Although it is clear in Portugal that the investment income that arises from unit-linked products is subject to taxation at redemption, the Portuguese tax authorities (PTA) have taken different (and, in some way, opposing) positions regarding the definition of the taxable basis over time, particularly in the case of partial redemptions. This has raised some uncertainty in the market and among tax practitioners.
According to Article 5(3) of the Portuguese Income Tax Code, the amount received on the redemption, early repayment, or maturity of a life insurance product may qualify as investment income, with the taxable amount determined by the positive difference between the sum received at such moment and the respective premiums paid by the policyholder.
In the case of a total redemption, the taxable basis corresponds to the positive difference between the amount received and the respective premiums paid, as expressively determined by the above provision. But what about the situation regarding partial redemptions?
The initial position of the PTA, issued in 2006, followed the understanding that there are no reasons justifying unequal treatment of a total or partial redemption of a life insurance product.
In December 2022, in accordance with the above stance and in the context of an answer to a binding ruling request, the PTA released the opinion that the taxable basis at a (total or partial) redemption event should be determined by the positive difference of the aggregated (total) value, assessed from the beginning of the insurance contract, between the amount received and the respective premiums paid. This position has led to the understanding that the (net) positive difference would only be subject to taxation at such date and under the above rule if, at the partial redemption date, the amount redeemed exceeded the premiums paid until such moment and assessed from the beginning of the insurance contract.
Portuguese tax authorities revoke 2022 position
More recently, in April 2024, the PTA issued another opinion on this matter (revoking the position taken in 2022 and approaching the initial stance of 2006), further to a clarification request made by the Portuguese Insurers Association. The PTA determined that, at the partial redemption date, the amount redeemed is always composed of a capital component (premiums) and an income component (raised by such premiums), and the net positive difference between these two assessed components should be considered taxable income on each partial redemption date, based on a pro rata approach.
This pro rata methodology has prompted several discussions in the insurance market and among the parties concerned, especially in cases where, during the lifetime of the insurance policy, the investor assesses, at the partial redemption date, a positive difference between the amount redeemed and the premiums paid (being subject to taxation at such taxable event), but, at the maturity date, the asset’s appreciation trend reverses and the investor has a negative return. In this case, in line with the general taxation rules applicable to investment income, it cannot be offset against other positive income obtained during the year, as it occurs, for instance, in the case of capital gains and losses during the year.
Indeed, one could argue that this income assessment guidance concerning partial redemptions of unit-linked products, as determined by the PTA, may not conform to certain general tax principles, especially the accrual income principle and the tax deferral regime that usually accompanies unit-linked products. Under the latter, as a tax advantage for investments in these products, the oscillation of the underlying asset portfolio is not subject to taxation during the lifetime of the insurance product.
This discussion is particularly relevant for insurance companies domiciled in Portugal, which are responsible for the withholding tax, if any, on the amounts paid from insurance policies. However, for non-resident insurance companies, including those acting in Portugal under the freedom to provide services regime, the responsibility to pay any taxes on the amount received generally falls on the taxpayer.
Key takeaways based on the Portuguese tax authorities’ current stance
Vieira de Almeida & Associados has become aware of several recent Portuguese arbitration court decisions following the understanding that taxation should only occur when the amount received exceeds the premiums paid (and, as such, the decisions favored the taxpayers). Insurance market players should therefore be fully conscious of the formal position of the PTA on this matter, which, although controversial and subject to several discussions and interpretations, will probably be the one followed by the tax authorities, for instance, during a tax inspection.
The recent arbitration court decisions should also be kept in mind, as they provide the necessary grounds to respond to a tax assessment issued on the basis of the pro rata approach.
