Maria Santa Martha
Abreu Advogados, Porto
maria.s.martha@abreuadvogados.com

Sara Soares
Abreu Advogados, Porto
sara.soares@abreuadvogados.com

Introduction

The reduced VAT rate on urban rehabilitation projects has been part of the VAT Portuguese legislation for more than 15 years. Although one might expect a certain level of stability in its application, the fact is that it has produced almost persistent controversy, first within the Portuguese Tax Authority (PTA) and later in the Tax Courts.

The rule at stake – item 2.23 of List I of the VAT Code – was introduced in 2009 and remained unchanged until the ‘More Housing’ Package, which entered into force in October 2023. The interpretation of such provision, however, continually changed, leading to contradictory rulings from the PTA and Tax Arbitral Courts. Taxpayers inevitably faced uncertainty, and litigation multiplied.

The dispute was ultimately brought before the Supreme Administrative Court (SAC), which, on 26 March 2025, issued a uniformisation judgment aimed at resolving the issue. The matter, however, remains unsettled, as an appeal has been submitted to the Constitutional Court and is still pending.

This article retraces the trajectory leading to the present debate – from the original legislative framework, through the PTA’s evolving interpretations, to the divergent judgments of the courts – and concludes with an assessment of the SAC’s decision and the uncertainties that persist.

Legal background

The 2009 wording of item 2.23 of List I of the VAT Code applied the reduced VAT rate to 'urban rehabilitation works', as defined in specific legislation, carried out on buildings located within urban rehabilitation areas (ARUs) duly delimited under the law.

Following the 2023 amendment, the provision was reformulated to refer to 'building rehabilitation works' in ARUs duly delimited under the law. For the purposes of the present analysis, however, the pre-2023 text remains the most relevant.

The cross-reference to ‘specific legislation’ leads to the Legal Regime for Urban Rehabilitation (RJRU). Under Article 2(j) of this diploma, urban rehabilitation is defined as an integrated intervention in the existing urban fabric, aimed at the preservation and modernisation of buildings, infrastructures and public spaces. Article 7 assigns municipalities a central role, empowering them both to delimit ARUs and to approve Urban Rehabilitation Operations (ORUs). According to Article 7, paragraphs 2, 3 and 4 of the RJRU, each ARU must correspond to an ORU, and the approval of the ARU and the ORU may take place either simultaneously or at different times.

The interpretative conflicts arise from the divergence of the view on what is required by the VAT law to apply the reduced VAT rate: is it only necessary for an approved ARU, or is it also necessary, being cumulative requirements, for the prior approval of an ORU? This has been at the core of the interpretative conflicts that have persisted for more than a decade.

The PTA’s position

Even the PTA’s position on this issue has shifted over time. Initially, they accepted that the building’s location within an ARU was, in itself, sufficient to justify application of the reduced VAT rate, with no need for municipal certification.

Subsequently, in a binding ruling issued in 2017,^[1] the PTA sustained a broader interpretation, holding that the VAT reduced rate could also apply to rehabilitation works on buildings outside ARUs, provided the building was more than 30 years old and noticeably in need of rehabilitation. Nevertheless, this wide interpretation proved short-lived and two years later,^[2] the PTA reversed its position, reaffirming that only works on buildings located in ARUs were eligible for the application of the reduced VAT rate.

From 2018 onwards, the PTA began to impose additional legal requirement that were not set forth in the Portuguese VAT Code. They first required a municipal certificate confirming the property’s location within an ARU^[3] and, subsequently, from around 2020, made the application of the VAT reduced rate conditional upon the building being located an ARU with an approved ORU.^[4]

Conflicting case law

Taxpayers challenged the PTA restrictive interpretation, and the matter was soon brought before Tax Arbitral Courts, where two divergent positions emerged.

The first endorsed the PTA’s reasoning: in the absence of an ORU, there could be no genuine ‘urban rehabilitation works’ within the meaning of the RJRU, and consequently, the reduced VAT rate could not apply. This position relied on Article 7 of RJRU, which establishes a connection between ARUs and ORUs, concluding that both were necessary conditions.

The second line of argument was based on the VAT Code containing no reference to ORUs and Article 14 of RJRU expressly granting access to tax incentives upon the delimitation of an ARU, without requiring the prior approval of an ORU. To impose such a condition amounted to supplementing the legal provision and, ultimately, to a breach of the principle of legality in tax matters.

The coexistence of these two conflicting approaches gave rise to inconsistent arbitral decisions, thereby paving the way for an appeal to the SAC with a view to ensuring the uniformity of case law.

The SAC’s uniformisation ruling of 26 March 2025

The SAC was called upon to address three issues related to the application of the VAT reduced rate to urban rehabilitation works:

1. the definition of ‘urban rehabilitation works’;
2. whether that concept could extend to new construction; and
3. whether municipal certification, on its own, was sufficient for the application of the VAT reduced rate.

Of these, only the first was admitted for purposes of uniformisation of the case law.

In its judgment, the SAC aligned with the PTA’s restrictive position, holding that the reduced VAT rate applies solely to rehabilitation works carried out in buildings located in ARUs for which an ORU has been approved.

The Court’s reasoning drew heavily on the structure of the RJRU. Articles 7 and 8, in its view, place ARU and ORU in an indissociable relationship: without both, there can be no genuine urban rehabilitation works. The Court also invoked a teleological argument, stressing that RJRU legislator’s intention was to promote integrated and coordinated interventions rather than isolated projects – this being the reason why ORUs’ approval is fundamental for the existence of urban rehabilitation works and for applying the VAT reduced rate. The STA further stated, in its judgment of 26 March 2025, that the interpretation adopted therein complies with the principle of legality. This is because item 2.23 of List I of the VAT Code provides that the application of the reduced rate presupposes an urban rehabilitation contract, which, under the RJRU, only occurs where the property is located in an ARU with an approved ORU.

The SAC’s reasoning has not gone unchallenged, and an appeal was submitted to the Constitutional Court, where it is still pending. Nonetheless, the STA’s ruling, having harmonised case law, now binds the lower Tax Courts.

Consequences of the SAC’s harmonised case law

Once the SAC rules for the harmonisation of case law, both Tax Arbitral Courts and lower Tax Courts seldom depart from it, as any deviation would expose their decisions to further appeals. Since March 2025, several arbitral decisions have already followed the SAC’s interpretation, although dissenting opinions continue to register firm disagreement.^[5]

The practical consequences for taxpayers are considerable. The PTA may now reassess situations in which the reduced rate was applied to works located in ARUs without an approved ORU, provided that the statute of limitations has not yet expired. This may entail the payment of additional VAT (the difference between six per cent and 23 per cent), together with compensatory interest and fines under the General Regime of Tax Infractions. For corporate taxpayers, the penalties may reach significant amounts.

Some taxpayers relied on municipal certificates or even on prior VAT rulings which appeared to endorse the broader interpretation. Nevertheless, whether such reliance affords protection remains unresolved.

Conclusion

The application of the reduced VAT rate to urban rehabilitation works has been a persistent source of controversy in Portugal. Although the legal provision governing this matter has remained unchanged for many years, its interpretation has been constantly shifting. Further to conflicting views of the Tax Courts, the SAC has been called upon to harmonise the case law. A ruling was issued on 26 March 2025, aligning with the PTA’s restrictive view, but it does not bring the debate to a close, as an appeal was lodged and is pending before the Constitutional Court.

Until the Constitutional Court delivers a ruling, taxpayers, municipalities and practitioners must operate on an uncertain legal framework, shaped by the binding force of the SAC’s ruling, the possibility of constitutional review and ongoing tax audits.

It remains to be seen whether the Constitutional Court will settle the matter definitively or merely open a new stage in the discussion. What is clear is that the controversy surrounding VAT and urban rehabilitation in Portugal is not yet concluded.

Notes