Copying and distributing are prohibited without permission of the publisher

Portugal: Liquidation proceeds sourced in Spain and exemption method for non-habitual tax residents

15 October 2018

ITR Correspondent

Email a friend
  • Please enter a maximum of 5 recipients. Use ; to separate more than one email address.


A recent Portuguese Arbitration Court decision (Case 639/2017-T), dealing with the application of the exemption method to foreign-based liquidation proceeds for non-habitual tax residents serves as a good illustration of how this domestic exemption works.

As a background to this case, the Portuguese non-habitual resident (NHR) regime was successfully introduced back in 2009 and provides special tax rules for a period of 10 years for persons taking Portuguese tax residence.

The manner in which the NHR regime is designed provides that a NHR qualifies as a full resident taxpayer for personal income tax (PIT) purposes subject to the same filing obligations as for regular residents (the fallback regime); nonetheless, they are taxed favourably on certain items of income via either: (i) application of an exemption with progression on qualified foreign income; or (ii) application of a flat 20% tax rate on qualified domestic income.

The Arbitration Court case deals with the workings of the exemption method for passive income, in particular the interaction under the NHR between the domestic and tax treaty qualification of income.

Portuguese domestic law stipulates that for an NHR, foreign-sourced investment income (category E) and capital gains (category G) are exempt from tax provided that one of the following conditions is met: (i) the income "may be taxed" by the source state under the provisions of a tax treaty; or (ii) the income "may be taxed" in another non-treaty state according to the provisions of the OECD model, as interpreted in accordance with the observations and reservations made by Portugal and such income is not: (i) derived from a blacklisted jurisdiction; (ii) paid by a Portuguese resident entity; or (iii) attributable to a Portuguese permanent establishment.

In the case at hand, the applicants were NHRs seeking the annulment of the 2016 tax assessment levied on the liquidation proceeds received from winding up a Spanish limited liability company.

Portuguese taxation was being levied on the positive difference between the value attributed to the share of assets received upon liquidation and the acquisition value of the respective shareholding. The liquidation proceeds were reported to the Spanish tax authorities and taxed in Spain.

The applicant opted for the exemption method and considered that the conditions to apply this exemption were fulfilled as the Spanish liquidation proceeds were taxable in Spain pursuant to paragraph 2(a) of the protocol to the tax treaty, which provides that "with respect to Article 10, paragraph 3, it shall be understood that the term 'dividends' includes the profits from the liquidation of a company".

Under Article 10(2) of the tax treaty, as dividends may be taxed in the state in which the company paying the dividends is a resident (i.e. Spain), this would be sufficient to operate the exemption method for the NHR and have 0% tax.

The Portuguese tax authorities argued that there was a lack of evidence that in a winding-up of a Spanish company the approach should lead to cumulative taxation rights for both Spain and Portugal instead of exclusive taxation rights for Portugal as set out in Article 13(6) of the tax treaty dealing with capital gains.

The Arbitration Court favoured the taxpayer and reiterated the functioning of the NHR exemption method by stating the following:

  • For investment income or capital gains to be exempt, it is necessary only to validate whether the income may be taxed in the other source state in accordance with a tax treaty (or the OECD model in its absence).
  • The rule of the treaty applicable in this particular case should not be Article 13 (capital gains), but instead the "lex specialis" of paragraph 2(a) of the protocol, which forms an integral part of the tax treaty.

The Arbitration Court concluded that the income derived from liquidation proceeds arising from a Spanish-based company and received by a Portuguese NHR should qualify as dividends, which may ultimately be taxed in Spain and therefore qualify for no taxation in Portugal (under the 10-year period available for NHRs).

This decision is relevant because it correctly addresses the functioning of the cross-border qualification of income derived by an NHR in situations where there is a specific treaty clause that allocates taxation rights to the source state. It is also relevant because it reinforces the principle that a protocol is considered to be a treaty in its own right that amends or supports the existing tax treaty.

As the rule of NHRs for passive income is based on the 'may be taxed' rule, the outcome under each of the applicable tax treaties becomes particularly relevant, and there are some nuances in each of them. We expect similar disputes to arise in cases involving the disposal of real estate rich companies or qualified participations.

Tiago Cassiano Neves (tiago.cassiano.neves@garrigues.com)
Garrigues, Taxand
Tel: +351 231 821 200
Website: www.garrigues.com






International Correspondents