Does the Portugal non-habitual resident (NHR) residency ten-year tax holiday do what it says on the tin?
The answer is yes and no, writes Howard Bilton, chairman of The Sovereign Group.
The first peculiarity of the scheme is that in order to be considered as a NHR you must be habitually resident. That means spending at least six months of the year in Portugal.
However, it is unlikely that anybody would check that a taxpayer has adhered to the minimum number of days spent in Portugal, nor is it likely that the Portuguese tax authorities would reject any taxpayer filing a tax form.
The rules state that tax residency can only be maintained in Portugal by spending a majority of the year there. This in itself seems to contradict the other residency principles which is that a person can become tax resident in Portugal by spending more than 180 days per year in Portugal or by having accommodation available for the use in Portugal and making frequent or substantial visits to Portugal.
The latter suggests that tax residency can be achieved without spending 180 days in Portugal.
Tax assumptions and reality
Irrespective, many have come to Portugal assuming that there is no tax here for ten years apart from the more recent change of pensions being taxed at 10%.
This is not quite correct. Portuguese sourced income is taxed at 20% but also, and this is the most important matter, foreign income is only exempt from Portuguese tax if it has already been taxed or has been subject to tax outside Portugal.
This limited exemption can be used to great effect but internationally mobile people who have landed in Portugal have often parked their wealth offshore in zero tax jurisdictions and income and capital gains generated would be subject to the full normal rates of Portuguese tax at up to 48% without some planning.
CFC
In practical terms, an NHR is required to file a tax return annually which declares all his/her income from every source and that would include any and all income and capital gains rolled up within non-resident.
Portugal has comprehensive Controlled Foreign Corporation (CFC) type legislation which would tax the undistributed profits of standard offshore structures. Thus, income which belongs to offshore companies, which belong to an NHR, must be declared on the tax form and is attributed to the taxpayer and taxable in his hands irrespective of whether it is actually received or not.
In short, standard offshore structures do not prevent Portuguese tax applying on the underlying income and capital gains in those structures.
It is thought that CFC legislation is inapplicable if the company is owned by a discretionary trust. However, if the trustees later receive dividends and distribute same to an NHR, that distribution will be taxed in Portugal.
Thus, although the trust would appear to give an NHR indefinite tax deferral, it also rather artificially converts dividends which would not suffer tax, into distributions which are taxable. A discretionary trust could provide a useful planning tool for tax deferral after the taxpayer’s NHR status ends.
Bear in mind that under the Common Reporting Standard (CRS) any and all offshore structures will automatically be reported to the tax authority local to that taxpayer so there is no chance whatsoever of the existence of those structures escaping the attention of the local tax authority.
Thus, if a taxpayer fails to reveal CFC type income, it is highly probably that questions will be asked and the natural result of the failure to declare is tax will be imposed together with penalties.
Other countries
The get out of jail card is that structures in Malta and Cyprus currently can be beneficially utilised to avoid further tax on dividends from them being taxed in Portugal.
In simple terms, a Cyprus company pays no capital gains and tax on income of 12.5%, shortly to rise to 15%. A Malta company pays 35% tax on income but then can be pay a dividend and the payee can immediately reclaim all but around 6% of the tax paid so the effective net tax rate is indeed 6%.
Dividends paid by either a Cyprus or a Malta company are not further taxed in Portugal so companies in both jurisdictions can be extremely effective in reducing/eliminating Portuguese tax for NHR’s.
Non-tax paying offshore structures are not effective.
Summary
The presumption is that the rather complicated tax arrangements required to avoid Portuguese tax are a position taken by Portugal which they think will be more acceptable to the rest of the European Union who are very concerned about their own tax revenues being reduced by Portugal attracting their own residents and citizens to relocate.
As always, there is a sort of game going on between all nation states who offer tax breaks to attract wealthy new residents whilst trying not to annoy the OECD member states and the European Union member states too much.
Portugal’s NHR programme has been extremely successful in attracting new residents and generating revenues for Portugal.
While NHR’s may not pay much income tax, they are of great benefit to the Portuguese exchequer as they hire staff, buy properties, buy goods and services upon which VAT is paid and generally send money round the system.
Each and every country is keen to have these mobile wealthy persons and Portugal is no exception.
This article was written for International Adviser by Howard Bilton, chairman of The Sovereign Group.
