It has become a trend for EU countries to, simultaneously with the establishment of anti-abuse rules and reporting obligations that require taxpayers to disclose the source of their income and the substance of their activities, adopt provisions that aggravate taxation on transactions connected to low tax jurisdictions also known as tax havens.
The main purpose of these provisions is countering tax avoidance and evasion.
Portugal is no exception to this rule, and it has been implementing along the years several rules that either increase the tax rates, refuse the enforcement of exemptions, or do not allow cost deductions in cases connected to assets or income sourced in low tax jurisdictions or paid to residents in those jurisdictions.
While enforcing these rules, Portuguese law usually refers to jurisdictions listed in an Order issued by the Ministry of Finance, with currently 80 jurisdictions, usually called ‘blacklisted jurisdictions’.
The European Court of Justice (ECJ) has been addressing issues related to the European freedoms and anti-avoidance rules for a long time now.
In this context, ECJ’s decisions have been dealing mainly with the freedom of establishment, which is limited to transactions within the EU, and with the free movement of capital, which applies to transactions that may also involve third countries.
In most cases, the ECJ has found that both freedoms oppose to a domestic piece of legislation that increases taxation on both inbound or outbound investments whenever it applies only to certain assets or items of income based on their source or to certain taxpayers based on their place of residence.
In fact, such difference of treatment or restriction may discourage non-residents from making investments in a member state or member state’s residents from doing so in other countries.
The ECJ has, however, consistently affirmed that a restriction is permissible if it is justified by public interest reasons, such as preventing tax avoidance, but only to the extent that the restriction is suitable for securing the objective and does not go beyond what is necessary to attain it.
In this vein, the ECJ has already decided that EU law opposes to restrictions that are aimed at avoiding fraud but are based on irrebuttable presumptions that do not allow taxpayers to provide evidence of the economic justifications for the transactions.
Regarding low tax jurisdictions, the ECJ has even clarified that a low tax rate applicable to a company established in a third country may constitute an indication of tax evasion or avoidance, but it is not sufficient grounds to find that in all cases (see C-135/17).
In the case of third countries this reasoning may rely on the existence of administrative and legislative measures permitting to verify the accuracy of such evidence, which may well be the case of some Portuguese blacklisted jurisdictions, such as Hong Kong, with whom Portugal has executed double tax treaties with exchange of information provisions, or Gibraltar, Cayman Island or Jersey with whom Portugal has executed tax information exchange agreements.
The matter has been recently addressed for the first time in a decision issued by a Portuguese arbitral court rendered last year and published in March (see arbitral case 217/2021-T).
The case involved two individuals residing in Lebanon, a blacklisted jurisdiction, who had sold immovable property in Portugal. Under Portuguese law, gains resulting from the sale of real estate are taxed at 28% if they are obtained by ‘standard’ non-resident taxpayers and at 35% in case taxpayers are resident in a blacklisted jurisdiction.
Taxpayers have decided to challenge their tax assessment based on the fact that the aggravated 35% tax rate (when compared to the 28% rate) is precluded by the free movement of capital.
The arbitral court found that the 35% tax rate was indeed a restriction to said freedom but it further considered that said restriction could be justified by anti-avoidance concerns. However, according to the court the restriction was not proportional to said concerns, because the Portuguese list of backlisted jurisdictions was especially vast when compared to the EU list of non-cooperative jurisdictions, the case did not involve legal entities that could have been artificially interposed and, above all, the Portuguese provision did not allow taxpayers to evidence that their residence in a backlisted jurisdiction was not artificial.
The court further decided that given the existing consolidated ECJ case law, it was not necessary to refer the question for a preliminary ruling.
This decision addresses for the first time the aggravated taxation imposed in connection to blacklisted jurisdictions in a manner consistent with ECJ case law, confirming that the fight against fraud does not authorise the legislator nor the tax authorities to assume fraud and impose increased taxes no matter the specifics of each case.
It may therefore constitute a good precedent for future cases opposing taxpayers to the tax authorities and open the door to a more thorough and constructive approach to these matters.
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