Does Portuguese tax law discriminate against EU pension funds?

Portuguese documentation requirements for tax exemption require EU pension funds to submit certifications that are difficult to obtain. Is this ultimately deterring pension funds from investing into Portugal?

Although the taxation of European pension funds in Portugal may sound like a dead topic, the subject still involves the discussion of several million euros in Portuguese courts.

The European Court of Justice (ECJ) concluded on October 6 2011 that the taxation of dividends distributed by Portuguese companies to EU-based pension funds on shares held for more than one year encompasses a restriction on capitals free movement. As a result, in order to be compliant with European Union (EU) law, Portugal amended its tax law in January 2012 and accommodated the ECJ’s case law on discrimination of non-resident pension funds (Commission v. Portugal, C-493/09).

Since then, corporate income tax exemption is expressly enshrined in Portugal’s Tax Benefits Code for EU pension funds, provided some requirements are met:

The foreign pension fund exclusively assures the payment of retirement pensions granted from: the elderly, the handicapped, the pre-retired, as well as health, post-employment, and death benefits;
It is managed by an entity covered by the Directive 2003/41/EC;
It is the effective beneficiary of the income; and
The share participation is held for more than 1-year.

The first three criteria must be expressly confirmed by the foreign regulatory authority. As per this amendment, EU based pension funds may face two different scenarios:

If the Portuguese paying entity is provided with a certificate issued by the foreign regulatory authority attesting that the pension fund fulfils the requirements mentioned in criteria (1), (2) and (3) prior to the payment date, the exemption is immediately applicable; and
If the formal criteria cannot be attested prior to the payment date, the pension fund may apply for a refund of the corporate income tax withheld. This refund request may be submitted to the Portuguese tax authorities within two years from the date of delivery of the tax withheld.

Given the amendment of the law, some may argue that Portugal’s tax legislation is no longer discriminatory based on the dividend recipient’s residence.

However, Portuguese tax authorities are refusing the exemption’s application and tax refund based on a lack of proper documentation. This means that the law’s amendment may amount to a legal trap as not all EU pension funds are able to obtain a certificate issued by the foreign regulatory authorities attesting to the fulfilment of all conditions set in Portuguese tax law, either prior to or after the date of the dividends’ payment. In some countries, the foreign regulatory authority is only able to issue standard statements of supervision. As a result, the documentation requirements foreseen by Portuguese legislation often leads to the exemption’s non-application or to the direct dismissal of the refund request, ultimately discouraging European pension funds from investing in Portugal.

One may argue that EU pension funds may still challenge the tax authorities’ position in the Portuguese tax courts, but this would lead us to another question: do these tight criteria represent a new way of restricting the free movement of capital?

It should be noted that the Portuguese tax authorities’ position to prevent EU-based pension funds from submitting alternative evidence is not justified in the name of fiscal effectiveness. To accommodate the ECJ’s case law, an EU pension fund should be able to provide any equivalent documental evidence that clearly and precisely ascertains that it meets the exact requirements foreseen in Portuguese law, either by way of a single statement of supervision or by means of any other suitable evidence.

Nonetheless, this is not happening in practical terms, which leads us to a quick conclusion: non-resident pension funds are being excluded from benefiting from the exemption on dividends whenever they do not obtain the exact statement of supervision requested by Portuguese tax law, even if they attest to the fulfilment of all legal requirements by means of other valid elements. Isn’t this still discriminatory under EU law?

To overcome this obstacle, alternative approaches should be implemented by pension funds, namely by obtaining documents legally certified by custodians, financial intermediaries, or pension funds themselves and, then, to wait for a tax court ruling.