A law was enacted on December 5 2008 and came into force the following day. However, one of its rules was given retrospective effect from January 1 2008. The rule in question increased the corporate tax rate on certain expenses from 5% to 10%. As a result, the tax due on representation expenses and costs incurred in respect of light passenger vehicles for the preceding 11 months unexpectedly doubled.

Less unexpectedly, a company challenged the legality of the measure, arguing that it violated legitimate expectation and the principle that changes to tax legislation may not be applied retrospectively. The claim was upheld by the court of first instance, but the decision was appealed to the Constitutional Court.

For many tax practitioners, the judgment that followed was unthinkable. The court held that the constitutional prohibition against retroactive effects is limited to certain tax rules - namely, those that apply to events or circumstances that have already given rise to their full effect. On this analysis, the principle does not apply to corporate income tax, which is due on a continuous sequence of events or circumstances with tax implications. Thus, the related tax consequences cannot be fully finalised until December 31 - until the end of a given year, taxpayers can never be fully aware of the terms on which their taxpaying status will be determined. Portugal's tax system does not guarantee taxpayers any advance knowledge of the basis on which they will be deprived of their income.

The decision sends a clear message: as far as the principle of legitimate expectation is concerned, taxpayers' interests take second place to the interests of the public administration. Moreover, taxpayers have no legitimate right to expect that laws will not be changed.

The company which had challenged the change maintained that by December 5 of a given year, its choices about which expenses to incur in that year have already been made; nothing, it argued, can change the consequences of those choices. The court responded that the taxpayer could not claim to have incurred expenses over most of the year which it would not otherwise have incurred had it expected or known that the rate of tax relating to such expenditure would rise. The taxpayer had incurred the expenses in question because they were necessary, irrespective of other considerations. As such, foreknowledge of the increase in the tax rate would not have caused it to act differently.

The court noted that the state had never implied that the tax rates in question were immutable, and held that taxpayers should always consider the possibility of a tax increase where such a measure would be in the public interest. Furthermore, the court stated that taxpayers have no constitutionally guaranteed right to expect that tax increases will apply only to future facts and circumstances.

This decision follows the reasoning of Decision 399/2010 on a claim relating to the principle of non-retroactivity in tax legislation. In that decision it was held that a new law on income tax liability did not violate the principle, although it affected facts and circumstances that had occurred before its entry into force.

From now on, taxpayers must be aware that for corporate income tax purposes, whenever an appeal to public interest is made, retroactive measures may be allowed and legitimate expectations are likely to be dismissed as irrelevant. Managing bodies should prepare for a regulatory environment in which a company may face a sudden tax increase on certain expenses, even if it has not made a taxable profit. Predictability in the tax system is apparently less important than the need for budgetary revenue.

It is hard to ignore the question of how far this concept of legitimate expectancy can be, in legal terms, from that of the average person. Perhaps it would be better to go back to basics.

For further information on this topic please contact Ricardo Peão or João Espanha at Espanha e Associados sociedade de advogados RL by telephone (+351 21 353 8705), fax (+351 21 314 3704) or email ([email protected] or [email protected]).