Portugal private clients series, part one: New Stock Options Tax Regime
In the first article of a two-part series on the tax landscape for Portuguese private clients, Ana Carrilho Ribeiro and António Queiroz Martins of Morais Leitão, Galvão Teles, Soares da Silva & Associados report significant proposed changes to the taxation of stock options.
A bill proposal to amend the tax regime applying to stock options is pending before the Portuguese Parliament. The new regime (the ‘New Stock Options Tax Regime’) should be effective as of January 1 2023.
These new rules aim at creating one of the most attractive tax regimes in Europe regarding income of this sort and thus incentivising the start-up ecosystem, which is booming in Portugal.
Clearly targeting the start-up scene, the New Stock Options Tax Regime creates a legal definition of ‘start-up’ and ‘scale-up’ company, focusing on innovation and technological clusters, and favouring companies with relevant investment in R&D, patents, brands, drawings, industrial models, and software.
In a nutshell, this new taxation regime seeks to align the use of options by employees with the verification of liquidity events at the level of start-ups, by allowing the deferral of the taxable event until the sale of such options, where employees are expected to benefit from a favourable cashflow situation. Moreover, and despite such income qualifying as ‘employment income’ in the hands of employees, the revenue is subject to an effective tax rate of 14% (which compares with the general progressive personal income tax rates, which may be as high as 48%).
The New Stock Options Tax Regime may apply to a vast number of companies, such as:
Start-up companies, as defined by this regime;
Small and medium-sized companies, as defined by Portuguese domestic legislation with reference to EC Recommendation No. 2003/361/EC of May 6;
Small mid-cap companies (fewer than 500 employees as determined above); and
Any other entity that develops its business through innovation, which is deemed to occur whenever an entity invests at least 10% of its costs or turnover in R&D, patents, brands, drawings, industrial models, or software.
In this context, employees who were granted stock options by eligible entities and hold such rights or shares for a minimum period of one year are granted the benefit of applying a 28% rate levied on only 50% of the taxable base (i.e., an effective tax rate of 14%).
Analysis of the changes
One improvement of the New Stock Options Tax Regime is that it clarifies when income is subject to tax (i.e., a taxable event), which is deemed to occur at the earliest of the following moments:
The sale of shares or equivalent rights granted by the exercise of the option at stake. In this case the gain is determined by the positive difference between the sale price and the strike price (increased by any amount that the employee has paid to acquire the option upon its granting).
The loss of Portuguese tax residency. In this case the gain is determined by the positive difference between the fair market value at this time and the strike price (increased by any amount that the employee has paid to acquire the option upon its granting).
Pursuant to the above, one negative note is the introduction of an exit tax intended to tax unrealised gains. This new provision is especially inconsistent when inserted in a favourable set of tax rules which are addressed to an extremely mobile population of highly skilled employees working in the innovation cluster. Furthermore, this regime is:
Silent on the possibility of deferring the payment of taxes (following the Anti-Tax Avoidance Directive example, an instalment plan of at least five years could be seen as a feasible alternative to address a similar situation);
Silent on the potential interest calculation;
Silent regarding the need to present collateral (as decided already by the European Court of Justice (ECJ), “those guarantees in themselves constitute a restrictive effect”); and
Silent on the relevant percentage of shareholding of the company.
Hence, and considering the present draft of this set of provisions, it is more likely than not that the ECJ would consider it to be in breach of EU law, violating the freedom of establishment.
It is also relevant to note that the New Stock Options Tax Regime does not apply to founders holding directly or indirectly more than 10% of shares or voting rights, and board members, of the entity granting the plan. In any case, this exclusion does not apply whenever the relevant entity qualifies as a micro or small company (i.e., in such cases, the New Stock Options Tax Regime would be applicable without any restrictions).
Start-ups and other relevant companies operating in Portugal may need to adapt their employee share ownership plans or others of a similar nature to ensure these are aligned with the final version of the referred-to rules.
Please note that in light of the parliamentary calendar, the New Stock Options Tax Regime may still be amended. In any case, however, the final and approved version is expected to be released soon.