Process: 96/2015-T

Date: June 30, 2015

Tax Type: IRS

Source: Original CAAD Decision

Summary

Arbitral Process 96/2015-T concerns the IRS taxation of a non-resident taxpayer who changed tax residence from Portugal to the United States in 2011. The central issue involves whether the Portuguese Tax Authority (AT) legally denied the carryforward of Category F (real estate income) losses incurred in 2010, when the taxpayer was still a Portuguese resident, to offset Category F income earned in 2011 and 2013 as a non-resident. The AT issued IRS assessments totaling €9,657.99 for tax years 2011 and 2013, refusing to recognize the loss carryforward. The Claimant challenged these assessments at the CAAD Tax Arbitration Centre, arguing multiple legal violations. The taxpayer contended that AT violated constitutional principles of actual income taxation and tax legality (Article 103 CRP), the Portugal-USA Double Taxation Convention (specifically Article 26's non-discrimination clause), and various provisions of the IRS Code (Articles 22, 55, and 72). The Claimant argued that Portuguese law expressly permits Category F loss carryforward for five years and contains no provision limiting this right exclusively to residents. The taxpayer emphasized that the determination of net Category F income and loss deduction operates identically for both residents and non-residents, making AT's interpretation an unlawful restriction not contemplated by legislation. AT defended its position based on the territoriality principle applicable to non-residents (Article 15(2) IRS Code), arguing that non-residents' income is not aggregated and therefore loss deductions from prior years cannot apply. The case raises fundamental questions about tax equality between residents and non-residents regarding real estate income taxation, the scope of double taxation convention protections, and the limits of administrative discretion in tax assessment. The Claimant also sought reimbursement of unduly paid taxes plus compensatory interest pursuant to Article 43(1) of the General Tax Law.

Full Decision

CAAD – Tax Arbitration Centre

ARBITRAL PROCESS NO. 96/2015-T

Subject: IRS. Taxation of non-residents. Real estate income.

ARBITRAL DECISION

  1. REPORT

A, taxpayer with NIF …, tax resident in the United States of America, …, represented by B, with NIF …, resident at Avenue …, in the capacity of Fiscal Representative (hereinafter referred to as the Claimant), filed a request for the constitution of an arbitral tribunal, pursuant to the provisions of article 10 of the Legal Framework for Tax Arbitration (RJAT) and articles 1 and 2 of Ordinance No. 112-A/2011, of 22 March, against which the Tax Authority and Customs Authority is called (hereinafter AT or Respondent), with a view to declaring the illegality and annulment of the IRS assessments for the year 2011 (assessment No. 2012 ..., in the sum of € 2,271.95) and the year 2013 (assessment No. 2014 ..., in the sum of € 7,386.04), in the total amount of € 9,657.99, as well as the decisions rejecting the administrative appeals and hierarchical appeals filed against the same assessments.

Cumulatively, the Claimant makes requests for reimbursement of the tax unduly paid, as well as a condemnation of the Respondent to the payment of compensatory interest on the respective amounts.

The following are the grounds for the requests to annul the IRS assessment acts for the years 2011 and 2013 and the decisions rejecting the administrative appeals and hierarchical appeals, notified to the Claimant:

  1. In the years 2011 and 2013, the Claimant, resident in the United States of America, submitted the IRS form 3 declaration, in which she declared having earned income from category F and borne expenses relating to the real estate sources of such income, located in Portugal, having opted for the aggregation of the declared income;

  2. The IRS assessments issued by AT for the years in question (2011 and 2013) did not take into account the carryforward of losses from category F, relating to the year 2010, the year in which she was resident in national territory;

  3. On 27 July 2011, the Claimant notified AT of the change of her tax residence to the United States of America, as well as the designation of her Representative in Portugal;

  4. The Claimant argues that the contested assessment acts, as well as the decisions rejecting the administrative appeals and hierarchical appeals filed against them, violate the principles of the taxation of actual income and tax legality, contained in article 103 of the Constitution of the Portuguese Republic (CRP);

  5. They further violate the provisions of article 2, no. 2, of the CRP, by violation of article 26 of the Convention to Avoid Double International Taxation between Portugal and the United States of America (CDT);

  6. The said tax acts and rejection decisions suffer from the defect of violation of law, by violation of the provisions contained in articles 22, no. 1 and no. 3, paragraph a); 55, nos. 1 and 2 and 72, nos. 8 and 9, all of the IRS Code and of article 8 of the General Tax Law (LGT);

  7. They should also be annulled because they are based on error of fact and of law, attributable to AT, and because they lack substantiation;

  8. They are based on error regarding the rules of aggregation of income earned by non-resident entities and in violation of the CDT concluded between the United States of America and the Portuguese State, specifically its article 26;

  9. The AT's understanding is based on: (i) article 72, no. 1, of the IRS Code – taxation of real estate income earned by non-residents; (ii) article 22, nos. 1 and 3, of the IRS Code – taxable income is that which results from the aggregation of the various categories, after deductions and abatements have been made, non-residents' income not being aggregated; (iii) article 15, no. 2, of the IRS Code – IRS due by non-residents applies only to income obtained in Portuguese territory, disregarding the contributory capacity of non-residents; (iv) no. 1 of article 15 of the IRS Code – only in cases where the tax base is determined through aggregation may deductions of losses determined in prior years be made;

  10. However, the law expressly establishes the communicability of losses determined in category F, which cannot and should not be disregarded;

  11. For the carryforward of losses from category F to income of the same category, for the period of five years, the contributory capacity of non-resident taxpayers is irrelevant;

  12. The manner of determination of net income from category F and the deduction of losses is identical, whether it concerns resident taxpayers or non-residents;

  13. There is no provision in the internal legislation that limits the carryforward of losses from category F to net income from the same category for non-residents;

  14. With regard to the option of aggregation by non-residents, the Claimant understands that it may only be prohibited in violation of the legal provisions mentioned, including in violation of the principle of non-discrimination, adopting in this request all the doctrine set out on this matter in Arbitral Decision No. 127/2012-T;

  15. However, regardless of the understanding that is adopted regarding the option of aggregation by non-residents, what must be concluded is that the deduction of losses from category F does not depend on aggregation;

  16. The principle of legality requires that AT does not introduce limitations that are not contained in the law;

  17. The Claimant opted to pay the tax, despite it being illegal, and has the right to compensation for the damage caused by the administrative error, pursuant to article 43, no. 1, of the LGT.

Notified in the terms and for the purposes provided in article 17 of the RJAT, AT presented its response in a timely manner, in which it contests the facts and arguments on which the request for arbitral pronouncement is based, advocating for the maintenance of the IRS assessments for the years 2011 and 2013 which are the object of that request, with the grounds that follow, briefly set out:

  1. The Claimant was, in 2010, tax resident in Portugal and, in 2011, changed her tax residence to the United States of America, a situation that would continue in the year 2013;

  2. Being the owner of real estate located in Portugal, she earned, between 2011 and 2013, income from category F, deriving from a rental contract;

  3. In 2010, the Claimant submitted the IRS form 3 declaration, still with the status of resident in national territory, composed only of annex F, with real estate income and expenses relating to the real estate from which such income originated, from which losses resulted to be carried forward;

  4. The Claimant proceeded to submit the income declaration for the year 2011, in the capacity of non-resident in national territory, composed solely of annex F, in which she declared real estate income and withholdings at source;

  5. Notified of the contested assessment, the Claimant filed an administrative appeal, in which she sought the annulment thereof, because it did not consider the deduction of losses declared in 2010;

  6. From the rejection of the administrative appeal, a hierarchical appeal was filed, which was rejected;

  7. The Claimant proceeded to submit the IRS form 3 declaration for the year 2013, in the capacity of non-resident, composed solely of annex F, in which real estate income and withholdings at source were recorded;

  8. Notified of the assessment, she filed an administrative appeal, in which she sought its annulment, because it did not consider the deduction of losses declared in 2010; the administrative appeal was rejected;

  9. (…) In light of the principle of territoriality or source of income, as opposed to the principle of "world wide income" applicable to residents, article 15, no. 2, of the IRS Code provides that "in the case of non-residents, IRS applies only to income obtained in Portuguese territory.";

  10. With regard to the income of non-residents, article 22, no. 3, paragraph a) of the IRS Code determines, and determined, that aggregation does not occur, rather providing for taxation via the application of rates with a special or liberatory character, notably that which is provided for in article 72 of the IRS Code;

  11. Real estate income earned by non-residents was taxed in accordance with the provisions of article 72, no. 1, of the IRS Code, at the rate of 15%, in 2011 and 16.5%, in 2013;

  12. Article 72 of the IRS Code did not provide for the aggregation of income from category F earned by non-residents; the aggregation of income of non-residents was only provided for in cases of nos. 4, 5 and 6, which do not include real estate income;

  13. For non-residents, aggregation was only permitted in the situations of no. 8 of article 72, situations that do not fit the factual circumstances of the present case;

  14. The special rates of article 72 of the IRS Code are not liberatory, presupposing declarative obligations, and the withholdings at source arising therefrom have the nature of advance payment;

  15. (…) Taking as established that the income earned by the Claimant in the years 2011 and 2013 were not capable of aggregation, it must be determined what is the nature of aggregation: this is the operation by which the totality of income from the various categories is determined, with a view to determining net income, after deductions and abatements provided for in the following sections have been made (article 22, no. 1, of the IRS Code);

  16. The operation of deductions, especially the deduction of losses (which is not a specific deduction of category F), and abatement is a prior, anterior and conditional process, conditional by the possibility of aggregation (bold in the original);

  17. In the absence of a normative provision that enables the aggregation of income obtained in national territory by non-residents, by even greater reason, that prior operation (deduction of losses) cannot be carried out, inasmuch as it would always be conditional on the prior aggregation of income, only possible for residents;

  18. It is, in the view of the Respondent, coherent to conclude that the legislature did not have the intention to apply the loss carryforward regime provided for in article 55 of the IRS Code, since it opted for isolated and analytical taxation of income from category F earned by non-resident taxpayers;

  19. (…) the regime of article 55 cannot be interpreted in any other way than in the sense that only in cases where the tax base is determined through the aggregation of income may the deduction of losses, determined in prior years, be made (bold and underlined in the original);

  20. (…) As for the alleged violation of article 26 of the CDT concluded between the Portuguese Republic and the USA, it must be stated that the special rate of taxation of real estate income earned in national territory by taxpayers resident in the USA, being proportional to the amount of income earned, is all the more beneficial compared to the rate applicable to the same income earned by residents in Portugal, the greater the amount in question;

  21. (…) the provisions of article 26 of the CDT permit that the Portuguese State provide a taxation regime for income earned in national territory by taxpayers resident in the USA, different from that which is applied to its residents (…);

  22. Furthermore, pursuant to article 6 of the CDT, Portugal is granted the right to tax income derived from real estate, with it subsequently being up to the State of residence (USA) to eliminate double taxation;

  23. (…) the legal conformity of the tax acts that are the object of the present arbitral petition is evident (…), it cannot be considered that there has been an error attributable to the services in the issuance of the assessments in question, an indispensable condition for the condemnation to the payment of compensatory interest.

The request for the constitution of the arbitral tribunal was filed with CAAD on 13 February 2015, was accepted by the Esteemed President of CAAD on 16 February 2015 and automatically notified to the Tax Authority and Customs Authority on the same date.

As the Claimant opted not to appoint an arbitrator, the Ethics Council of CAAD appointed the undersigned as arbitrator of the singular arbitral tribunal. The appointment accepted within the applicable timeframe, the Parties were notified of this designation on 13 April 2015, and raised no objection thereto.

The Singular Arbitral Tribunal was duly constituted on 28 April 2015 and is materially competent to examine and decide the dispute that is the subject of the present case.

The Parties have juridical personality and capacity, are legitimate and are duly represented (articles 4 and 10, no. 2, of the RJAT and article 1 of Ordinance No. 112-A/2011, of 22 March).

The process is not affected by nullities and no exceptions were raised.

Article 3, no. 1, of the RJAT expressly permits "The cumulation of requests even if relating to different acts (…) when the merits of the requests depend essentially on the examination of the same factual circumstances and on the interpretation and application of the same principles or rules of law".

As no exceptions were raised nor additional evidence production requested, the holding of the meeting referred to in article 18 of the RJAT was dispensed with.

By order of 2 June 2015 and, considering the content of the decisions of the administrative appeals and hierarchical appeal filed by the Claimant, under the principles of autonomy of the Arbitral Tribunal in conducting the proceedings, expedience, simplification and procedural informality (articles 19, no. 2, and 29, no. 2, of the RJAT), the dispensing of written pleadings was proposed, if the Claimant did not object within a period of 10 days, with 30 June 2015 being fixed as the date for the pronouncement of the arbitral decision.

In the request addressed to this Singular Arbitral Tribunal on 2 June 2015, the Claimant stated that she did not object to the dispensing of written pleadings.

  1. FACTUAL MATTER.

a. Facts deemed proven.

2.1. In 2010, the Claimant was resident in Portugal;

2.2. On 27 July 2011, the Claimant notified AT of the change of her tax residence to the United States of America, as well as the designation of her fiscal representative in Portugal, identified above;

2.3. In the year 2011, the Claimant submitted the IRS form 3 declaration, in the capacity of resident in national territory, referring to income earned in 2010;

2.4. The said declaration contained only annex F, in which real estate income obtained in Portugal of € 21,900.00, withholdings at source on IRS borne on the amount of rents received and expenses with the leased real estate, in the amount of € 82,902.93, were declared, from which losses to be carried forward resulted, of € 61,002.93 and a refund of the sum of € 408.30;

2.5. In 2012, the Claimant submitted the IRS form 3 declaration registered under No. ..., in the capacity of non-resident, containing only an annex F, in which real estate income obtained in Portugal, in the amount of € 22,236.18, withholdings at source of € 423.89, made on the rent of € 2,569.00, were recorded, having opted for the aggregation of the declared income;

2.6. As a result of the declaration submitted, assessment No. 2012 ... was issued, in the amount of € 2,271.95, with a payment due date of 31 August 2012;

2.7. The following are the relevant elements for the evaluation of assessment No. 2012 ...:

2.7.1. – Total income: € 22,236.18; – Specific deductions: € 4,263.97; – Losses to be recovered: € 0.00; – Taxable income: € 17,972.21; – Total tax: € 2,695.84; – Net tax: € 2,695.84; – Withholdings at source: € 423.89; – Tax determined: € 2,271.95; – Amount to pay: € 2,271.95;

2.8. On 8 August 2012, administrative appeal No. ... was filed, in which the annulment of the contested assessment and the issuance of a new assessment was requested, which would result in a refund of € 423.89, equivalent to the amount of withholdings at source borne;

2.8.1. As grounds for the requests, the disregard of the losses carried forward from the previous year was invoked, considering that annex F of the IRS form 3 declaration did not contain any field to mention the losses to be carried forward in that income category;

2.8.2. Administrative appeal No. ... was rejected by order of the Head of the Revenue Service of Lisbon …, of 21 September 2012, notified to the Claimant, represented by her Representative, by official letter of the same date and Revenue Service, sent by registered mail, with proof of receipt;

2.8.3. The decision rejecting the administrative appeal was the subject of hierarchical appeal No. ..., rejected by order of the Chief of the Division of Administration of the IRS Services Directorate, of 9 December 2014, notified to the Appellant, represented by her Mandatary, through official letter No. … of the Division of Administrative Justice of the Finance Directorate of Lisbon, of 9 January 2015, sent by registered mail, with proof of receipt;

2.9. On 27 May 2014, the Claimant, in the capacity of non-resident, submitted the IRS form 3 declaration, which would be included in batch J…-64;

2.10. In this declaration, containing only an annex F, real estate income obtained in Portugal, in the amount of € 36,045.35 and withholdings at source of € 770.82, were recorded, having opted for the aggregation of the declared income (field 5B of annex F);

2.11. As a result of the declaration submitted, assessment No. 2014 ... was issued, in the amount of € 7,386.04, with a payment due date of 3 September 2014;

2.12. The following are the relevant elements for the evaluation of assessment No. 2014 ...:

2.12.1. – Total income: € 36,045.35; – Specific deductions: € 6,913.74; – Losses to be recovered: € 0.00; – Taxable income: € 29,131.61; – Total tax: € 8,156.86; – Net tax: € 8,156.86; – Withholdings at source: € 770.82; – Tax determined: € 7,386.04; – Amount to pay: € 7,386.04;

2.13. On 22 October 2014, the Claimant filed an administrative appeal against assessment No. 2014 ..., filed under No. ...;

2.13.1. The Claimant sought the correction of the assessment, as it had not taken into account either the option of aggregation of the declared income, or the carryforward of losses from prior years;

2.13.2. From such correction would result not only the annulment of the amount of tax assessed, but also the issuance of a refund of € 770.82, equivalent to the amount of withholdings at source borne in the year 2013;

2.13.3. The administrative appeal was rejected in accordance with the order of the Head of the Revenue Service of Lisbon 5, of 17/11/2014, notified to the Claimant, represented by her fiscal representative, by official letter of the same date and Revenue Service, sent by registered mail, with proof of receipt;

2.14. The grounds for the decisions rejecting the administrative appeals and hierarchical appeal identified are identical to those contained in the response transmitted by AT to the case;

2.15. The Appellant proceeded to pay the assessments that are the subject of the request for arbitral pronouncement.

b. Justification of the proven factual matter

The conviction of this Singular Arbitral Tribunal regarding the facts described above was based on a critical analysis of the procedural documents contained in the file, on the documentary evidence produced (copies of the requests and the decisions rejecting the administrative appeals and hierarchical appeal and their respective notifications, and copies of the IRS assessment notes for the years 2011 and 2013), as well as, with regard to the payment of the assessed tax, on its non-contestation by the Respondent, which implicitly admits it by arguing that it should not be condemned to pay compensatory interest.

c. Facts not proven

There are no facts of interest for the determination of the case that should be considered as not proven.

  1. LEGAL MATTER – JUSTIFICATION

3.1. Order of examination of the defects

In accordance with the provisions of article 124, no. 1, of the CPPT, of subsidiary application to the arbitral tax proceedings, pursuant to article 29, no. 1, paragraph a), of the RJAT, in the absence of defects leading to a declaration of inexistence or nullity of the act(s) contested, the tribunal should examine the defects alleged that determine their voidability, with article no. 2, paragraph b) of the same article providing that, with respect to these latter, the order of examination shall be as indicated by the contestant, whenever a relationship of subsidiarity is established between them, without prejudice to defects whose merit ensures the most stable or effective protection of the offended interests being examined first.

Considering that the merit of the defect of violation of law, due to error in the application of the law concerning the taxation of real estate income earned by the Claimant, in the years mentioned above, will result in effective protection of the offended interests, we shall proceed to its examination.

3.2. Delimitation of the questions to be decided

Considering the facts established and the arguments raised by the Parties, there are two main questions to be decided: (i) whether the aggregation of real estate income earned, in the years 2011 and 2013, by non-residents in national territory would be admissible; (ii) whether, even if aggregation of the said income in those years were not admissible, the deduction of losses from category F, determined in prior years, would be possible.

3.2.1. On the possibility of aggregation of income earned by non-residents

The IRS Code, approved by Decree-Law No. 442-A/88, of 30 November, introduced a new model for the taxation of the income of individuals, in obedience to the constitutional requirement that "Income tax on personal income shall aim at the reduction of inequalities and shall be single and progressive, taking into account the needs and income of the family unit", established in [then] article 107, no. 1, of the Constitution of the Portuguese Republic (CRP).

Hence, the determination of taxable income came to be made through aggregation, that is, the sum of net income from the various categories (although not all), after specific deductions of each of those income categories, deduction of certain losses and, in an initial phase, of abatements (articles 55 and 56, in the original wording – "Abatements to total net income" and "Abatements for donations of public interest", respectively), thus finding the total net global income.

As justification for aggregation, point 3 of the Preamble to the IRS Code presents that "only the unitary perspective allows the distribution of the tax burden according to a rational scheme of progressivity, in consonance with contributory capacity".

However, the purpose of achieving the principle of contributory capacity in the taxation of personal income was not satisfied with the taxation of total net global income, determining that it be subjected to a table of progressive rates, that a "marital quotient", a "minimum of existence" and deductions to the tax of a personalizing character be established (a nature that would also be taken on by almost all of the previous abatements to total global net income, with the changes introduced to the IRS Code by Law No. 87-B/98, of 31 December (State Budget for 1999).

Thus, although the IRS initially comprised nine income categories, this would not prejudice the unitary treatment of taxable matter "reflected basically in the application of a single table of progressive rates" (point 6 of the Preamble to the IRS Code).

Understandably, this unitary perspective on the taxation of personal income would only apply to taxpayers resident in national territory, since non-residents would only be taxed on income obtained in this territory, subject to "special liberatory rates" (in the original version of the IRS Code, provided for in its article 74, subsequently split into liberatory rates and special rates), of a proportional nature and without the possibility of aggregation.

In the year 2011, real estate income (category F) earned by taxpayers non-resident in national territory or in another Member State of the European Union or the European Economic Area, provided that, in the latter case, there was an exchange of information on tax matters, relating to real estate located therein, was taxed at the special rate of 15%, without the possibility of aggregation (see article 72, no. 1, of the IRS Code, as amended by Law No. 55-B/2004, of 31 December: "1 - Capital gains and other income earned by non-residents in Portuguese territory that are not attributable to a permanent establishment located therein and that are not subject to withholding at source at liberatory rates are taxed at the autonomous rate of 25%, or 15% when it comes to real estate income, except as provided in no. 4." and no. 8, as amended by Decree-Law No. 249/2009, of 23 September, a contrario: "Residents in another Member State of the European Union or the European Economic Area, provided that, in the latter case, there is an exchange of information on tax matters, may opt, with respect to the income referred to in nos. 1 and 2, for the taxation of such income at the rate that, in accordance with the table provided for in no. 1 of article 68, would be applicable in the case it were earned by residents in Portuguese territory." For its part, article 22, no. 3, paragraph a) of the same Code, as amended by Law No. 67-A/2007, of 31 December, provided: "3 - The following are not aggregated for purposes of their taxation: a) Income earned by non-resident taxpayers in Portuguese territory, without prejudice to the provisions of nos. 7 and 8 of article 72;".

In the year 2013, real estate income was taxed at the special rate of 28%, in accordance with nos. 1 and 7 of article 72 of the IRS Code, as amended by Law No. 66-B/2012, of 31 December, aggregation being only possible when perceived by residents (no. 8 of article 72 of the IRS Code, as amended by Law No. 66-B/2012, of 31 December) or by residents in another Member State of the European Union or the European Economic Area, provided that, in the latter case, there was an exchange of information on tax matters (no. 9 of article 72 of the IRS Code, as amended by Law No. 66-B/2012, of 31 December). For this year 2013, the wording of paragraph a) of no. 3 of article 22 of the IRS Code, previously cited, which prevented the aggregation of income earned by non-residents, without prejudice to the provisions of nos. 8 and 9 of the same Code, remained in force.

For the reasons set out above and, despite the declarative obligation that rests on non-resident taxpayers who obtain real estate income (category F) in Portugal, not subject to withholding at source on a definitive basis, as special rates rather than liberatory rates apply thereto, it is not possible to aggregate such income earned by a resident of the United States of America.

In fact, aggregation has as its fundamental objective the taxation of the total income of taxpayers resident in national territory (and, more recently, also of residents in any of the Member States of the EU and the EEA), by the application of progressive rates, with a view to achieving the principle of contributory capacity in the taxation of personal income.

3.2.2. The taxation of net income. Specific deductions and loss deduction.

The historical legislator of the IRS assumed the taxation of income-accretion, with the express objective of broadening the taxable base; however, it did not intend the taxation of every and any accretion, but only of net accretion (indeed, both the conception of income-product and that of income-accretion always refer to net income, on which taxation must be levied, without damage to current assets[1]).

With respect specifically to real estate income, it is stated in point 11 of the Preamble to the IRS Code: "In the field of real estate income (category F), only the income actually received from leased real estate, whether urban or rural, is included in the tax base, and not, as was the case under the real estate contribution system, the rental value or lease rent of real estate not leased, since the aim is to tax only income actually earned. (…) Concomitantly, an autonomous municipal tax on the patrimonial value of rural and urban real estate is created, owed by their owners, with the collection of this being deducted from the IRS collection, in the proportion relating to the income aggregated from the real estate and up to the amount thereof.

Beyond this deduction, provision is also made in this income category for the deduction of all expenses relating to the real estate and not merely the presumed charges provided for in the current real estate contribution regime."

The Municipal Tax (CA) would be replaced by the current Municipal Real Estate Tax (IMI) and its consideration as a deduction to the tax would become a specific deduction to category F (in the wording given to no. 1 of article 40 of the IRS Code, by Law No. 30-G/2000, of 29 December; for the years 2011 and 2013 here in question, this specific deduction was provided for in no. 1 of article 41, in the renumbering carried out by Decree-Law No. 198/2001, of 3 July and in the wording introduced by Law No. 64-B/2011, of 30 December, respectively), which doctrine considers to be a new situation of economic double taxation[2].

However, the determination of net income is not satisfied merely with the contemplation of specific deductions for each income category, since the expenses borne in obtaining income in a given year may exceed the income of that same year.

Hence the necessity of, under penalty of, with taxation, reaching the source producing the income, still being allowed the deduction of losses from prior years which, in fact, are nothing more than the excess over the specific deduction to be considered in the year in which the expenses are borne.

In a pure perspective of total net income taxation, the communicability of losses between income categories would be justified; however, the legislator immediately perceived that communicability without restrictions would result in "a significant reduction in revenue", renouncing it without, however, ceasing to establish it, as a general rule, with respect to certain income categories, establishing the carryforward of losses within certain other categories, in future years (point 14 of the Preamble to the IRS Code), for limited periods.

The deduction of losses from category F already appeared in no. 3 of article 54 (Deduction of Losses), in the initial version of the IRS Code, with the following wording: "3 - The negative net result determined by the realization of conservation expenses of urban real estate, to the extent that these exceed the corresponding percentage provided for in no. 2 of article 40, may only be deducted from real estate income in the five following years.", remaining in force for the years 2011 and 2013 (no. 2 of article 55 of the IRS Code, as amended by Law No. 109-B/2001, of 29 December and by Law No. 64-B/2011, of 30 December, respectively).

3.2.3. Specific deductions, loss deduction and aggregation

The Respondent argues, in articles 38, 42 and 43 of its Response, that inasmuch as aggregation of real estate income earned by non-residents is not possible, "(…) specific deductions, abatements, deductions to the tax or their personal or family situation are not taken into account" and that, from this, "(…) it follows inexorably that the operation of deductions, notably the deduction of losses for what now interests us (which is not a specific deduction of Category F), and abatement is a prior, anterior and conditional process, conditional by the possibility of aggregation", "concluding that by the lack of normative provision that would enable non-residents to aggregate the income obtained by them in national territory - in the case at hand, Category F (real estate) income -, by even greater reason, that prior operation (deduction of losses) is not capable of being carried out, inasmuch as it would always be conditional on the prior aggregation of income (only possible for residents.)".

For the reasons pointed out above (3.2.1.), we also agree that aggregation of the income earned by the Claimant in national territory, in the years 2011 and 2013, to which the contested assessments relate, would not be possible.

It remains to be determined whether, aggregation not being possible, there should be no place for the "deduction" of specific deductions and the deduction of losses, as AT argues.

It should be noted, first, that AT's statement regarding specific deductions is contradicted by the reality of the facts, since, in accordance with the facts established, both assessment No. 2012 ... (2011 IRS) and assessment No. 2014 ... (2013 IRS), issued by AT, contemplate specific deductions from the declared income.

Nor could it be otherwise, given the legislative establishment of the principle of income-accretion, which, as has already been said, provides for the taxation of net income.

Now, considering that losses to be carried forward are nothing more than the accumulation of specific deductions that, in each year, can only be deducted from the taxable matter of that same year, up to their amount, and may be deducted from the positive taxable matter of subsequent years, within the legally established time limit, it is not understood how the said principle of taxation of net income can be satisfied without the losses to be carried forward from prior years being taken into account.

On the other hand, there is no provision that excludes the possibility of deduction of losses on the part of non-resident taxpayers.

If it is true that aggregation operates at a stage after subtraction of the "deductions and abatements provided for in the following sections", as provided in no. 1 of article 22 of the IRS Code (the term "deductions" will refer to both specific deductions of each income category and to loss deduction, while there ceased to be "abatements", since the repeal of article 56 by Law No. 64-A/2008, of 31 December), from this it will not necessarily follow that, if aggregation is not possible, it ceases to be possible to benefit from the "deductions" provided for in the following sections.

Naturally, the taxation of net income is that which best accords with the principle of contributory capacity, but this, when referring to taxpayers resident in national territory, is not satisfied with the taxation of net income alone, being deepened by its global taxation, through the application of a table of progressive rates and of deductions to the tax of a personalizing character.

AT affirms that "that prior operation (deduction of losses) is not capable of being carried out, inasmuch as it would always be conditional on the prior aggregation of income".

The difficulty in understanding how a prior reality could be conditional on that which is posterior to it, since, as a rule, causes are prior to their consequences, does not mean that, in the IRS Code, such is not possible, constituting an exception to the possibility of deduction of losses from prior years.

However, curiously, the only exception of this kind is that which refers to the deduction of losses from category G (relating to certain capital gains on securities), by residents in national territory, in accordance with no. 6 of article 55 of the IRS Code, as in force in the years under review, according to which "6 - The negative balance determined in a given year, relating to the operations provided for in paragraphs b), e), f) and g) of no. 1 of article 10, may be carried forward for the two following years, to income of the same nature, when the taxpayer opts for aggregation." (underlined in original).

Contrary to the position transmitted by AT on the possibility of deduction of losses without prior aggregation, doctrine has already pronounced itself on the taxation of income from category F earned by residents, by proportional rates (although these may opt for aggregation), instituted by Law No. 66-B/2012, of 31 December (article 72, no. 7, of the IRS Code). We permit ourselves to cite Rui Duarte Morais, who states "Note that, in the case of a special rate (and not a liberatory rate), it applies to income determined in accordance with general terms, that is to say, to net income, which means that the taxpayer continues to be permitted to make the specific deductions provided for by law. As will he also maintain the right to the carryforward of losses that he has had, in this category, in prior years."[3].

3.2.4. The Convention to Avoid Double International Taxation, concluded between Portugal and the United States of America (CDT). Principle of non-discrimination.

The Claimant, in articles 43 and following of its petition, invokes the principle of non-discrimination established in article 26 of the CDT, approved by Resolution of the Assembly of the Republic No. 39/95, of 21 June and ratified by Decree of the President of the Republic No. 73/95, of 15 September, both published in the Official Gazette, Series I A, of 12 October 1995.

However, the principle of non-discrimination is a corollary of the general principle of equality, with respect to the criterion of nationality, having as its content or objective element the fact that "«foreigners» (including stateless persons) do not become subject, in a given State, to any taxation or corresponding obligation different or more onerous than that to which nationals of that State who find themselves in the same situation are or could be subject." (…) "On the other hand, the discrimination prohibited is only that which is based on nationality, but not that which is based on residence, considered a legitimate criterion of differential tax treatment"[4], and nothing exists in the case that permits determination of the nationality of the Claimant.

The Claimant further invokes the decision rendered in arbitral process No. 127/2012-T; however, the question there decided concerns "taxation of capital gains resulting from onerous sale of real rights over real property, effected by a taxpayer resident in another Member State of the European Union", a situation that is, manifestly, neither objectively nor subjectively comparable to that in the present case.

However, the CDT applies to taxes in force in Portugal, namely to IRS (article 2, no. 1, paragraph a)) and, taking as established the status of non-resident of the Claimant, expressly accepted by AT for both years in question, it must still be determined whether the Protocol annexed to the CDT should be invoked, in whose no. 1, paragraph a) – i), and for clarification of the provisions of article 1 of the CDT, "Persons concerned", it is established that "It is understood that the Convention will not restrict in any way the exclusions, exemptions, deductions, credits, other benefits or tax incentives that are or may be granted in accordance with the legislation of the Contracting States (…)".

We must understand that no, given that the deductions in question (specific deductions of category F and loss deduction), forming part of the normative system of the tax, integrating, more specifically, the norms of determination of taxable matter, are not regarded as tax benefits[5].

Therefore, in the assessments that are the object of the request for arbitral pronouncement, the pertinent provisions of the IRS Code in force at the date of the facts, including those relating to specific deductions of category F and loss deduction, shall apply, since, in the concrete case, there exists no rule that expressly removes their application to income earned by non-residents, nor do they depend on the aggregation of income to be taxed.

3.3. Effects of the arbitral decision that does not admit appeal or contestation (article 24 of the RJAT)

As has been anticipated in the preceding points, the IRS assessments for the years 2011 and 2013, which are the object of the request for arbitral pronouncement, are illegal due to error in the application of the law to the concrete facts under examination, and therefore cannot be maintained in the legal order and must be annulled.

Similarly, the decisions rejecting the administrative appeal and the hierarchical appeal filed against the assessment of the year 2011 must be annulled, having as their object the correction of the IRS assessment issued for that year, with the processing of refund of € 423.89 and the decision rejecting the administrative appeal filed against the IRS assessment of the year 2013, from the correction of which would result a refund of € 770.82.

That such decisions rejecting appeals can be the object of judicial contestation, as acts of second and third instance that effectively knew of the legality of the assessment acts[6] is confirmed by the wording of paragraphs c) and d) of no. 1 of article 97 of the CPPT, as they permit the contestation "of those acts which, not falling directly on an assessment (hence their being qualified as administrative acts in tax matters), end up having it as their reference, to the extent that what is truly questioned is the amount of a tax to be paid (…)"[7] or to be refunded.

They are also admitted by paragraph e) of no. 1 of article 102 of the CPPT, by reference to "remaining acts that may be subject to autonomous contestation in accordance with this Code" (administrative appeal and hierarchical appeal) and, further, by paragraph a) of no. 1 of article 10 of the RJAT.

Article 24 of the RJAT establishes the terms under which AT is bound by the decision on the merits of the case, favorable to the taxpayer, which does not admit appeal or contestation.

AT is bound, namely, to (i) "Restore the situation that would exist if the tax act which is the object of the arbitral decision had not been performed, adopting the acts and operations necessary for that purpose" (article 24, no. 1, paragraph b) of the RJAT) and (ii) to "the payment of interest, regardless of its nature, in accordance with the terms provided for in the general tax law and in the Code of Tax Procedure and Process" (article 24, no. 5, of the RJAT).

(i) In the concrete case of the proceedings, the restoration of the "situation that would exist if the tax act which is the object of the arbitral decision had not been performed" entails not only the annulment of the contested assessments and the restitution of the amounts paid by virtue of those assessments, but also the restitution of the amounts paid by the Claimant by withholding at source, which in those assessments constituted deductions from the tax.

For, although withholdings at source do not constitute tax acts that must be reviewed, as they are found "in a relationship of prejudicial dependence or dependence with the tax acts which are the object of the arbitral decision, namely as they fall within the scope of the same tax legal relationship (…)" (article 24, no. 1, paragraph c) of the RJAT), they were taken on by AT in the final assessments of the tax, as advance payments of the tax due finally, integrating the concept of assessment in the strict sense, "translated in the determination of the tax through the application of the rate to the taxable matter", to which follow the "(eventual) deductions from the tax"[8].

It is, in fact, a matter of tax legally assessed through withholding at source (assessment by third party or assessment in substitution), whose restitution does not depend on a request, as it is automatic, integrating the final assessment, as was provided in no. 1 of article 16 of Decree-Law No. 42/91, of 22 January, as amended by Law No. 53-A/2006, in force at the date of both contested assessments, according to which "1 - The difference between the tax due finally and that which has been delivered to the State treasury as a result of withholding at source or advance payments, favorable to the taxpayer, must be refunded by the end of the periods provided for in no. 1 of article 97 of the IRS Code".

Thus, if, as a consequence of the annulment of a tax act, AT is obliged to review the tax acts that are found in a relationship of prejudicial or dependent relationship with it, by even greater reason must it proceed to the restitution of the tax assessed by a third party, as an integral part of the administrative assessment, as an advance payment of the tax due finally.

It happens, however, that, by requesting the annulment of the decisions rejecting the administrative appeals and the hierarchical appeal filed against the assessments under examination, in which the correction of the assessments issued and the processing of refunds equivalent to the amounts paid by withholding at source were requested, the Claimant is, concomitantly, requesting the restitution of those same amounts, to which she is entitled.

ii) With regard to compensatory interest, it is evident that the arbitral tax process was conceived as an alternative means to judicial contestation (see the legislative authorization granted to the Government by article 124, no. 2 (first part) of Law No. 3-B/2010, of 28 April – State Budget Law for 2010).

Thus, despite article 2, no. 1, paragraph a) of the RJAT using the expression "declaration of illegality" as delimiting the competence of the arbitral tribunals functioning at CAAD, it should be understood that this competence comprises the powers that in the process of judicial contestation are attributed to tax tribunals, such as that of examining error attributable to the services, as a source of the obligation to indemnify.

In fact, one of the prerequisites of the duty to indemnify through the payment of compensatory interest, pursuant to no. 1 of article 43 of the General Tax Law, is that the annulment, in administrative appeal or judicial contestation, of the assessment act from which resulted the payment of the tax debt in an amount superior to that legally due, becomes due to error, of fact or of law, of AT.

Error attributable to the services may consist of error regarding the factual premises, which occurs whenever there is "a divergence between reality and the factual matter used as a premise in the performance of the act"[9], or error regarding the legal premises, when "in the performance of the act there has been incorrect interpretation or application of the legal norms, such as norms of objective and subjective incidence (…)"[10] and "is demonstrated when an administrative appeal or judicial contestation of that same assessment proceeds and the error is not attributable to the taxpayer"[11].

Article 43 of the LGT contemplates other situations in which compensatory interest is due, namely that provided for in paragraph a) of its no. 3, that is, "When the legal period for automatic restitution of taxes is not complied with", in line with the provision of no. 2 of article 16 of the aforementioned Decree-Law No. 42/91, of 22 January, as amended by Decree-Law No. 134/2001, of 24 April, according to which, if not, for reasons attributable to the services, complied with the period established in its no. 1 (automatic restitution of tax withheld at source or paid on account, within the period indicated in no. 1 of article 97 of the IRS Code), compensatory interest would be due, counted day by day from the end of the period fixed for the refund until the date on which the corresponding credit note was issued.

However, if the tax paid by withholding at source integrates the concept of assessment, being automatically refunded as a consequence of the annulment of the assessment in which it was considered as a deduction from the tax, already the provision of no. 2 of article 61 of the CPPT, by referring to "the judicial decision from which that right results" (compensatory interest), inculcates the idea that recognition of such a right depends on a request, as the judgment cannot, "condemn in quantity superior to or in object different from that which is requested" (article 609, no. 1, of the Code of Civil Procedure, subsidiarily applicable to arbitral tax proceedings, by referral of article 29, no. 1, paragraph e) of the RJAT).

Now, the Claimant, "having made the payment of the assessed tax", petitions for the compensatory interest due "in accordance with article 43, no. 1, of the LGT" (article 57 of its petition), that is, the compensatory interest on the amounts contained in the assessments made by AT, as "Tax determined".

Recognizing the error of AT in the issuance of the IRS assessments for the years 2011 and 2013, for the reasons pointed out above, the right of the Claimant to compensatory interest must be recognized, in accordance with article 43, no. 1, of the LGT; but not on the values of the withholdings at source to be refunded, as these were not requested.

  1. DECISION

On the basis of the factual and legal grounds set out above and, pursuant to article 12 of the RJAT, it is decided:

a. To declare the illegality of the IRS assessment acts for the years 2011 and 2013, which are the object of the request for arbitral pronouncement, determining their annulment;

b. To determine the restitution of the amounts paid by the Claimant, as "Tax determined" by AT in the said IRS assessments for the years 2011 and 2013;

c. To recognize the right of the Claimant to compensatory interest on the same amounts and to condemn AT to its payment, from the date of each of the undue payments, until the date of actual restitution;

d. To declare the illegality of the decisions rejecting the administrative appeal and the hierarchical appeal filed against the IRS assessment of the year 2011, which are annulled;

e. To declare the illegality of the decision rejecting the administrative appeal filed against the IRS assessment of the year 2013, which is annulled;

f. To determine the restitution of the amounts paid by the Claimant, by withholding at source, in each of the years 2011 and 2013.

AMOUNT IN ISSUE: In accordance with the provisions of article 306, nos. 1 and 2, of the CPC, 97-A of the CPPT and 3, no. 2, of the Regulation of Costs in Arbitral Tax Proceedings (RCPAT), the amount in issue of the proceedings is fixed at € 9,657.99 (nine thousand six hundred and fifty-seven euros and ninety-nine cents).

COSTS: Calculated in accordance with article 4 of the RCPAT and Table I annexed thereto, in the amount of € 918.00 (nine hundred and eighteen euros), at the charge of the Respondent.

Lisbon, 30 June 2015.

The Arbitrator,

/Mariana Vargas/

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

The drafting of this decision is governed by the orthographic agreement of 1990.

Frequently Asked Questions

Automatically Created

Can non-residents in Portugal deduct expenses related to property income (Category F) for IRS purposes?
Yes, non-resident taxpayers in Portugal can deduct expenses directly related to Category F real estate income under IRS rules. Article 72 of the IRS Code governs real estate income taxation for non-residents, and the determination of net Category F income follows the same methodology for both residents and non-residents. Non-residents may deduct expenses necessarily incurred to obtain and maintain real estate income, such as property maintenance costs, condominium fees, IMI property tax, and financing interest. However, the Portuguese Tax Authority's position in this case distinguished between current-year expense deductions (which are allowed) and the carryforward of losses from previous tax years (which AT contested when residency status changed). The law establishes that Category F losses can be carried forward for five years to offset future Category F income, though controversy exists regarding whether this right transfers when a taxpayer changes from resident to non-resident status.
Is it legal for the Portuguese Tax Authority to deny loss carryforward from Category F when a taxpayer changes residency status?
The legality of denying loss carryforward when a taxpayer changes residency status is the central dispute in Process 96/2015-T. The Claimant argued that AT's denial was illegal because Portuguese IRS Code contains no provision explicitly limiting Category F loss carryforward exclusively to residents. Articles 55 and 72 of the IRS Code establish that Category F losses may be deducted from Category F income for five years, with no textual distinction based on residency status. The taxpayer contended this denial violated the principle of tax legality (Article 103 CRP), which prohibits tax authorities from creating restrictions not established in law. Additionally, the Claimant invoked Article 26 of the Portugal-USA Double Taxation Convention, which contains non-discrimination provisions prohibiting less favorable tax treatment of nationals and residents of contracting states. The Tax Authority defended its position based on Article 15(2) and Article 22(3)(a) of the IRS Code, arguing that non-residents are taxed only on Portuguese-source income without aggregation, which AT interpreted as precluding loss carryforward rights that originated during residency. The case fundamentally questions whether loss carryforward is an inherent attribute of Category F income or a benefit contingent on maintaining resident status.
How does the Portugal-USA Double Taxation Convention (Article 26) affect IRS taxation of property income earned by non-residents?
Article 26 of the Portugal-USA Double Taxation Convention contains non-discrimination provisions that significantly impact this case. The Claimant argued that AT's refusal to recognize Category F loss carryforward violated these treaty protections by discriminating against a US resident earning Portuguese-source real estate income. Tax treaties typically prohibit contracting states from subjecting nationals or residents of the other state to taxation that is more burdensome than taxation imposed on their own nationals in similar circumstances. The non-discrimination principle ensures that taxpayers are not penalized solely due to their residency status or nationality. The Claimant's argument suggests that if a Portuguese resident could carry forward Category F losses for five years, denying this same right to a US resident earning identical Category F income in Portugal constitutes discriminatory treatment prohibited by the Convention. Article 2(2) of the Portuguese Constitution incorporates international treaty obligations into domestic law, giving treaty provisions direct applicability. Therefore, even if Portuguese domestic law could be interpreted to limit non-residents' loss carryforward rights, such interpretation would be superseded by the non-discrimination obligations under the bilateral tax treaty, which takes precedence over conflicting domestic provisions pursuant to constitutional hierarchy of legal norms.
What is the arbitral tribunal procedure for challenging IRS assessments at CAAD under Process 96/2015-T?
The arbitral tribunal procedure at CAAD (Centro de Arbitragem Administrativa) for challenging IRS assessments follows the Legal Framework for Tax Arbitration (RJAT) established by Decree-Law 10/2011 and Ordinance 112-A/2011. Process 96/2015-T followed this procedure: (1) The taxpayer first exhausted administrative remedies by filing an administrative appeal (reclamação graciosa) against the IRS assessments, which AT rejected; (2) The taxpayer then filed a hierarchical appeal (recurso hierárquico), which was also rejected; (3) Having exhausted administrative channels, the Claimant filed a request for constitution of an arbitral tribunal at CAAD pursuant to Articles 10 of RJAT and Articles 1-2 of Ordinance 112-A/2011; (4) The request identified the contested acts (IRS assessments for 2011 and 2013 totaling €9,657.99), the legal grounds for illegality, and requested annulment plus reimbursement with compensatory interest; (5) AT was notified under Article 17 RJAT and presented its response contesting the facts and legal arguments; (6) The arbitral tribunal then analyzes the case and issues a binding arbitral decision. This alternative dispute resolution mechanism provides taxpayers a faster, more specialized forum than judicial courts for resolving tax disputes, with arbitrators expert in tax law rendering decisions typically within 6-9 months.
Are non-resident taxpayers entitled to a refund and compensatory interest when IRS assessments are declared illegal?
Yes, non-resident taxpayers are entitled to reimbursement and compensatory interest when IRS assessments are declared illegal, pursuant to Article 43 of the General Tax Law (LGT). When a tax assessment is annulled due to illegality, the taxpayer has the right to restitution of amounts unduly paid. Article 43(1) LGT establishes that taxpayers who suffer damages resulting from illegal acts or errors by tax administration are entitled to compensation for demonstrated harm. Compensatory interest (juros indemnizatórios) serves to compensate taxpayers for the financial loss of having funds improperly retained by the State. These interest payments run from the date of undue payment until reimbursement is made, calculated at legally established rates. The Claimant in Process 96/2015-T specifically requested both principal reimbursement of the €9,657.99 in contested assessments and compensatory interest on these amounts. This right applies equally to resident and non-resident taxpayers, as the obligation to restore illegally collected taxes and compensate for their retention derives from fundamental principles of legality and State liability. The cumulative nature of these requests—annulment, reimbursement, and compensatory interest—ensures full restitution when administrative errors or illegal interpretations result in excessive tax collection.