Exercising the activity of operating local accommodation establishments
Decree-Law No. 128/2014 of 29 August, approved the legal framework for the operation of local accommodation establishments, which came into force on 27 November 2014.
While many of the situations existing previously generated an income which was regarded as rental property income for personal income tax purposes (IRS), the new regime, approved by Decree-Law No. 128/2014, made it obligatory to present a declaration of the commencement (or alteration) of the activity of holding an establishment for the providing of accommodation services (in accordance with Article 6, paragraph 2, line e) of Decree-Law No. 128/2014).
Decree-Law No. 128/2014, of 29 August, states that income arising from the activity of operating local accommodation establishments is, therefore, considered to be Category B income – business and professional income – for IRS purposes.
Having regard to the fact that a large proportion of the taxpayers with this nature of income are registered under the simplified regime of Category B, the question arises in relation to the coefficient that should be applied to this income, in accordance with Article 31 of the IRS code (CIRS), for the purposes of calculating the taxable income in Category B under the simplified regime.
According to paragraph 1 a) of Article 31 of the CIRS, the coefficient applicable to income from services performed in connection with hotels and similar activities is 15%. In contrast, income from services not specifically provided for in other sub-clauses of paragraph 1 of Article 31 are subject to the coefficient of 35%.
What has not yet been clarified is the coefficient applicable to income calculated, under the simplified regime of Category B, in relation to the activity of the operation of local accommodation establishments (15% or 35%).
For our part, we consider that the coefficient applicable to services related to local accommodation establishments should be 15%, i.e. as provided for in paragraph 1 a) of Article 31 of the CIRS, as we understand that this type of activity still falls under the broader designation of hotels and similar activities, referred to in the aforementioned legal provision. The coefficient of 35% would, therefore, apply to income from situations not specifically provided for in that legislation.
Following the contact we have had, on an informal basis, with the relevant departments of the Tax and Customs Authority (hereafter "AT"), we have found out that the issue of which coefficient (15% or 35%) should be applied to income derived from the operation of local accommodation establishments is currently under review.
After higher approval, within the hierarchy of AT, of which coefficient should be applied, this and other related issues will lead to the issuing of an administrative clarification (probably in the form of a circular or an official notification). However, we have not been advised as to when their decision will be available. If the issue is referred to the Centre of Fiscal Studies, it may take some time to receive an official answer.
Transfer of property between the private sphere and business of the taxpayer
2.1 Declaration of commencement of activity
It seems to us that it is foreseen in Article 10, paragraph 1, and Article 21, paragraph 2, of Decree- Law No. 128/2014, that the building which is a local accommodation establishment becomes, including for tax purposes, an asset of the business and professional activity – with various implications in terms of taxation, especially when the property owner is also the person who operates the activity of local accommodation establishments.
In these terms, it is important to analyse the implications of the transfer of the property of a taxpayer from a private sphere (when the property owner is concerned) to their business (when it is he himself who exercises the activity of operating a local accommodation establishment using the property concerned). Such a transfer results from the presentation of the Declaration of the Commencement of Activity, in which the property is identified as a local accommodation establishment.
Indeed, the formal obligations arising from Decree-Law No. 128/2014 make it clear, even for tax purposes that the property is allocated to the business and professional activity. This is something that usually doesn't happen in a situation where there is no organised accounting system, i.e. in situations covered by the simplified regime of Category B.
The transfer of personal property assets to a business and professional activity (self-employed activity) by its owner may generate a capital gain, in accordance with Article 10, paragraph 1, line a) of the CIRS.
This is taxable as a gain under Category G, and is added to other taxable income and taxed under the progressive IRS tax rates. Only 50% of the gain is taxable if the taxpayer is resident for tax purposes in Portuguese territory (Article 43, paragraph 2).
There is, however, a deferral of taxation, and the gain is only considered to have been obtained at the time of a subsequent sale of the property (or of the occurrence of another fact that effectively results in a similar position). Thus, the taxpayer will be taxed on any gain arising from the transfer of a property from being a private asset to a business activity operating local accommodation establishments, only in the year in which one of the following conditions occurs:
In situations where there is a transfer of a property from a private sphere to a business and professional activity, the value of the property for the purpose of calculating the capital gain is the market value at the date of allocation, in accordance with Article 44, paragraph 1 c).
In this situation, it is not expected that the taxable value (patrimonial value) of the property will take precedence when it is higher (the opposite of Article 44, paragraph 2). We, therefore, consider that the calculation will take account of the aforementioned market value, even when the taxable value of the property is higher.
On the other hand, the provisions of Article 44, paragraph 4, and Article 29, paragraph 4, should be taken into account, i.e. the market value assigned by the taxpayer at the time of allocation of the property to the business may be subject to correction by AT, if they consider that the this does not correspond to the market value that would be charged between independent persons.
2.2. Cessation of activity
The cessation/closing of the activity of operating a local accommodation establishment by the owner of the property implies, in our view, a transfer of this property (or properties) back to the private assets of the owner, and this has corresponding tax effects.
The transfer of a business asset of the sole trader back to a private asset constitutes a capital gain obtained in the course of the income-generating activity of the business, in accordance with Article 3, paragraph 2, line c) of the CIRS.
In situations where there has been a transfer of property which has been used in the rental business by the sole trader to their own private assets, the acquisition value of the property for the purposes of the subsequent capital gains calculation is the market value at the date of transfer (in accordance with Article 47 and Article 29, paragraph 3).
The gain resulting from the transfer of the property from a business to a private asset is, in itself, considered to be a business and professional income, subject to taxation within Category B, as follows:
- - taxation within personal income tax (IRS) for the year in which the transfer of the property to private assets was made, since there is no legal provision for deferment;
- - subject to the mandatory aggregation of income and taxed under the progressive IRS tax rates (i.e. income cannot be isolated and taxed at a flat rate);
- - the gain is calculated based on the acquisition value of the property, which is the market value at the date of the allocation of the property to the business and professional activity; the realisable value will be the market value at the date of allocation to being a private asset (if it were a situation of a sale to a third party, the realisable value would be the sales value);
- - the total of the gain is considered in the calculation, as the inclusion of the gain within Category B prevents the benefit foreseen in Article 43, paragraph 2, where residents are taxed on only 50% of the gain on properties under Category G.
However, there is another issue to consider in this regard – the question of the application of the simplified regime of Category B to the gain.
Although the issue is not entirely clear, we believe that only 95% of the capital gain in respect of the property shall be taxable, that is by applying the 0.95 coefficient provided for in Article 31, paragraph 1 d) of the CIRS. It is possible that this issue will be addressed in the circular or official notification referred to above, which is being prepared by AT.
Since the gain concerned is found to be included in the scope of business and professional income, by virtue of the power of attraction of Category B, given the property was allocated to the activity generating Category B income, it seems to us perfectly tenable that the gain is taxable pursuant to Article 31, paragraph 1 of the CIRS, by applying the simplified regime.
In this way, the net taxable income would result from applying the coefficient of 0.95 to the value of the gain, as set out in Article 31, paragraph 1 d) of the CIRS, on the positive balance between capital gains and losses and other increases to wealth.
We do not consider it seems feasible to apply the coefficients of 15% or 35% (in accordance with Article 31, paragraphs 1 a) and c), respectively), since these expressly refer to income from the sale of goods and products or of the provision of services – which is not the case with regards to the gains on property.
It should also be noted that, in our view, the cessation of activity stops the suspension of the gain concerning the initial allocation of the property from a private asset to the business and professional activity.
So, it seems to us that, in the year in which the cessation of the activity of operating local accommodation establishments occurs, the taxpayer is taxed, if you have gains in each of these situations:
- i) On the gain corresponding to the initial transfer of the property from being a private asset to the business and professional activity, which was suspended, and whose suspension ceases by virtue of the reallocation of property back to being a private asset.
This is a taxable gain/loss under Category G, considering only 50% of its taxable value if the taxpayer is resident for tax purposes in Portuguese territory (Article 43, paragraph 2).
The capital gain is calculated by taking into account the difference between the acquisition value of the property (updated through the monetary correction coefficients, if applicable) and the market value of the property at the date of the transfer to the business and professional activity.
- ii) and also by the gain/loss on the transfer of the property from the business back to being a private asset of the individual.
This is a taxable gain under Category B, and therefore the total gain is considered (not just 50%), although, in our view, you should apply the 0.95 coefficient provided for in Article 31, paragraph 1 d) of the CIRS, in the case of an asset transferred from a business activity which was subject to the simplified regime.
The capital gain/loss is calculated by taking into account the difference between the market value of the property at the date of the allocation of the asset to the business and professional activity (in our opinion, updated through the application of monetary correction coefficients, if applicable, since Article 50, paragraph 1 refers to the correction of the "acquisition value or equivalent"), and the market value of the property on the date it is transferred back to being a private asset.
2.3. Sale of the property used by the activity in the operation of local accommodation establishments (where there has not been a cessation of activity)
If the property is disposed of to a third party while the business is still active, the capital gains arising from the sale eventually constitute a Category B income. In fact, in accordance with Article 3, paragraph 2, line c), the gain is considered a business and professional income arising from the operation referred to in paragraph 1 of Article 10 (sale of rights over immovable property) when attributable to income-generating business and professional activity.
The capital gain is taxable in the same terms as referred to in 2.2 above.
The sale cannot benefit from the regime for the exclusion from taxation arising from reinvestment, as foreseen in Article 10, paragraph 5 onwards, since the property being sold is an asset relating to the operation of local accommodation establishments, and so cannot qualify as "property for the personal and permanent residence of the taxable person or their household". It is, therefore, missing, the basic requirement essential for the application of the exclusion from taxation regime. This makes the application of the regime unworkable, even if, eventually, there was a reinvestment.
3. Reaction against the fiscal framework arising from the declaration of commencement of activity
With regards to a possible reaction from taxpayers against the fiscal framework which has become applicable to them, as explained above, as a result of the presentation of the declaration of the commencement of an activity, if they have not anticipated all the tax consequences, we do not consider that an appeal will be easy.
Indeed, it does not seem that we are faced with any situation in which you could invoke, for example, the lack of compliance by AT to a duty to give reasons for a decision.
For its part, the principle of cooperation laid down in Article 59 of the General Tax Law, means that AT is bound to a series of information duties. However, in this situation under consideration, we have not been able to find any protection for the taxpayer in any of the legal provisions included therein.
Naturally, the taxpayer may, when notified of their IRS liability in which they feel the tax impact of the situation concerned, challenge the tax payable on the grounds of illegality of assessment, or even the violation of constitutional principles applicable in tax matters, such as the principle of legality or the principle of proportionality.
However, it appears to us that there is a reduced chance of success of this legal remedy, as it is up to the taxpayer to seek advice beforehand from their tax advisors, or by formally questioning the tax department regarding the tax consequences of its procedures, before taking a course of action.