In 2023, the Portuguese State Budget Law established a new tax incentive for the capitalisation of companies (ICC). It did so by introducing Article 43-D of the Tax Benefits Statute (TBS) and revoking the previous tax incentives associated with the capitalisation of companies; namely, the Regime on the Conventional Remuneration of Share Capital and the Regime on the Deduction of Retained and Reinvested Earnings.
However, following the controversy arising from the ICC’s application, it was amended within the first five months from the date it entered into force. A further amendment is also anticipated in the 2024 Portuguese State Budget Law, seemingly aimed at strengthening and adapting the regime to the current economic and financial context.
Overview of the Portuguese tax incentive regime
Generally, the ICC involves a deduction from the corporate income tax (CIT) taxable profit, calculated by applying a 4.5% rate to net increases in eligible equity. This amount can be increased by 0.5% for companies that qualify as micro, small, or medium-sized enterprises, or small mid-cap companies.
Under the TBS, net increases in eligible equity correspond to the difference between increases in eligible capital and cash or in-kind distributions to shareholders through a capital reduction, an asset division, or the distribution of reserves or retained earnings.
Increases in eligible equity include:
Share capital increases made in cash in the incorporation of the companies or afterwards;
Share capital increases made through contributions in kind that correspond to the conversion of credits into capital;
Share premiums; and
Equity increases derived from the application of profits (distributable in accordance with commercial legislation) in retained earnings, reserves, or a direct increase in share capital.
Net increases in eligible equity must be calculated considering the amounts computed in a given tax year and in each of the preceding nine tax years (starting in 2023). Net increases in eligible equity correspond to zero when there is a negative difference in this sum.
There was an amendment to the definition of eligible equity increases related to profits obtained in the previous tax year and used in retained earnings, reserves, or capital increases. While the initial wording of the provision only mentioned accounting profits, the wording of Article 43-D of the TBS introduced by Law 20/2023 limits the application of the ICC to distributable accounting profits under commercial legislation.
This amendment aims to exclude from the regime’s scope of application any gains obtained through using the equity method, thereby preventing two taxable persons from using this regime for the same financial profit.
Within this context, it remains to be seen whether it was specifically intended to exclude the regime’s application for taxable persons with negative retained earnings, even if they have positive accounting profits. This ambiguity is due to the terms of the Commercial Companies Code, under which the annual profits required to cover retained losses cannot be distributed to shareholders.
The maximum tax deduction for the ICC in each year is the higher of €2 million or 30% of the tax EBITDA, as defined for the purposes of the interest barrier rule. However, any amount exceeding 30% of the tax EBITDA can be carried forward for the next five tax years, following the deduction for that period and subject to the same thresholds.
To apply the ICC, taxpayers must:
Carry out commercial, industrial, or agricultural activities;
Not be entities subject to the supervision of the Bank of Portugal (Banco de Portugal) or of the Insurance and Pension Funds Supervisory Authority (Autoridade de Supervisão de Seguros e Fundos de Pensões), or branches in Portugal of credit institutions, other financial institutions, or insurance companies;
Maintain organised bookkeeping in accordance with accounting standards and other legal provisions;
Not have their taxable profit determined by indirect methods; and
Have their tax and social security obligations fully regularised.
To safeguard against an abusive application of the regime, the TBS excludes the following transactions from being considered increases in eligible equity:
Share capital increases made in cash, in the incorporation of the companies or afterwards, financed by net increases in eligible equity in another entity;
Share capital increases made in cash by a related entity, in the incorporation of the companies or afterwards, financed by loans granted by the beneficiary company or a related entity; and
Share capital increases made in cash, in the incorporation of the companies or afterwards, by an entity that is not tax resident in another EU member state, the European Economic Area, or a state or jurisdiction with which Portugal has a double tax treaty or a bilateral or multilateral agreement for the exchange of information for tax purposes.
Changes introduced by the 2024 Portuguese State Budget Proposal
Starting from 2024, the ICC should correspond to a deduction of the CIT taxable profit of an amount calculated by applying the average 12-month Euribor rate for that tax year, calculated on the last day of each month, plus a spread of 1.5%, to net increases in eligible equity, which can be increased by 0.5% for companies that qualify as a micro, small, or medium-sized enterprise, or small-mid cap companies.
Net increases in eligible equity must now be calculated by considering the amounts computed in a given tax year and in each of the preceding six tax years, rather than the nine periods previously established.
Also, the limit of €2 million has been raised to €4 million, without prejudice of the EBITDA threshold. It is expected that the CIT deduction will be increased by 50% in 2024, 30% in 2025, and 20% in 2026, subject to the above limits.
Consequently, the combination of the above and the reduction in the number of years considered for calculating the tax benefit should result in an earlier use of this benefit than under the current wording.
Regarding the aim of preventing an abusive application of the regime, the exclusion of capital increases financed through loans granted by the taxable person itself or by an entity with which it has a special relationship is also strengthened. The presumption is that the capital increases were financed by these loans, unless the taxable person can prove that they were used for other purposes.
Potential issues under the system
Considering the above, although the calculation method that should be introduced by the 2024 Portuguese State Budget Proposal is more advantageous due to the high interest rates applied at present, the regime may become less advantageous and more unstable than the current one because interest rates are expected to decrease in the long term.
To conclude, despite the above amendments, certain issues relating to the application of the ICC remain unresolved, notably the compatibility of the regime with the proposed European Council directive aimed at reducing the debt-equity bias (the DEBRA Directive), particularly regarding the limitations on the deduction of financing expenses.
Other issues have also emerged, including the restriction on distributable accounting profits under commercial law, which is likely to be clarified once the tax authorities gain insights into the regime’s practical application. For this reason, Cuatrecasas expects to revisit this issue in the near future.
