Process: 87/2018-T

Date: September 24, 2018

Tax Type: IRS

Source: Original CAAD Decision

Summary

This arbitral decision (Process 87/2018-T) addresses a critical question in Portuguese IRS taxation: when employment termination compensation paid in installments becomes taxable. The taxpayer received €224,521.46 in termination compensation from his employer, payable in 24 monthly installments starting February 2016. The Portuguese Tax Authority (AT) assessed IRS on the entire compensation amount in 2016, arguing that the full amount was "placed at the disposal" of the taxpayer upon signing the termination agreement, regardless of the installment payment structure. The taxpayer contested this, arguing that only the 11 installments actually received in 2016 (€102,905.66 gross) should be taxed that year, with remaining installments taxed as received in subsequent years. The core legal issue involves interpreting Article 2(1) of the Personal Income Tax Code (CIRS), which taxes income when "paid or placed at the disposal" of the beneficiary. The taxpayer argued the AT violated tax legality principles under Articles 103(2) and (3) of the Portuguese Constitution and Article 8 of the General Tax Law (LGT), as well as the right to participate in decisions affecting them (Article 60 LGT). The decision examines whether contractually agreed installment payments constitute actual availability of income for IRS purposes, or whether the mere signing of a termination agreement triggers immediate taxation on the full amount. This ruling has significant implications for employment termination compensation structures and the timing of IRS liability in Portugal.

Full Decision

ARBITRAL DECISION

REPORT:

A..., taxpayer no. ... and his wife, B..., taxpayer no..., resident at ..., no..., ... –... ..., hereinafter designated as Claimants, filed a petition for the constitution of an arbitral tribunal in tax matters and a petition for an arbitral award, pursuant to the provisions of paragraphs 1 and 2 of Article 10 of Decree-Law No. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter abbreviated as RJAT), requesting the annulment of personal income tax assessment no. 2017... relating to the year 2016, as well as the restitution of tax paid in the total amount of € 17,936.83, plus the corresponding compensatory interest.

To substantiate their request, they allege, in summary:

  • The personal income tax assessment no. 2017..., relating to the year 2016, results from an ex officio correction to the dependent employment income of the male Claimant declared in Annex A of the personal income tax return Form 3;

  • In the 2016 tax year, the Claimants earned Category A income in the total amount of € 83,335.78, of which € 49,558.87 relates to the male Claimant;

  • The Category A income of the male Claimant, in the stated amount of € 49,558.87, relates to: (i) salaries for January and February, holiday allowance and proportional holiday allowance, Christmas bonus of the year 2016 (€ 14,879.28) and (ii) 11 installments of the employment contract termination agreement concluded between the male Claimant and his employer (€ 34,679.59, this value relating only to the portion subject to personal income tax);

  • Under the employment contract termination agreement concluded, the employer undertook to pay the male Claimant compensation for the termination of the employment contract in the gross amount of € 224,521.46, in 24 monthly successive installments of € 9,355.06 each, with the first falling due on 25/02/2016 and the remainder on the same day of subsequent months;

  • The Tax Authority issued the assessment referred to in the preceding item, arguing that the taxable income was placed at the disposal of the male Claimant on the date of execution of the respective contract termination agreement, and that it is irrelevant for this purpose whether payment in installments of the respective amount was agreed between the parties;

  • Contrary to what the Tax Authority argues, the Claimant is only obliged to pay, in the year 2016, tax relating to income actually paid in that year and not on the total value of the agreement concluded;

  • The contested assessment violates Article 2 of the Personal Income Tax Code and the principle of tax legality provided in Articles 103, paragraphs 2 and 3 of the Constitution and Article 80 of the General Tax Law;

  • The Tax Authority also violated the right of taxpayers to participate in the formation of decisions that concern them, enshrined in Article 60 of the General Tax Law, and the contested assessment further suffers from the defect of lack of reasoning;

  • The Claimants attached 7 documents and did not summon any witnesses.

In the petition for an arbitral award, the Claimants chose not to designate an arbitrator, wherefore, pursuant to the provisions of Article 6, paragraph 1 of the RJAT, the undersigned was designated by the Ethics Council of the Administrative Arbitration Centre, the appointment being accepted in accordance with the legally provided terms.

The arbitral tribunal was constituted on 23 May 2018.

Notified in accordance with the terms and for the purposes provided in Article 17 of the RJAT, the Respondent filed a reply, invoking, in summary:

  • The contested assessment was subject to an ex officio correction, with global income changing from € 129,473.41 to € 127,473.41, resulting in tax payable by the Claimants in the amount of € 16,969.57;

  • What is relevant for purposes of tax incidence are the income payments or those placed at the disposal of the taxpayer;

  • In the present case, the agreed compensation was placed at the disposal of the male Claimant on the date of execution of the employment contract termination agreement, and it is irrelevant for this purpose that the male Claimant agreed to payment in installments of the amount owed;

  • The contested assessment does not suffer from any defect.

It concludes, requesting the dismissal of the petition.

The Respondent attached 1 document and the administrative file, and did not summon any witnesses.

Given the position assumed by the parties and the absence of any need for additional evidence production, the holding of the meeting referred to in Article 18 of the RJAT, as well as the presentation of submissions, was dispensed with.

PRELIMINARY MATTERS:

The Arbitral Tribunal was regularly constituted and is materially competent.

There are no nullities that invalidate the proceedings.

The parties have legal personality and capacity and are legitimate, with no defects in representation.

There are no other nullities, exceptions, or preliminary issues that preclude examination of the merits and which should be examined ex officio.

ISSUES TO BE DECIDED:

Given the positions assumed by the parties, set forth in the arguments presented, it is found that the only issue to be decided by this Tribunal is whether, having been agreed between the parties that payment of compensation due by the termination of the employment contract would be made in installments, payment of the corresponding personal income tax is due in the year of execution of the respective agreement, applying to the entire agreed amount, or, instead, in the year(s) when the respective installments are paid, applying only to the installments actually paid in each year.

FACTUAL MATTERS:

Proven Facts

With relevance to the decision to be rendered in the present proceedings, the following facts are established as proven:

  1. By an employment contract termination agreement executed on 25/02/2016 between the male Claimant and C... S.A., payment to the male Claimant was agreed, as a comprehensive pecuniary compensation for termination of the employment contract, in the gross amount of € 224,521.46;

  2. It was further agreed that payment of the amount referred to in the preceding item would be made in 24 monthly successive installments, each in the gross amount of € 9,355.06, with the first falling due on the date of execution of the agreement (25/02/2016) and the remainder on the same day of subsequent months;

  3. In the year 2016, 11 installments in the gross amount of € 9,355.06 each were paid to the male Claimant;

  4. The Claimants paid the personal income tax assessment for the year 2016, in the amount of € 17,936.83, on 19/12/2017;

  5. The petition for constitution of the arbitral tribunal in tax matters and for an arbitral award was filed on 12/03/2018.

Unproven Facts

No facts of interest to the proceedings were found to be unproven.

Grounds for Factual Findings

The conviction regarding the facts established as proven was formed on the basis of documentary evidence submitted by the parties, indicated with respect to each point, whose correspondence to reality was not challenged, as well as alleged matter not controverted.

As regards unproven factual matters, this was based on the total absence of evidence to that effect.

ON THE LAW:

With the factual matters now established, it is necessary to apply the applicable law by reference thereto.

The issue to be decided concerns the interpretation of the provision contained in paragraph 1 of Article 2 of the Personal Income Tax Code, which provides as follows:

"All remuneration paid or placed at the disposal of its beneficiary shall be considered dependent employment income. (...)"

In this regard, the Claimants invoke that, by an employment contract termination agreement executed on 25/02/2016 between the male Claimant and C..., S.A., it was agreed that the male Claimant would receive comprehensive compensation for termination of the employment contract in the gross amount of € 224,521.46.

It was further agreed that payment of the stated amount would be effected in 24 monthly successive installments of € 9,355.06 gross each, with the first falling due on the date of signature of the agreement and the remainder in subsequent months, ending in January 2018.

Thus, since in the year 2016 the male Claimant received only 11 of the 24 agreed installments, in the gross amount of € 102,905.66, the personal income tax relating to that 2016 tax year can only apply to the amount actually earned by the male Claimant in that same year and not to the total agreed amount, an amount that was not received by the male Claimant in 2016.

To this end, they argue in summary that, given the wording of Article 2, paragraph 1 of the Personal Income Tax Code, and since the respective tax applies only to remuneration paid or placed at the disposal of the beneficiary in each year, in the year 2016 the Claimant is only obliged to pay personal income tax on remuneration actually earned and not on the total value contained in the employment contract termination agreement.

For this reason, the Claimant argues that there is no legal basis for the contested assessment.

For its part, the Respondent argues that the regulation of the cited Article 2, paragraph 1 of the Personal Income Tax Code points to an interpretive sense, whereby, with the execution of the employment contract termination agreement, the economic compensation agreed therein was placed at the disposal of the male Claimant, since, according to the Respondent, by "placed at the disposal" should be understood the moment from which the worker may receive the income to which he is actually entitled, and the agreement regarding installment payments concluded is not binding on the Tax Authority.

Given the position of the parties, let us examine what should be, in accordance with the rules of legal interpretation enshrined in law, the interpretation of Article 2, paragraph 1 of the Personal Income Tax Code, transcribed above.

From a simple reading of the stated provision, it is evident, without great difficulty, that the key issue centers on the expression "placed at the disposal" used by the legislator.

Specifically, it is necessary to determine at what moment income should be considered as "placed at the disposal": whether at the moment of execution of the installment payment agreement or at the moment of payment of each installment.

For the assessment of this issue, it is first necessary to recall here some legal concepts and statutory definitions.

Thus,

Pursuant to Article 11, paragraph 1 of the General Tax Law, tax provisions shall be interpreted in accordance with the principles of legal interpretation, whereby it is "today settled that tax laws are interpreted as any other laws, and their true meaning must be determined in accordance with the techniques and interpretive elements generally accepted by doctrine" (...) (see Court of Administrative Appeals Decision, 21/09/2010, case 3748/10 in www.dgsi.pt and Rui Duarte Morais, "On Personal Income Tax," 2nd edition, Almedina, 2010, page 56).

Now, Article 9 of the Civil Code provides that the interpretation of law is not limited to its letter, but rather should be made as a reconstruction from the legislative intent, providing, however, that the interpreter cannot consider a legislative intent that does not have in the letter of the law a minimum of verbal correspondence, even if imperfectly expressed, and the interpreter must presume that the legislator knew how to express his intent in adequate terms.

This means that literal interpretation (letter of the law) presents itself as the first stage of interpretive activity.

As FERRARA states, "the text of the law forms the substrate from which the interpreter must depart and on which he must rely."[1]

Since the law is expressed in words, the verbal meaning they contain must be extracted from them, according to their natural connection and grammatical rules.

The text of the law is the starting point of interpretation, and it has, from the outset, a negative function: that of eliminating those meanings that have no support, or at least some correspondence or resonance in the words of the law.[2]

However, where the words used by the legislator are equivocal or indeterminate, it will be necessary to resort to logical interpretation, which attends to the spirit of the provision being interpreted.

Let us apply, then, what has been set forth to the present case, that is, to the interpretation of paragraph 1 of Article 2 of the Personal Income Tax Code, specifically regarding the phrase "placed at the disposal of its beneficiary."

Beginning with literal interpretation, it seems evident that the cited Article 2, paragraph 1 of the Personal Income Tax Code, in providing that all dependent employment remuneration paid or placed at the disposal shall be considered income, requires that the income be effectively placed at the disposal of its beneficiary.

"To place at the disposal of" means the action of disposing of something to, placing something in a situation or condition to be used or to be useful to.

See in this regard the Decision of the Supreme Administrative Court (STA) No. 0827/06, of 29 November 2006, in www.dgsi.pt, "placement at the disposal corresponds to the de facto power of the beneficiary to actually receive or freely withdraw the value in question (...)."

In the present case, placing the income at the Claimant's disposal means, thus, placing the income in the actual possibility of being received by him, so that the actual receipt thereof depends solely and exclusively on his will.

In the case at hand, as appears from the proven facts (item 2), it was agreed between the parties that the payment owed would be effected in installments.

It is true, as the Tax Authority argues, that the fact that "receipt of the amount in question" "is made according to an installment plan is a situation to which the Tax Authority is indifferent."

But the truth, however, is that the Claimant agreed with his employer the payment of the amount in question in installments, whereby only with the payment of each installment is the income placed at his disposal.

Contrary to what the Tax Authority argues, the global income was not placed at the Claimant's disposal on the date of execution of the employment contract termination agreement, but rather with the payment of each of the agreed installments.

Thus, because in the year in question in the present proceedings the male Claimant received only 11 of the 24 agreed installments, only in that same year were the income corresponding to the sum of the installments delivered placed at his disposal or placed in his possession.

It is, thus, on this income that the personal income tax relating to the year 2016 should apply and not on any other, since it was this and only this income that was earned by the male Claimant relating to the employment contract termination agreement concluded.

In this sense, and although it concerns a situation different from that of the present case, see the aforementioned decision of the STA – "agreed between the taxpayer and his employer the termination of the employment contract between them, with the latter undertaking to pay him certain amounts over several years, the law to be applied for purposes of personal income tax is that in force in each of the years in which there were receipts in fulfillment of such agreement."

The same judgment further clarifies that in the case of long-term contracts "the tax effects, in particular those relating to annualized taxes, as is the case with personal income tax, occur, and only occur in each of the years in which, by force of the contract's execution, the subject receives income."

This is, in my opinion, the only possible interpretation of the cited Article 2, paragraph 1 of the Personal Income Tax Code, and no possibility of any other understanding or any ambiguity is discerned from the letter of the law.

Wherefore there will be, in the present case, no necessity to resort to the remaining elements of legal interpretation.

Indeed, any other interpretation of the cited Article 2, paragraph 1 of the Personal Income Tax Code would violate the principle of tax capacity.

This principle requires that taxation be effected in accordance with the actual income of the taxpayer, whereby income is only subject to taxation to the extent that it is placed at the disposal of its beneficiaries.

In this sense, see the decision of the STA of 26 June 2002 rendered in case no. 26811, cited in the aforementioned decision of the same Court, which reads that "what counts is the moment when income is obtained or income is utilized, because it is only then that tax capacity exists. It would be unconstitutional to demand a tax from someone who has no tax capacity because he does not have the income at his disposal."

Now, if, as has already been stated, the Claimant, in the year 2016, received only 11 of the 24 agreed installments, it is manifest that the corresponding tax can only apply to those installments received and not to the installments that the Claimant has not yet received.

Indeed, it seems evident that the Tax Authority cannot demand the payment of personal income tax on income that has not yet been earned and that, in 2016, the Claimant does not know whether he will actually receive in its entirety, since at that time the Claimant does not know whether his employer will fulfill the agreed payment.

Note further that the interpretation of Article 2, paragraph 1 of the Personal Income Tax Code here defended does not result in any prejudice to the Tax Authority.

With this interpretation, the Tax Authority does not fail to receive the taxes owed. It only receives them, as required, at the moment of actual receipt of the income by the taxpayers.

In the present case, the Claimants will have to, in the 2017 and 2018 tax years, declare the installments earned and pay the respective tax.

Only if they fail to do so in the stated tax years may the Tax Authority assess the tax owed ex officio.

In light of the foregoing, it is evident that there is no legal basis for the contested assessment, insofar as it includes in the global income the amounts relating to installments that were not earned in the year 2016, whereby the contested assessment, in this respect, suffers from illegality.

As to the remaining part, the contested assessment merits no objection, as it relates to income actually earned by the Claimants in the year 2016.

Having established the partial illegality of the contested assessment, the examination of the other defects that the Claimants attribute to the contested assessment is precluded.

Finally,

The Claimants petition for the condemnation of the Respondent to pay compensatory interest.

As to compensatory interest, paragraph 1 of Article 43 of the General Tax Law provides:

"Compensatory interest is due when it is determined, in a petition for review or judicial challenge, that there was an error attributable to the services resulting in payment of the tax debt in an amount exceeding the legally due amount."

In the case at hand, it is found that, by error attributable to the services, the Claimants were forced to pay a tax in an amount exceeding that which was due.

Thus, compensatory interest is due, to be paid by the Respondent to the Claimants, calculated on the amount of tax assessed on income exceeding the amount actually earned by the Claimants in the year 2016, at statutory rates, from 20 December 2017 until effective and complete reimbursement by the Respondent.

Thus, the petition formulated regarding the annulment of the personal income tax assessment in the amount of € 17,936.83 is partially granted, and the Respondent must reimburse the Claimants the amount paid in excess, relating to tax assessed on income not earned by the Claimants in the year 2016, and pay the corresponding compensatory interest, calculated on the amount of tax assessed on income exceeding the amount actually earned by the Claimants in the year 2016, at statutory rates, from 20 December 2017 until effective and complete reimbursement by the Respondent.

V. RULING

In light of the foregoing, it is decided:

a) To rule partially in favor of the petition for annulment of the personal income tax assessment for the year 2016, in the amount of € 17,936.83, as to the amount of tax assessed on income exceeding the amount actually earned by the Claimants in the year 2016;

b) To condemn the Respondent to reimburse the Claimants the amount paid in excess, relating to tax assessed on income not earned by the Claimants in the year 2016;

c) To condemn the Respondent to pay the Claimants the corresponding compensatory interest, calculated on the amount of tax assessed on income exceeding the amount actually earned by the Claimants in the year 2016, at statutory rates, from 20 December 2017 until effective and complete reimbursement by the Respondent.

The value of the case is fixed at € 17,936.83, in accordance with subparagraph a) of paragraph 1 of Article 97-A of the Code of Procedure and Tax Process, applicable by force of subparagraphs a) and b) of paragraph 1 of Article 29 of the RJAT and paragraph 2 of Article 3 of the Regulation of Costs in Tax Arbitration Proceedings.

The arbitration fee is fixed at € 1,224.00, in accordance with Table I of the Regulation of Costs in Tax Arbitration Proceedings, as well as paragraph 2 of Article 12 and paragraph 4 of Article 22, both of the RJAT, and paragraph 4 of Article 4 of the cited Regulation, to be paid by the Claimants and the Respondent in proportion to their respective non-success (67.85% borne by the Tax Authority and 32.15% borne by the Claimants).

Let this be recorded and notified.

Lisbon, 24 September 2018.

The Arbitrator,

Alberto Amorim Pereira

Document prepared by computer, in accordance with paragraph 5 of Article 131 of the Code of Civil Procedure, applicable by reference from subparagraph e) of paragraph 1 of Decree-Law No. 10/2011, of 20/01.

[1] FRANCISCO FERRARA, Interpretation and Application of Laws, 1921, Rome; Translation by MANUEL DE ANDRADE, Arménio Amado, Editor, Successor – Coimbra, 2nd Edition, 1963, p. 138 et seq.

[2] In this sense, see JOÃO BAPTISTA MACHADO, Introduction to Law and Legitimizing Discourse, Almedina, Coimbra, 1994, p. 182.

Frequently Asked Questions

Automatically Created

How is employment termination compensation taxed under Portuguese IRS when paid in installments?
Under Portuguese IRS law, employment termination compensation paid in installments is taxed based on when the income is considered "placed at the disposal" of the taxpayer according to Article 2(1) of CIRS. This case established that when a termination agreement specifies payment in monthly installments over multiple years, the critical question is whether the mere signing of the agreement constitutes having the full amount "at disposal" or whether each installment is only taxable when actually paid. The Tax Authority argued that the entire compensation becomes taxable in the year of the agreement's execution, regardless of the installment structure, while the taxpayer contended that only installments actually received in each tax year should be subject to IRS in that year.
Can the Portuguese Tax Authority (AT) tax the full termination agreement amount in the year it was signed rather than when installments are received?
The Portuguese Tax Authority took the position that it can tax the full termination compensation amount in the year the agreement was signed, arguing that the entire sum was "placed at the disposal" of the taxpayer on the contract execution date (25/02/2016). The AT considered the installment payment arrangement between employer and employee irrelevant for determining the tax year of incidence. This interpretation means that even though only 11 of 24 installments were actually paid in 2016, the AT assessed IRS on the complete €224,521.46 compensation in that tax year. This approach prioritizes the legal availability of funds over actual receipt, treating the contractual right to future payments as equivalent to having received the full amount immediately.
What does Portuguese tax law say about the moment income is considered available for IRS purposes under Article 2 of CIRS?
Article 2(1) of the Portuguese Personal Income Tax Code (CIRS) states that dependent employment income (Category A) includes all remuneration "paid or placed at the disposal of its beneficiary." The critical phrase "placed at the disposal" (colocado à disposição) creates interpretive challenges when income is contractually due but paid over time. Portuguese tax law recognizes two potential moments of availability: (1) actual payment to the taxpayer, or (2) when the taxpayer has the legal right to receive payment, even if not yet physically received. In this case, the dispute centered on whether signing a termination agreement that creates a contractual obligation to pay over 24 months constitutes having the full amount "at disposal" immediately, or whether each installment only becomes "available" when actually paid or when the specific installment falls due.
Does paying employment termination compensation in monthly installments affect IRS tax liability in each fiscal year?
The structure of employment termination compensation as monthly installments is precisely what created the tax dispute in this case. The taxpayer argued that paying compensation in 24 monthly installments of €9,355.06 each should result in IRS liability distributed across the tax years when installments are received - meaning 11 installments taxed in 2016 and 13 in 2017. This approach would allow the taxpayer to benefit from progressive tax rates applied to lower annual income amounts in each year, rather than having the full compensation taxed in a single year at potentially higher marginal rates. The installment structure also affects cash flow, as the taxpayer would only pay tax on funds actually received. However, the Tax Authority rejected this treatment, insisting that the installment arrangement was merely a payment facility that didn't alter the fundamental tax year of incidence.
What are the taxpayer's rights to participation and proper justification in IRS correction decisions by the Portuguese Tax Authority?
Portuguese taxpayers have constitutional and statutory rights that were invoked in this case. Article 60 of the General Tax Law (LGT) guarantees taxpayers the right to participate in the formation of decisions that concern them, which includes proper notification and opportunity to respond before tax corrections are made. The taxpayers also alleged violation of the right to a reasoned decision, arguing the AT failed to adequately explain why the installment structure was disregarded. Additionally, Article 103(2) and (3) of the Portuguese Constitution enshrines the principle of tax legality, requiring that taxation only occur based on clear legal authority and that tax incidence, rates, and benefits be established by law. These procedural and substantive rights are fundamental protections in Portuguese tax law, and violations can constitute grounds for annulling tax assessments through administrative or arbitral review.