Wealth structuring and regulation
Any foreign structure held by a Portuguese resident individual which is located outside the Portuguese territory may raise challenges, taking into account some specific provisions of the Portuguese domestic law.
The first set of rules to point out relates to controlled foreign company (CFC) legislation, which aims at avoiding the deferral (or even elimination) of taxation of income by means of the use of entities that are either located in low-tax jurisdictions or that are not subject to tax on their profits.
CFC rules apply to resident individuals who hold, directly or indirectly, a significant interest in non-resident entities subject to a more favorable tax regime. For this purpose, the non-resident entity is deemed to have a favorable tax regime not only when located in a black-listed jurisdiction, but also when such entity is either fully exempt or subject to an income tax rate lower than 10.5 percent ( ie, less than 50 percent of the Portuguese Corporate Income Tax (CIT), due if the company was Portuguese).
According to this set of rules, the income derived by the foreign entity is allocated to the Portuguese-resident shareholder regardless of any distribution. In particular, the profits of the foreign company may not consist of more than 25 percent of:
- royalties or any other income generated from intellectual property, image rights or similar;
- dividends and income from the disposal of shares;
- income from financial leasing;
- income from insurance, banking (even if not performed by credit institutions), insurance and other financial activities contracted with entities with special relationships;
- income from invoicing companies that earn sales and services income from goods and services purchased from and sold to associated enterprises, and add no or little economic value; and
- interest or any other income generated by financial assets.
Another rule to highlight relates to the presence of entrepreneurs who manage their international business from the Portuguese territory. Under the CIT Code, companies are taxed in Portugal on their worldwide profits in the event they are resident for tax purposes in Portugal. A company is deemed to be resident in Portugal if it has its corporate seat or (alternatively) its place of effective management in Portugal. Although there are no legal criteria to define where the place of effective management is located, according to Portuguese case law, ‘place of effective management’ might be defined as the place where the most relevant decisions are taken (eg, where the board meetings take place) and where adequate substance (eg, people and buildings) is present.
For instance, depending on the structure of the board of directors of the companies, if the sole shareholder and the CEO of a given company is the sole presence of that company in Portugal, while the relevant decisions are taken in board meetings which take place in abroad, we take the view that the ‘place of effective management’ rule should not apply. On the other hand, if no board of directors exists or if no relevant decisions are being executed from abroad, that company may indeed be deemed as Portuguese resident, which would lead to corporate taxation in Portugal based on the aforementioned rule.
Moreover, the presence of a CEO in Portugal may also raise questions as to whether the foreign company may have a permanent establishment (PE) in the Portuguese territory, which would also lead to corporate taxation of the companies in Portugal to the extent there were profits attributable to such PE.
Finally, it is also important to point out that the Portuguese tax law includes a general anti-abuse rule (GAAR) that allows PTA to disregard corporate entities without proper economic substance (ie, that were created having as their sole or main purpose the obtaining of tax advantages).
The above-mentioned remarks regarding CFC legislation, place of effective management and the general anti-abuse clause aim at pointing out that any wealth structuring which includes a foreign corporate structure without proper substance or an economic rationale behind it may raise challenges.
In addition, the proposal for the implementation of the EU’s Anti-Tax Avoidance Directive 3 will bring another layer of challenges to corporate or fiduciary structures, which may ultimately lead to situations where these entities are denied tax residence certificates, preventing them having access to DTTs .
At the internal level, the PTA has issued a recent ruling regarding the tax treatment of distributions made by anyone société d’investissement à capital variable (SICAV funds).3
The ruling in question analyzes how distributions made by SICAV funds to Portuguese tax residents who benefit from the NHR should be taxed and considers the possibility of treating this type of income as a dividend for the purposes of applying DTTs. Should this type of income be treated as a dividend, then, in principle, it would be subject to taxation at the source state as determined by the DTT concluded between Portugal and Luxembourg, which would imply that this item of income should not be subject to PIT in Portugal under the NHR rules.
In the ruling, the PTA resorted to the Commentaries to the OECD’s Model Convention to Avoid Double Taxation to determine if this type of distribution should be treated as a dividend for the purposes of applying the Portugal–Luxembourg DTT. Because the mentioned commentaries do not provide a closed definition of what types of income should be included in the concept of dividends, and considering that the commentaries also mentioned that such definition is impossible, considering the disparities in the internal legislations of OECD jurisdictions, the PTA concluded that distributions made by investment funds should not be comparable to profit distributions made by companies to shareholders and, therefore, should have a different tax treatment and not be regarded as dividends for the purposes of application of the DTT. As such, the PTA claimed that these distributions should be treated as ‘other income’ under the applicable DTT and be exclusively taxed on the jurisdiction where the taxpayer is resident. Therefore, the exemption under the NHR rules would not be applicable in Portugal and these distributions should be subject to PIT at a 28 percent rate.
The conclusions expressed in the mentioned ruling are difficult to justify considering that it seems to ignore the broad concept of ‘dividend’ under the applicable DTT which includes income from shares, privileged shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights which are subject to the same taxation treatment as income from shares by the laws of the state of which the company making the distribution is a resident. Not only does the ruling fail to address the nature of the SICAV to assess whether or not the holder of the units has a corporate right but it also does not include any reference to the treatment in Luxembourg of distributions made by these entities and whether or not such distributions have a similar tax treatment as the one applicable to dividends.
The position expressed on this ruling by the PTA should probably trigger litigation as it is far from being well grounded and it seems not to be aligned with the correct application of the concept of dividends in DTTs.
This highlights that any individuals who relocate to Portugal and benefit from the NHR may enjoy an exemption from foreign-source dividends and interest provided the income is not sourced in a black-listed jurisdiction. These features of the NHR and the challenges raised by foreign corporate structures that may be used for wealth planning purposes seem to imply that for HNWI relocating to Portugal, holding assets at the personal level – at least for the 10-year period the NHR lasts – may not be a bad idea.
However, it is surprising that, in the context of US LLCs (tax transparent entities), the tax treatment of transparent entities has already been clarified by the PTA in (at least) two tax rulings.4
The PTA have considered that profit distributions from United States LLCs – to their shareholders who are resident for tax purposes in Portugal – should be qualified as investment income, even though the distributions are not an actual dividend for tax purposes (given the tax transparent treatment provided by US domestic law).
Regarding the income qualification for double tax convention (DTC) purposes, in both cases the PTA considered that the distribution of revenues accrued at the level of the US LLC should fall within the ‘other income’ provision of the DTC celebrated between Portugal and the United States, which provides for shared taxing jurisdiction, hence triggering the exemption of tax for individuals under the NHR.
Also, no CFC rules were raised by the PTA on the LLC structure, which makes it attractive for HNWI who have their estate based in the United States, in view of a relocation to Portugal, despite all the reservations that may result from the anti- abuse provisions established by Portuguese domestic law.