I accept your point that Portugal chooses to refer to ‘control’ rather than ‘management’ in its definition of a CFC. I also accept that in addition to the CFC rules, there may also be additional entity tax residency rules.
However, these points only seem to underline the general point that a foreign entity either a) effectively managed from Portugal, or b) controlled by a Portuguese resident, will be liable to Portuguese CIT as if it were a domestic entity.
Your final point about the double tax treaty is the key one.
Do you have a source for the claim that the treaty will exempt a foreign entity from the residency/CFC rules? Do you know if it applies to just HK, or does Portugal have similar arrangements with other territories?
Just to make it clear: if a foreign entity is being effectively managed from Portugal, then it shall be considered tax resident in Portugal and thus subject to Portuguese corporate income tax (as any other Portuguese company). On the other hand, if a foreign entity is controlled by a Portuguese resident and is caught by the Portuguese CFC rules, the consequences will not be at the company level (i.e. the company itself will not be impacted and it will not be taxed in Portugal as a Portuguese company) but at the level of the Portuguese shareholder, who will pay income tax on the net profits made by the foreign company during the relevant FY (even if those profits are not distributed - in the form of dividends - by the foreign company to the Portuguese shareholder).
corporate tax residency / effective management from Portugal: affects the company directly
Portuguese CFC rules / control: affects the Portuguese shareholder
What a double tax treaty does is to define which state has the right to tax a certain type of income in a particular situation. Whereas local legislation might exempt some tyes of income in certain situations based on the taxing powers defined in a specific tax treaty.
As you know, certain types of income might be tax exempt under the NHR rules depending on where the income is being paid from and on the relevant double tax treaty (if any) signed between Portugal and the relevant source state. This is why every situation is different and needs to be looked at on a case by case basis.
As far as dividends are concerned, the double tax treaties agreed and signed by Portugal all have the same rules and are all drafted in the same way (i.e. they grant the source state the possibility to tax said income). Hence, dividends will generally be tax exempt under the NHR rules even if paid by an entity located in a blacklisted jurisdiction, as long as the relevant blacklisted jurisdiction has signed a double tax treaty with Portugal. This is currently the case of HK, the UAE and Panama (and as I said, this has been confirmed in writing by the tax authorities).
Interest income is a bit more tricky since some types of income qualified as interest (by the paying entities) do not fall into the definition of “interest” as determined by the double tax treaty between Portugal and the relevant source state. Hence, this type of income needs be looked at on a case by case basis.
As a personal conclusion, it doesn’t make much sense that the Portuguese tax authorities, on the one hand, acknowledge that dividends paid by an entity located in a blacklisted jurisdiction would be tax exempt under the NHR if there is a double tax treaty signed between Portugal and said state, and on the other hand, try to apply the CFC rules to that same entity because it would be qualifiying the same income twice and differently (not sure whether I expressed myself clearly here…).
dividends received from HK, Panama or UAE are tax exempt under the NHR (which the tax authorities already confirmed being the case); or
dividends/income from the HK, Panama or UAE company are caught by the CFC rules and thus fully subject to tax in Portugal.
Actually, in the decision from the tax authorities in which they confirm that dividends from HK, Panama and UAE are tax exempt under the NHR, the tax office had first decided to apply a 35% withholding tax to said dividends (because they were being paid from a blacklisted jurisdiction) and this decision was later overruled so as to acknowledge the tax exemption under the NHR rules.
If there’s a specific situation that you’d like to discuss, just let me know.
Understood, so to clarify my understanding: if you are a Portuguese tax payer and have a foreign entity you need to be mindful of:
The tax residency of the foreign entity. If the Portuguese authorities deem the entity tax resident, through application of the relevant tests (i.e. effective management rule, etc.), the entity will be subject to Corporation Tax as if it were a domestic Portuguese entity.
The Controlled Foreign Corporation (CFC) rules. If the authorities accept that the entity is non-resident for tax purposes, they could still deem it a CFC according to application of the relevant tests. In this case, the entity wouldn’t be subject to any additional tax, but the Portuguese tax payer would be taxable on their portion of the entity profits – irrespective of whether that income has been distributed as dividends.
I’m still not clear on the exemption though, my understanding of your point is that: due to the double tax treaty between Hong Kong, Panama and the UAE which explicitly states that dividends would be tax exempt under NHR, the implicit conclusion is that this would waive the entity residency/CFC rules too.
I’m keen to understand how this mechanism would work. My reading of that would be that – even though these are blacklisted states – if you have income from a small shareholding that isn’t subject to residency/CFC rules, you could still claim the NHR relief on it, but I’m very curious if that’s not the case!
And would it apply with an EU entity also? The CFC rules seem to carve out an exclusion for EU entities, but i’m unclear on the residency aspect. An Irish Limited would be an attractive entity for me due to the legal shielding, EU residency aspects.
The exemption is part of the NHR rules, not the DTT. According to the NHR rules, foreign dividends are tax exempt if that income may be subject to tax in the source state (irrespective of whether such income is effectively taxed or not in the source state):
under the rules of an existing DTT between Portugal and that state; OR
under the rules of the OECD model convention if there is no DTT between Portugal and that state, in which case such income can not be portuguese-sourced nor be paid from a blacklisted jurisdiction.
All the DTTs signed by Portugal grant the source state the right to tax dividends and thus the condition for exemption under the NHR rules is met, as long as such income is paid from a “whitelisted” jurisdiction (i.e. not blacklisted) or from a blacklisted jurisdiction with whom a DTT has been signed.
Let’s go through an example: let’s assume you hold 100% of a UAE company (blacklisted in Portugal + DTT signed with Portugal) and that this company made 100 net profit in 2019.
if you’re the only director of the company and if you manage it from Portugal, the portuguese authorities might deem the company to be effectively managed from PT and thus might want to tax the 100 net profit as if it was profit made in Portugal.
if you’re under the NHR and pay yourself 50 or 100 in dividends from the UAE company, these dividends would be exempt under the NHR rules since (i) these are foreign-source dividends and (ii) the DTT between Portugal and the UAE grants the UAE the right to tax those dividends .
if the company was caught by the portuguese CFC rules, you (as PT resident 100% shareholder) would be attributed 100% of the net profits of the company (i.e. 100) and be subject to personal income tax in Portugal at the normal rates (up to 48% + surcharges).
What I am trying to say is that scenarios 2 and 3 are not compatible: either you accept that the income being distributed as dividends is tax exempt for NHR purposes (scenario 2) or you deem that income to be subject to tax at the level of the shareholder under the normal tax regime. I don’t see how you could have both scenarios in practice since the income in question (net profits of the company / dividends) is the same.
Yes, EU companies are excluded from the CFC rules. However, the tax residency tests apply to every single foreign entity. This is different for every country since some countries only deem resident the entities incorporated or with a head office in the country; other countries, like PT, apply the head office or effective management test.
hey ! thanks. for the detailed explanation. for 50K with zero expenses you mentioned the “effective tax rate” is 31% .
1/ by effective tax rate, do you mean it includes “social security tax + income tax” or is that just the income tax ?
2/ could you please provide quick steps of how you get to that 31 % number ?
The number is slightly different as social security is calculated according to ~70% of your gross not your net income (figure after applying vocational co-efficient) as I originally thought. (In fact SS calculation is a little more involved than this putting you into a tier based on some multiple of IAS, but crucially for the self-employed there is a cap at 12 times IAS according to my understanding.)
I thought that NHR and simplified regime could not be had at the same time
Not the case. Anywhere where the marginal rate of PIT would be applied, the special NHR rate can be applied. (If you choose it to be.) In some instances, e.g. you’re in a profession which enjoys the 35% coefficient in the simplified regime, and your income is below a certain threshold, you’d actually be better off applying the marginal rate!
My understanding is that for NHR, you don’t pay social security at 21.4% but at 34.75%
NHR status doesn’t impact your social security contributions. The way to think about NHR is it only affects your PIT rate. As social security is calculated separately from your income tax, you calculate it in the same way as any other Portuguese resident. For the self-employed, the social security rate is 21.4%. (Social Security | Tax guide 2019 | PwC Portugal)
@guifig Your post on April 3 is very clear and helpful. I am trying to work out if NHR would work for me before the Brexit transition ends on 31 Dec. The situation you describe about NHR and CFC rules being incompatible for receiving tax free dividends from a 100pct owned foreign company is my concern. Have you (or anyone else) found out how Portugal treats this incompatibility?
The NHR system does seem to take some tax planning. I suppose there are many people earning pensions, or dividends from holding shares in Tesco or something for 20 years and moving to Portugal, without having to make careful plans, but people with active businesses need to do some homework.
Hi everyone, thank you a lot for the detailed explanations. It was very insightful.
@Rod1, @guifig could you please share on how Portugal treats the incompatibility mentioned when operating with a UK limited company ? (CFC rules vs NHR).
About the requirements to pass the effective management test, here are some some of the requirements as far as I know:
make sure that any contracts, minutes of the company (eg declarations of dividends, approval of accounts) are made outside of Portuguese territory and keep records of this in case of a query / inspection arising.
at a higher level, is that the company employees / nominates a non resident director, and he/she signs contracts etc
I dont know re: a UK company and am not a tax lawyer. I understand for a company tax resident in a country with a DTA with Portugal, if all income is dividended, then the divs would be exempt from tax under the NHR. So even if the company is a CFC, it has no undistributed income left to be taxed at your personal rate.
This is a most informative discussion as this is a dilemma I have been fighting with for some time.
But here is my latest interpretation after consulting legal advisers in Portugal, the UK and online.
Portuguese fiscal resident with NHR
Sole director of a UK Limited company with it’s sole commercial activity being with UK companies, hence it’s original incorporation.
My considered conclusion
As the UK is in the EU at the moment, the company is not considered a CFC, firstly because it is in the EU and secondly because it was formed to trade exclusively in the UK.
Also, after Brexit one would hope the UK would not make it on to the CFC list, because it is unlikely to be ever considered a tax haven.
Salary: Paying myself via PAYE would not attract taxation in Portugal due to the double tax treaty, although would need to be declared.
Dividends: Even though I have NHR, they could still be potentially taxed in Portugal.
Therefore, it seems that simply paying myself salary in the UK thought PAYE is the most effective tax strategy. It is also easily confirmed with the Portuguese finances through pay slips or an HRMC confirmation.
It is difficult to find a professional who understands all the elements to this dilemma and I have paid for conflicting advice from a number of sources. This leads me to believe there may not necessarily be an absolute answer and that the Portuguese finances may in turn interpret the situation as they see fit at the time, which might be difficult to challenge without the right expert in my corner.
Portuguese accountants give wildly varying advice on this matter, not many are experts in International tax law but all seem willing to give advice, much of which I have subsequently discovered to be inaccurate in varying degrees.
I don’t see how the UK company would be deemed tax resident in Portugal. The UK isn’t on the list of blacklisted countries, therefore it would not be considered to be in a tax favourable location and therefore not a CFC. Also, if ever the UK were to be considered a favourable tax location and added to the list, the company would still not be a CFC based on the following conditions:
Non-resident companies are excluded from the CFC measures in the following cases, cumulatively:
at lest 75% of the allocated profit is derived from the exercise of an agricultural, industrial or commercial activity; in the commercial activity case, no counterpart resident in the Portuguese territory shall be involved, or, if so, the commercial activity is mainly aimed at the market of the company’s location.
the main business of the non-resident company does not consist, in particular, in banking operations, insurance of goods located outside the company residence territory or persons not residing in that territory; transactions in shares or securities, intellectual or industrial property rights, information supply on know-how in industrial commercial or scientific areas, or the provision of technical assistance; asset lease except real estate located in the territory residence of the CFC.
I therefore conclude the company would not be deemed tax resident in Portugal for all those reasons listed above. In the unlikely event it were, it would still only be PBT rather than revenue that would be looked at for tax purposes. As I am planning paying salary rather than dividends, I don’t see why there would ever be a reason for the tax authorities to ever explore it any any detail.
Thank you, that is an informative link… but it does raise a couple of further questions:
It actually contradicts the CFC information… ie: the company may not be a CFC but could be considered a PE in Portugal. If deemed the latter, would it simply be a case of declaring nett profit in Portugal.
Also, how would it be complicated if I am paying myself via PAYE in the UK. Assuming year end shows zero profit, surely there would be no tax liability.
From a PAYE perspective, with the double taxation treaty I would not need to top up my taxes in Portugal if I demonstrate PAYE has been deducted in the UK.
It’s a bit of a nightmare to figure out and with a relatively modest income, I cannot justify the high fees for a PWC consultant to get everything set up correctly.