Portugal: Europe’s newest tax haven for retirees

Attracted by a new tax regime, Europeans from high tax jurisdictions are now flocking to Portugal
Benefits include tax exemption of pensions and other foreign passive income
Domestic income from high value-added occupations is taxed at relatively low flat rate

Obstacles to full implementation finally overcome

In 2009, a special tax regime was introduced for those taking up residency in Portugal. The benefits, which can be substantial, apply for a fixed ten year period, but are available only to so-called non-habitual residents (“NHRs”), namely those not previously resident for at least five years.

The prevailing culture in the Portuguese Finance Department is to tighten compliance and to close loopholes rather than to grant exemptions, so it is not surprising that a number of further administrative rulings were sought before the regime could be practically applied.

It was only in December 2012 that the Department issued the first NHR assessments for those with no foreign-sourced pension income. The remaining assessments followed at the end of March 2103 but, despite the long delay, these initial assessments were incorrect, as they still sought to tax other types of foreign-sourced passive income, even when exemption requirements were clearly met.

Appeals followed and corrected assessments were eventually issued at the end of 2013. The regime is now finally being fully and consistently applied.

The motivation behind the generous benefits on offer is to deliver a boost to the Portuguese economy by attracting Northern European retirees and high net worth individuals, as well as workers in high value-added occupations. It is also intended to encourage well-qualified, affluent expatriates to move back to Portugal.

Right from its inception, interest in the scheme from the Scandinavians has been strong, partly fuelled by the publicity given to it by PWC (see “Europe’s Best Kept Secret”) and other big accounting firms including KPMG.

More recently, the regime has captured the interest of the tax-fatigued French, who are visiting Portugal and buying property in ever greater numbers.

Qualifying as a non-habitual tax resident

To qualify, non-residents must first obtain a valid resident permit, then register as tax resident and only then apply for the NHR status.

Tax residence may be acquired by spending more than 183 days of the year in the Portuguese territory, whether consecutive or not. Tax residence may also be acquired if, on 31^st December of the year in question, the individual is staying in an abode with the demonstrable intention of holding and occupying it as a permanent residence. Evidence for this can include ownership or a long-term rental contract.

NHR status should be requested no later than 31^st March following the year in which residency was obtained.

NHR status will only be granted if the individual has not been a tax resident for the previous five years. In this regard, the applicant’s statement is sufficient. It is no longer necessary to produce foreign certificates of residence and tax payment history for this five year period.

So long as residency requirements continue to be met, NHR status is valid for ten years, after which the individual will be taxed according to the standard regime applicable to permanent residents.

Rules and benefits

The NHR regime includes two sets of rules, one applicable to foreign-sourced passive income, the other to active income whether derived from foreign or domestic sources.

Foreign-sourced passive income may include interest, dividends, capital gains, income from property and pensions.

The active income covered by the second set of rules refers to income derived from employment, personal services and royalties.

Foreign-sourced passive income is tax exempt so long as it may potentially be taxed in the source state under the rules of a tax treaty with Portugal, or under the OECD Model Tax Convention, and it is not considered to arise from a Portuguese source, nor from a source on the Portuguese tax haven blacklist.

Foreign-sourced active income is also exempt provided that it is actually taxed in the source state under the rules of a tax treaty with Portugal, etc.  Otherwise, if foreign-sourced active income is not taxed at source, then it will be treated in the same way as domestic-sourced active income.

If active income derives from one of the high value-added activities of a scientific, artistic or technical nature as listed in the Ministerial Order, then it is taxed at a flat rate of 20% and not at the progressive rates generally applicable.

The Ministerial Order defines a long list of high added-value workers, including artists and musicians, construction, medical, legal and accounting professionals, academics, researchers and IT staff.

The flat rate gets bumpy

The state “austerity” budgets for 2013 and 2014 have applied an “extraordinary” surtax of 3.5% on the taxable income of individuals. The surtax is applicable to all NHR income which is not exempt under the rules. It therefore increases the flat rate on income from high value-added activities from 20% to 23.5%. And it is difficult to say when this surtax might be reduced or eliminated.

For high-earning professionals, even 23.5% can appear attractive compared to top marginal rates of between 40% and 50% prevailing elsewhere in Europe. In Portugal itself, the top marginal “austerity” rate is currently 55.5% for income exceeding €250,000.

Factor in the weather and lifestyle benefits, and small firms with mobile, high-value workforces may be tempted to relocate.

Social security stays lumpy

But the attraction of the NHR regime diminishes when adding social security to the mix. Contributions total nearly 35%, with 11% paid by the employee and a whopping 23.75% by the employer.

Being self-employed doesn’t help, as contributions are still between 25.4% and 32% depending on the range of benefits, and, if you are paid mostly by one company, the company must make an additional 5% contribution.

Who can benefit

While the overall incentive package may not be enough to tempt firms to relocate their business to Portugal, it is certainly a very attractive package for those earning mostly passive, foreign-sourced income, whether in the form of pensions, dividends, rents or capital gains.