007, of 2 November, to come to expressly refer to the possibility of the real property referred to therein being situated "in Portuguese territory or in the territory of another Member State of the European Union or of the European Economic Area", substituting the previous provision that restricted the regime in question to real property situated "in Portuguese Territory".

In this manner, taking into account that from the letter of paragraphs 3 and 4 of Article 43 of the CIRS it does not follow that such regime is applicable only to capital gains generated by micro and small enterprises with seat or effective direction within national territory, and that an interpretation of the same provisions in that sense would be contrary to the rational and teleological elements of interpretation, as they would lead to a solution contrary to the imperative of ensuring the Community principle of freedom of movement of capital, which should not be considered as intended by a reasonable legislator, it is concluded that the aforementioned regime does not permit distinction between capital gains generated by micro and small enterprises with seat or effective direction within national territory and capital gains generated by micro and small enterprises with seat or effective direction in another Member State.

By understanding it otherwise, the assessment that is the subject matter of the present arbitral action incurred an error of law and should be annulled, proceeding in that measure with the arbitral request formulated.

However, as results from the arbitral request formulated, the Applicant seeks the total annulment of the assessment in dispute, which proceeds to tax 100% of the capital gains realized by her, and not 50%, as required by the aforementioned provisions of paragraphs 3 and 4 of Article 43 of the applicable CIRS.

Now, as the Supreme Administrative Court has repeatedly understood:

"I - The tax act, while a divisible act, both by nature and by legal definition, is susceptible of partial annulment.

II - The criterion for determining whether the act should be totally or partially annulled is to assess whether the illegality affects the tax act as a whole, in which case the act should be entirely annulled, or only in part, in which case partial annulment is justified."

Now, in the case and as stated, what is verified is that the tax act that is the subject matter of the present arbitral action considered subject to taxation 100% of the capital gain realized by the Applicant, and not 50%, as required by the aforementioned provisions of paragraphs 3 and 4 of Article 43 of the applicable CIRS.

In this manner, the annulment of such act should be only partial, being restricted to the amount of tax assessed in excess, and annulling, correspondingly and consequently, the decision on the administrative complaint that had the assessment act sub iudice as its subject matter.

As for the request for compensatory interest formulated by the Applicant, Article 43(1) of the General Tax Code (LGT) establishes that compensatory interest is due when it is determined that there was an error attributable to the services that results in payment of the tax debt in an amount exceeding what is legally due.

In the case, the error that affects the partially annulled assessment is attributable to the Tax and Customs Authority, which issued it without the necessary legal basis.

The Applicant therefore has the right to be reimbursed the amount she paid (in accordance with the provisions of Articles 100 of the LGT and 24(1) of the RJAT) by virtue of the partially annulled act, and further to be indemnified for the payment made in excess through the payment of compensatory interest by the Respondent, from the date of that payment until its reimbursement, at the legal supplementary rate, in accordance with Articles 43(1) and (4) and 35(10) of the LGT, Article 559 of the Civil Code and Ordinance No. 291/2003, of 8 April.

C. DECISION

Therefore, this Arbitral Tribunal decides to uphold the arbitral request formulated in part and, in consequence:

a) Annul the assessment act for Personal Income Tax (IRS) No. 2017..., made by reference to the fiscal year 2016, insofar as it subjects to taxation more than 50% of the value of capital gains declared by the Applicant, arising from the alienation of her equity interest in the company governed by French law B... SARL, as well as, to the same extent, the decision on the administrative complaint that had such act as its subject matter;

b) Condemn the Tax Authority to pay compensatory interest, in the terms determined above;

c) Condemn the parties to bear the costs of the proceedings, fixing the amount of € 1,530.00 to be borne by the Applicant, and € 1,530.00 to be borne by the Respondent.

D. Value of the Proceedings

The value of the proceedings is fixed at € 138,878.10, in accordance with Article 97-A(1)(a) of the Code of Tax Procedure and Process, applicable by virtue of Article 29(1)(a) and (b) of the RJAT and paragraph 3 of Article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

E. Costs

The value of the arbitration fee is fixed at € 3,060.00, in accordance with Table I of the Regulation of Costs in Tax Arbitration Proceedings, to be paid by the parties in proportion to their respective losses as fixed above, given that the request was partially successful, in accordance with Articles 12(2) and 22(4), both of the RJAT, and Article 4(5) of the aforementioned Regulation.

Notify.

Lisbon, 30 August 2019

The Arbitrator President

(José Pedro Carvalho)

The Arbitrator Member

(Rita Guerra Alves)

The Arbitrator Member

(Paulo Lourenço)

Frequently Asked Questions

Automatically Created

Does the 50% exclusion for capital gains under Article 43(3) and (4) of the IRS Code apply to shares in non-resident companies?
The arbitral tribunal's decision is not fully provided in the excerpt, but the central issue was whether Article 43(3) and (4) of the IRS Code, which provides a 50% exclusion for capital gains from micro and small enterprises, applies to shares in companies not resident in Portugal. The taxpayer argued for its application to her French company shares, while the Tax Authority contested this interpretation, limiting the benefit to Portuguese-resident entities.
How are capital gains from the sale of shares in foreign companies taxed under Portuguese IRS?
Capital gains from selling shares in foreign companies are generally taxed under Portuguese IRS at autonomous rates, unless specific exemptions apply. For non-habitual residents, certain foreign-source income may be exempt. However, capital gains from transferring shares are typically subject to a 28% rate (or progressive rates if opted). The question of whether the 50% exclusion for micro and small enterprises applies to non-resident companies depends on whether such limitation violates EU free movement principles.
What was the outcome of CAAD arbitration process 703/2018-T regarding mobile capital gains?
CAAD arbitration process 703/2018-T concerned a French national, Portuguese tax resident under the Non-Habitual Resident regime, who challenged an IRS assessment of €138,878.10 on capital gains from selling shares in a French micro-enterprise. The taxpayer claimed the 50% exclusion under Article 43(3) and (4) of the IRS Code should apply equally to non-resident EU companies. The case raised fundamental questions about territorial scope of tax benefits and EU law compatibility.
Can Portuguese tax residents claim reduced taxation on capital gains from selling shares in companies based outside Portugal?
The ability of Portuguese tax residents to claim reduced taxation on capital gains from selling shares in companies based outside Portugal depends on the interpretation of Article 43(3) and (4) of the IRS Code. While the provision explicitly refers to micro and small enterprises, it does not specify residency requirements. Taxpayers may argue that restricting the benefit to Portuguese companies discriminates against EU establishments and violates freedom of establishment and free movement of capital principles under EU law.
What is the procedure for challenging an IRS tax assessment on capital gains through CAAD arbitration?
To challenge an IRS tax assessment on capital gains through CAAD arbitration, taxpayers must: (1) file an administrative complaint (reclamação graciosa) within the legal deadline; (2) after rejection, submit a request for arbitration within 90 days; (3) pay applicable fees; (4) clearly identify the contested act and grounds for challenge. The arbitral tribunal is automatically constituted, and proceedings follow RJAT rules. The process offers an alternative to judicial courts with typically faster resolution times for tax disputes.