The Portuguese Arbitration Court (‘CAAD’) has recently ruled in three similar cases dealing with the application of the General Anti-Avoidance Rule (‘GAAR’). This is the first time a Portuguese court has ruled on the application of the Portuguese GAAR, which reflects the transposition of the Anti-Tax Avoidance Directive (‘ATAD’).

These rulings deal with a step transaction in which individuals holding shares in an operational entity (‘OpCo’) undertook a corporate reorganisation. Each shareholder incorporated a personal holding vehicle (‘SPV’), which acquired OpCo’s shares at fair market value with a deferred purchase price (which was ultimately never paid). In the following years, the OpCo distributed dividends to the SPV which were exempt from income tax under the participation exemption regime. Subsequently, the SPV proceeded to use those dividends to pay the deferred purchase price of OpCo’s shares.

The Portuguese Tax Authority (‘PTA’) considered that the transaction, which began in 2015 and was completed by 2018, gave rise to a tax advantage in the form of taxation of capital gains for an effective 14% tax rate vis-à-vis a 28% rate applicable on dividends. As a result, the PTA issued Personal Income Tax assessments for FYs 2016-2018 through the application of the GAAR.

The CAAD ruled that the application of the ATAD’s GAAR, which entered into force in 2019, to a set of facts taking place prior to that date was retroactive and therefore unlawful.

First key takeaway: new GAAR, same old rules

Portugal has a long experience with the application of GAARs, having such a provision in place since 1999. In 2001, the Portuguese GAAR was given the nature of a “substance over form” provision and it was broadened to cover any transactions which were “aimed essentially or mainly (…) at reducing, eliminating, or postponing of taxes (…)”.

In 2019, after the entry into force of the ATAD, Portugal amended its GAAR to encompass any arrangement or a series of arrangements which have “(…) been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law”.

The PTA claimed that, under the 2001 GAAR, the burden of proof as to whether a taxpayer employed artificial or fraudulent means lay on the PTA. However, this such burden of proof would shift to the taxpayer pursuant to the 2019 GAAR (i.e., it would be the taxpayer having to prove the lack of artificiality of the transaction).

The CAAD disagreed with the PTA’s interpretation and ruled that a principal purpose test underlies both 2001 and 2019 GAARs, which have the same scope and similar burdens of proof (always on the PTA). This position was not, however, unanimous, as dissent votes highlighted that the 2001 GAAR requires that obtaining a tax advantage be the essential or main purpose, whereas the 2019 GAAR would only require tax advantages to be one of the main purposes.

Despite ruling that both GAARs were similar in substance, the CAAD relied on the PTA’s interpretation to conclude the application of the 2019 GAAR to facts taking place up to 2018 amounted to unlawful retroactivity, since this provision did not ensure the same level of protection of taxpayers’ rights.

In conclusion, the CAAD ruled that, despite different wording, the 2001 and 2019 GAARs have the same scope and impose the same burden of proof on the PTA. However, it is worth pointing out that this conclusion was reached without analysing any case law from the Court of Justice of the EU and one could therefore reasonably expect significant litigation on this issue.

Second key takeaway: timing will determine which GAAR applies

The CAAD reached its conclusion in a rather straightforward manner, considering that, since all the steps of the transaction took place prior to the entry into force of the 2019 GAAR, this provision would not (lawfully) be applicable. However, the ruling allows for further significant conclusions.

As the GAAR was construed as a substance over form provision that expands the scope of incidence provisions, it is subject to the above-mentioned prohibition of retroactivity. This means that the 2001 GAAR would apply to step transactions beginning during the period the 2001 GAAR was in force, but ending after the 2019 GAAR came into force. As a result, it appears that the 2019 GAAR would only apply to transactions that start after its entry into force.

Nevertheless, this conclusion appears to be logical only if the 2001 and 2019 GAARs have different scopes and/or levels on burden of proof. If, as the CAAD seemingly concludes, there is no difference between the material scope of these provisions, then one may question whether the issue of which version of the GAAR would apply it is irrelevant. Once again, further litigation is expected on these points.

The CAAD’s approach to timing issues in the application of the GAAR also gave rise to two additional possibilities: (i) depending on the actual approach adopted by the PTA on a case-by-case basis, taxpayers may claim that the first step took place before 2019 to avoid the application of the 2019 GAAR; and (ii) if a similar approach is adopted in other jurisdictions, in countries with no established anti-abuse rules or doctrine, the application (and effectiveness) of the ATAD’s GAAR will be limited in the first few years since only transactions starting in 2019 would be covered .

Third key takeaway: the GAAR and the PPT may be two sides of the same coin

Under the OECD’s Multilateral Instrument (‘MLI’), Portugal opted to include the Principal Purpose Test clause (‘PPT’) without a simplified Limitation on Benefits clause in its treaties. This choice was admittedly based on the significant experience with the application of GAARs.

The CAAD’s ruling appears to mirror that same tax policy reasoning by stating that the GAARs reflect a principal purpose test when assessing whether a transaction is abusive or not. This might be an indication that, when called upon to interpret and apply the MLI’s PPT, the Portuguese courts may well conclude that its scope is similar to that of the GAAR.

AUTHORS: Dinis Tracana and Rita Medalho