Parliament approves 2008 budget law

The Portuguese Annual Budget Law for 2008 (“Budget”) was recently approved by the Portuguese Parliament (Law 67-A/2007, December 31). The present article aims at detailing the main amendments and innovations established therein regarding the Portuguese tax framework.

1. Personal Income Tax (“PIT”)

Investment income

The Budget establishes that income obtained from certain swap transactions will henceforth be considered as interest income (and, therefore, be subject to the tax framework applicable to interest payments, including withholding tax).

This amendment is particularly relevant when payments are made to entities resident in a State with which Portugal has entered into a Double Tax Treaty (“DTT”) and such DTT establishes that the definition of interest should be made in accordance with the domestic rules of the parties. 

Previously, withholding tax could be avoided pursuant to said DTT’s (considering such income as “Other Income”).  However, from January 2008 onwards, interest payments will be subject to withholding tax according to domestic rules and the tax payers will be able to apply for the DTT reduced withholding tax rates.

Non-resident individuals - Taxation according to Portuguese rules

Individuals resident in a EU member state (other than Portugal) or in the European Economic Space (provided, in this last case, that the exchange of tax information is guaranteed) may in some cases choose to be taxed as a Portuguese individual, according to the Portuguese progressive PIT rates (instead of the special tax rates applicable to non-residents).  This possibility is limited only to income obtained in Portugal from capital gains and to income allocated to permanent establishments located in Portugal.

The worldwide income obtained by the individual will be considered for the purposes of determining the applicable progressive PIT rate.

Income obtained in Portugal by non-resident individuals

Employment income, professional income (except for income resulting from intermediation in the execution of contracts) and pension income obtained in Portugal by non-resident individuals will be henceforth be taxed at a final withholding tax rate of 20% (instead of the previous 25% final withholding tax rate).

Avoidance of Double taxation

According to Portuguese legislation, the application of DTT’s provisions depends - in broad terms - on the certification of a specific form (RFI form) by the foreign tax authorities and the presentation of such form to the entity paying the relevant income.  From January 2008 onwards, such form may be presented to the paying entity until the end of the legal deadline established for the delivery - to the tax authorities - of tax which should have been withheld (and not, as per the previous rule, until the moment in which the obligation to withhold occurs).

In case the form is not presented to the paying entity, the tax substitute will be liable for the payment of the tax that should have been withheld (said liability - except for the penalty - is excluded when it is proven that the conditions for the application of the DTT are fulfilled).  This exclusion of liability is applicable to situations that occurred prior to the entry into force of the Budget, regardless of the fact that tax was already assessed (except when tax was already paid and there is no pending administrative or court claim).

 2.  Corporate Income Tax (“CIT”)

Parent Subsidiary Directive

According to amendments introduced by the Budget, in order to apply the withholding tax exemption on the distribution of dividends by a Portuguese company to its EU parent company in the terms and conditions of the Parent Subsidiary Directive, the EU parent company will need to hold a minimum 10% share stake in the Portuguese company (previously 15%) or a lower participation with an acquisition value higher than
20.000.000 € (previously non-existing criteria) both for an uninterrupted period of one year (previously two years).

These same conditions are applicable to the distribution of dividends by a Portuguese company to a EU permanent establishment of a company resident in another EU member state.

Capital losses arising from company’s liquidations

From January 2008 onwards, capital losses arising from the liquidation of a company will only be deductible for tax purposes if the following requirements are fulfilled:

• the shares have been held for three consecutive years prior to the date of winding-up;
• deduction will only be allowed in the amount that exceeds transferred tax losses obtained in the tax grouping regime, when applicable (new criteria);
• the liquidated entity is not resident in a black listed country (new criteria).

Avoidance of Double Taxation

Evidence of the withholding tax exemption for resident CIT payers, and fulfilment of the legal conditions for the application of DTT’s (for the purposes of non-taxation or application of reduced withholding tax rates), can now be presented by the date for payment of the tax withheld.  In respect of situations governed by a DTT, evidence must be provided by means of a specific form. Previously, the required evidence had to be provided by the moment when the obligation to withhold occurred.

When the income beneficiary is a central bank or governmental agency domiciled in a country with which Portugal has entered into a double tax treaty, the relevant forms do not have to be periodically renewed.

If the mentioned evidence is not presented, the tax substitute will be liable for payment of the tax that should have been withheld. This notwithstanding, the above liability is excluded (except in respect of the corresponding penalty) if the tax substitute subsequently proves (in situations governed by double tax treaties, by means of the abovementioned form), that the conditions for the application of the exemption or reduced withholding tax rates have been fulfilled.

This exclusion of liability is applicable to situations that occurred prior to the entry into force of the Budget, regardless of the fact that the tax has already been assessed, except when payment has already been made and no administrative claim, appeal or judicial claim is pending.

Furthermore, forms for the purposes of double tax treaties may now be used for two years when they concern the payment of interest and royalties, and one year in remaining cases, regardless of the existence of a contractual relationship (as was previously required).

Advanced Pricing Agreements

A new article is introduced in the Portuguese CIT code, namely the possibility for Portuguese taxpayers to enter into pricing agreements with the Portuguese Tax Authorities establishing - in advance - the method or methods of price formation capable of guaranteeing the terms and conditions applicable to operations executed between related parties.  In case the related party is resident in a country with which Portugal has entered into a double taxation treaty, authorization must be requested to the foreign tax authorities.

The contents of such agreements (whose maximum term is three years) are confidential and will remain protected under tax privilege.

3.         Value Added Tax (“VAT”)

Amendments to the VAT rules regarding partially exempt taxpayers

The rules applicable to partially exempt VAT taxpayers where amended in the following terms:

• Operations falling out of the scope of VAT  (e.g., dividends) are excluded from the prorata denominator (possibly increasing the amount of deductible VAT for such taxpayers);
• Deduction of VAT incurred for the purposes of performing transactions falling out of the scope of VAT should be determined according to the direct allocation method;
• The use of the direct allocation method should be made on the basis of objective criteria that allow an accurate determination of the degree of use of the goods and services acquired for operations that grant deduction of input VAT and operations that do not grant such right;
• Deduction of VAT (based on the direct allocation method) regarding the acquisition of assets is now subject to adjustments, when a variation higher than €250 occurs in any of the years between the first year of use of the asset and any of the subsequent 4 or 19 years (with regard to, respectively, movable and immovable assets).

Deduction of VAT on real estate activity

Amendments were introduced to the regime establishing the possibility to waive the VAT exemption regarding acquisitions and leases of real estate property.  Accordingly, the lease annual value was decreased from the former 1/15 of the property or acquisition value to 1/25 (implying a reduction of the minimum yield from 6,66% to 4%).

Moreover, the Budget foresees that the VAT exemption concerning financial leases of property under construction will only be effective when the lessee takes possession of such property (provided that the taxpayer holds a valid exemption certificate and the legal requirements for the waiver of the exemption are duly met).

Anti-abuse provision

Taxable persons taxed under the general VAT regime at the date of termination of activity may not benefit from the VAT exemption regime if they restart the same or another activity:

• Within 12 months after termination of the activity (this rule already existed); or
• In the year after termination of activity, if they were included in the general tax regime and have not declared the termination of the activity (new).

Application of the reduced VAT rate (5%)

The following transactions are (among others) now subject to the Portuguese VAT reduced rate of 5%:

• Works on property owned by urban development companies, provided that the construction agreement is directly entered into with the contractor;
• Practice of physical and sports activities.

4.         Stamp Tax

Capital Increases

Stamp Tax on cash capital increases is excluded as a result of Case Law C-366/2005 of the European Court of Justice.

5.         Tax Benefits

Venture Capital

Tax benefits foreseen for Venture Capital Companies (participation exemption under certain conditions) are extended to Venture Capital investors (which, according to the Portuguese law should act through a sole quota company).

Portuguese-Speaking African Countries

Dividends distributed to Portuguese resident companies by East Timor companies, may, under certain circumstances, benefit from the Portuguese participation exemption regime.

Small / Medium enterprises

Portuguese SME’s benefit, under certain conditions and until 2010, from a deduction to the CIT taxable base of 3% of the amount of share capital realized in cash on the incorporation or increase of share capital.

Urban property rehabilitation tax regime

An Urban property rehabilitation tax regime was approved for rehabilitation works (carried out in determined areas and subject to certain conditions), with the following main rules:

• Temporary property tax exemption (“IMI”) on rehabilitated urban property;
• CIT exemption on income obtained by real estate investment funds, whose assets are mainly rehabilitated urban property;
• Special 10% PIT or CIT withholding tax rate on income obtained by resident entities arising from stakes in the abovementioned real estate investment funds. The 10% withholding is considered as a payment on account for CIT and PIT taxpayers carrying out entrepreneurial activities, and as final tax for other PIT taxpayers. A general tax exemption applies to income obtained by non-resident entities (except black listed entities) and non-resident entities held in more than 25% by Portuguese residents (which will be taxed at the abovementioned 10% final rate).