Global Tax Alert | 31 July 2013
Significant changes proposed to Portugal's Corporate Income Tax law
In January 2013, the Portuguese Government appointed an independent Commission to perform a study and propose changes to the country’s Corporate Income Tax (CIT) law. Drivers of the CIT reform are (i) review and simplification of the CIT law and tax obligations, and (ii) a restructuring of the international tax policy to be more competitive both for inbound and outbound investment.
On 30 July 2013, the Commission released its proposals. Public comments are requested by the end of September. The proposed changes to the CIT law, if approved, are expected to be enacted in 2014. This Alert covers the key provisions applicable to business.
Withholding tax exemption on outbound dividends
In addition to the existing exemption on outbound dividends paid to European Union (EU), European Economic Area (EEA) member-states with a tax cooperation agreement, and Switzerland, the proposed changes expands the regime to tax treaty countries with tax cooperation agreements.
The existing minimum holding requirements for the EU/EEA (direct shareholding of 10% and one year holding period) are greatly reduced. Under the proposal the shareholding requirement is reduced to 2% (including indirect holdings through EU/EEA eligible companies) and although the minimum period of holding is maintained it can be met after the dividend distribution. Companies outside the EU/EEA must be subject to CIT at a minimum rate of 10%.
The existing full participation exemption regime for EU/EEA dividends is proposed to be significantly amended, as follows:
- • Reduction of the minimum holding percentage from 10% to 2%. This holding percentage can be met indirectly via EU/EEA holdings of eligible companies.
- • The subsidiary can be located in any country, except a tax haven territory, provided that it is subject to one of the taxes listed in the EU Parent-Subsidiary Directive or to a minimum CIT rate not lower than 10% (and this can be waived if the dividends are from an entity which derives more than 50% of its income from an active business activity or if its assets are not composed more than 50% by (i) shareholdings of less than 2%, (ii) shareholdings in tax haven entities, (iii) other financial assets and (iv) Portuguese real estate).
- • Application of the regime to the amortization of shares without a share capital reduction.
The regime should not apply if the dividend is tax deductible for the entity making the distribution. On the other hand, it is proposed to eliminate the specific anti-abuse provision that currently requires that the dividends are distributed out of income that has been effectively taxed.
The administrative procedures to justify eligibility for the regime are also being made easier to comply with.
In addition, the proposal intends to clarify that the imputation of profits under CFC rules should not apply if a dividend distribution would benefit from the participation exemption regime.
Capital gains and losses on shareholdings and other equity instruments
The concept of capital gains and losses is expected to be clarified, inter alia, in relation to restructuring transactions executed outside the tax neutrality regime, share capital reductions and liquidations. Furthermore, it is clarified that FIFO should be considered when computing capital gains and losses.
A full participation regime is proposed for capital gains and losses on shareholdings held for at least 12 months (no minimum holding percentage requirement) provided the remaining conditions for the dividends participation regime are met. This applies to gains and losses from onerous transfers of shares and other equity instruments (namely, supplementary contributions), capital reductions, restructuring transactions and liquidations.
Losses from the onerous transfer of shareholdings in tax haven entities are no longer allowed as a deduction (currently, this only applied to liquidation losses).
On the other hand, losses resulting from shares and equity instruments are not deductible in the portion corresponding to the amount of dividends and capital gains that were excluded from tax during the previous four years under the participation regime or the underlying foreign tax credit relief.
As a consequence, the provisions that restricted the deduction of losses, in full or in part, regarding shareholdings (inter alia, acquired from related parties and held for less than three years or transferred intra-group) and other equity instruments (namely, supplementary contributions) are being eliminated. Moreover,
the reinvestment relief of 50% is also eliminated with respect to shareholdings.
Exemption regime for foreign permanent establishment (PE) profits
The proposal includes the possibility for resident taxpayers to opt for an exemption regime for foreign PE profits, in which case foreign PE losses are also not deductible, provided the PE is subject to one of the taxes listed in the EU Parent-Subsidiary Directive or to CIT at a rate of no less than 10% and the PE is not located in a tax haven territory.
The transactions between the head-office and the foreign PE should respect the arm’s length principle and the costs related to the PE should not be allowed as a deduction for the head-office.
Recapture rules are also introduced, as follows:
- • PE profits should not be exempt up to the amount of PE losses deducted by the head-office in the 15 previous years.
- • In the case where the PE is incorporated, subsequent dividends and capital gains from shares should not be exempt up to the amount of PE losses deducted by the head-office in the 15 previous years.
- • Whenever the exemption regime ceases to apply, the PE losses and capital losses from shares (if the PE is previously incorporated) are not deductible up to the amount of the PE profits that were tax exempt during the previous 15 years.
Foreign tax relief
In addition to the existing foreign (ordinary) tax credit method, the proposal re-introduces the possibility to carry forward for five years the excessive credit not used because of insufficient tax liability in the year the foreign source income is earned and included in the taxable basis.
Furthermore, it is being proposed that taxpayers may opt to apply an underlying foreign tax credit in relation to foreign source dividends that are not eligible for the participation exemption regime. Several conditions must be met, including (i) a minimum holding percentage of 2% for at least 12 months, and (ii) that the entity distributing the dividends is not located in a tax haven territory as well as that the indirect subsidiaries are not held through a tax haven entity.
PE profits and related parties
The profits of a PE in Portugal should be computed as if it was a separate entity that carries out the same or similar activities, under same or similar conditions, taking into consideration its functions, assets used and risks assumed.
The threshold to be considered a related party, when a shareholding relationship is concerned, is expected to be increased from 10% to 20%.
Rules are proposed to establish that the taxable period in the year of inbound redomestication, as well as the relevant date of ownership in subsidiaries for the participation exemption regime, commences on the date the company becomes tax resident of Portugal.
Simplification of petition procedures
There are many situations where the current rules require taxpayers to file a petition with the tax authorities for approval. Many cases are expected to be replaced by a notice submitted to the tax authorities, within specified deadlines. Examples are:
- • Adoption of a tax year distinct from the calendar year, for resident companies that are not obliged to have consolidated group financial statements.
- • Transfer of tax losses to a PE in Portugal whenever a Portuguese company transfers tax residence abroad.
- • Changes in the measurement criteria regarding inventory, depreciation/amortization methods and provisions relating to the repair of environmental natural damages.
- • Changes in the fulfillment of a specific condition regarding insurance policies and/or pension plans whenever the non-compliance with such condition results from a restructuring process.
- • Transfer of tax losses under tax neutral transactions.
Tax transparency regime
Companies that carry on professional activities as listed in the annex to the Personal Income Tax (PIT) code would become subject to the tax transparency regime. The regime provides for taxable profit being imputed and taxed at the level of the shareholders provided that (i) at least 75% of the income is derived from such activities, (ii) in any day of the tax year, the share capital is held by no more than 5 shareholders (none of them being a public corporate person), and (iii) at least 75% of the share capital is held by professionals who carry out such activities, in part or in full, through the company. Currently, the company is treated as tax transparent only if all shareholders (individuals) are professionals of the same activity.
In addition to tangible assets, investment properties and non-consumable biological assets, reinvestment relief of 50% is also being proposed for intangibles.
Amortization/depreciation of intangibles, investment properties and non-consumable biological assets
The proposed changes intend to allow the amortization/depreciation of the following rights and assets:
- • Intangibles acquired for consideration for which there is no defined economic life (except if recognized by the taxpayer in the account as a result of a tax neutral transaction) – during 20 years.
- • Investment properties and non-consumable biological assets that are subsequently measured at fair value – during the remaining period of the maximum economic life.
Following the changes regarding the amortization/depreciation for tax purposes, the subsidies related to those rights and assets should be recognized, for tax purposes, on the same basis as amortization/depreciation.
The proposed changes include an IP regime that provides for a 50% exclusion from the taxable basis in relation to income derived from contracts of transfer or of temporary use of patents and industrial designs or models.
Several conditions apply for being able to benefit from the IP regime and it should only apply to patents and industrial designs or models registered on or after 1 January 2014.
Limitation on the deduction of financial expenses
From 2013 onwards, a limitation to the deduction of net financial expenses was introduced, which became capped by the greater of (i) €3 million or (ii) 30% of the EBITDA (although 70% applies in 2013 with a reduction of 10 percentage points per year until the 30% threshold is reached in 2017).
Significant changes are now being proposed, namely:
- • Reduction of the nominal limit to €1 million.
- • For tax groups, the limitation and thresholds may (upon election) be computed considering the group rather than each individual company (as it is today), except any carry forward (excessive net financial expenses or credit) existing from years before the tax consolidation regime applies to the company in question.
- • Introduction of a forfeiture rule for carry forwards in case there is a change in more than 50% of the share capital (on in the majority of the voting rights), although a petition can be filed to waive this restriction (similar to what applies to tax losses).
- • Adjustments to the EBITDA to exclude items such as changes in fair value of assets, impairment of investments, equity method, dividends and capital gains/losses benefiting from the participation regime as well as PE profits/losses excluded from the taxable basis.
The proposal aims to introduce very relevant changes to the tax grouping regime, inter alia, the reduction of the minimum holding percentage from 90% to 75% and the possibility to meet such requirement via nonresident companies that are resident in the EU/EEA, provided certain conditions are verified.
The period for tax losses carry forward is proposed to be increased from five to 15 years, although the cap of 75% of the annual taxable income is maintained.
The forfeiture of tax losses provision is significantly amended by eliminating the situations where there is a modification of the business purpose and/or a significant change in the business activity. Moreover, several exclusions are identified concerning the change of more than 50% in the share capital (or in the majority of the voting rights) rule, which is maintained for forfeiture of tax losses purposes.
On the other hand, it is clarified that FIFO should be considered for the purposes of deduction of tax losses carried forward, as it already exists for tax losses within tax grouping.
Tax neutrality regime
Following several situations challenged by the tax authorities and court decisions, it is being proposed to enlarge the number of eligible transactions to cover downstream mergers and splitting-mergers, mergers and splitting-mergers between sister companies without the attribution of shares to the sole common shareholder and upstream splitting-mergers into the sole shareholder.
Moreover, it is foreseen that tax benefits existing in merged companies can be automatically transferred to the beneficiary company, provided the relevant conditions are verified at the level of the latter. However, in the case of demergers or contributions of assets, an application must be filed with the Minister of Finance.
Liquidation of companies
Currently, in most cases, the gain upon liquidation of a subsidiary is treated as investment income. It is being proposed to treat such gain always as a capital gain.
Moreover, losses from the liquidation of subsidiaries are only deductible if the shares have been held for at least three years before dissolution. A minimum four-year holding period is expected to be adopted. On the other hand, if within the four-year period after the liquidation of the subsidiary its activity is carried out by the shareholder, or a related party, any loss deducted by the shareholder upon liquidation of the subsidiary should be added-back in 115% of the amount.
Minimum tax liability
The CIT code imposes that the tax liability cannot be lower than 90% of the amount that would be computed in the absence of several tax benefits and deductions, including the deduction of tax losses transferred to the taxpayer under a tax neutral transaction. The proposal eliminates this last restriction hence such losses should them be disregarded to determine the 90% amount.
Non deducted special payments on account (which are not refundable in the tax assessment) can nowadays be carried forward for four years. The proposal increases this to 15 years and the minimum amount from €1,000 to €1,500. It also changes the timing of such payments. On the other hand, the possibility to claim for a refund of such payments at the end of the carry forward period is being facilitated.
Contrary to what applies today, special payments on account should become deductible to determine the amount of regular payments on account, and not the other way around.
The proposal introduces a rule stating that withholding tax on income in kind should be levied on the sum between the market value of the assets or rights and the amount of the withholding tax, implying a gross-up procedure.
The existing domestic withholding tax exemption for interest income derived by pure holding companies (SGPS’s) from direct shareholders loans and bonds should be enlarged to all companies that meet the minimum holding requirements (10% and one year) and also include interest income from commercial paper.
The administrative procedures regarding the elimination or reduction of withholding tax on income obtained by nonresidents, namely in accordance with double tax treaties, should be facilitated.
Non deductible costs
Within the several proposed changes, it is being considered that costs related to income not subject to tax should not be allowed as a deduction. This may eventually mean that, for example, financial expenses related to shareholdings may not be tax deductible if the dividends and capital gains thereof are excluded from the taxable basis under the participation exemption regime.
Mark-to-market adjustments in investments
Adjustments of value concerning financial instruments recognized at fair value via the P&L account are only relevant for tax purposes, in what respects to equity instruments, in case they are listed in a regulated market and the taxpayer holds no more than 5%. This threshold is proposed to be reduced to 2%.
Alignment with accounting rules
The proposed changes aim to further align the taxable basis with the accounting basis in matters such as adjustments in inventory.
Tax returns for nonresidents without a PE
The proposal changes the deadlines to file some of the tax returns required for nonresidents without a PE in Portugal that obtain income herein not subject to final withholding tax.
Taxpayers should closely monitor the proposed changes and be prepared to take actions through the 2013 year-end to adapt and take advantage of the existing rules that will cease to apply as well as consider restructuring its group structures and transactions in light of the new rules.
For additional information with respect to this Alert, please contact the following:
Ernst & Young, S.A., Lisbon, Portugal
- • António Neves
+351 21 791 2295
- • Nuno Bastos
+351 21 791 2000
- • Carlos Lobo
+351 21 791 2146
- • Paulo Mendonça
+351 21 791 2045
- • Pedro Paiva
+351 22 607 0694
- • João Sousa
+351 21 794 9305
- • Anabela Silva
+351 22 607 9620
EYG no. CM3678