The Law No. 2/2014 of January 16 approved the reform of the Portuguese corporate income tax (CIT), which had the main purpose of promoting the competitiveness and internationalisation of Portuguese companies through the implementation of several measures. Among these measures, the introduction of the participation exemption regime can be highlighted.
Participation exemption regime
In Scenario 1 depicted below, which represents a domestic situation, under the Portuguese participation regime, capital gains may benefit from a full exemption even if it is a real estate company (provided that it is used for carrying out an agricultural, industrial or commercial activity).
The State Budget Law for 2018 introduced a new provision in the CIT code, according to which capital gains derived from the sale of a foreign entity are also taxable in Portugal provided that, at any point in time during the 365 days prior the sale of the shares, the latter derived more than 50% of their value directly or indirectly from immovable property located in Portugal.
Before this rule, Portuguese taxation would only be triggered if (at least) the real estate company was a resident entity. The new provision extended the Portuguese jurisdiction to tax transactions that have no direct connecting link with a Portuguese territory.
In Scenario 2 below, the authors have depicted a transaction where capital gains realised from the sale of shares in a foreign company (i.e. where all transaction is carried out outside Portugal) became taxable in Portugal as from January 1 2018.
Contrary to Scenario 1 and Scenario 2, in the case of the transfer of shares of a Portuguese entity by a foreign shareholder – we should look at Scenario 3 – where capital gains arising from such sales remain subject to taxation without the possibility to claim the exemption based on the effective use of the immovable property. Therefore, even if the Portuguese real estate company carries out a business and uses its real estate assets – agricultural, industrial or commercial activities, there will be no possibility (under current tax provisions) to claim a tax exemption upon sale. This situation clearly affects international groups investing in Portugal in standard “real estate based businesses”, such as hotels, other accommodation services, call centres, co-working spaces, agribusiness, etc.
The different tax treatment between Scenarios 1, 2 and 3 clearly constitutes a discrimination that hinders the freedom of establishment and the free movement of capital, as foreseen in the Treaty of Functioning of the European Union (TFEU). Therefore, while this discriminatory treatment remains in force, it is likely that the said breach of EU law gives rise to tax litigation and possibly to a referral to the European Court of Justice for a preliminary ruling.
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