My first contribution to NOVA TAX RESEARCH LAB is about inaction or failure to correct Portuguese tax legislation that was deemed in breach of EU law. The question posed is simple and attempts to ask if we are dealing with something serious or merely minor issue.
We learned at the law school benches that European Union law has primacy over the Portuguese national law and that this applies to both primary and secondary EU law. We also learned that where the Court of Justice of the European Union finds that Portugal is in breach of EU law, the latter is obliged to amend its legislation to remedy the situation.
Having these basic principles in mind, let’s see two examples of recognised violations of EU law and take some preliminary conclusions and consequences.
- The first case deals with the difference between the tax treatment in Portugal of interest paid to resident and non-resident financial institutions covered in C-18/15 (Brisal Case). In that case, the Court of Justice held that the difference in the tax treatment was an unjustifiable infringement of the freedom to provide services, because a Portuguese lender (such as any Portuguese bank) would be taxed at 25% on a net basis (after the deduction of allowable related business expenses) whilst a non-resident lender would be taxed via a gross withholding tax without any deductions (even reduced treaty tax rates may reduce this to 10% or 15%). By deeming this difference in treatment in breach of EU law, non-resident should be able deduct directly related expenses, such as financing costs, which are considered necessary for the grant such financing. Despite more than 5 years have passed from such decision, no amendments to Portuguese domestic law have been made to correct this difference in treatment and non-resident lenders have to raise claims if they want to recover any excess withholding tax paid in breach of EU law.
- The second case deal with the difference in treatment between resident and non-resident individual taxpayers on the disposal of real estate located in Portugal covered C-388/19 (MK Case). In this case the Court of Justice ruled that the Portuguese taxation of capital gains realized by non-resident individuals is contrary to EU law and confirmed that setting an option to choose between a discriminatory regime (28% over 100% of the gain) and a non-discriminatory regime (progressive rates over 50% of the gain) is not enough and Portugal has to fix the non-residents main rule. Further orders of the Court of Justice were issued on C‑224/21 (VX Case) and specially C‑647/20 (XG Case) that confirmed that the breach of EU law also applies to residents in third countries. Recently the tax community was confronted by one more delaying technique by the Portuguese State by filing an appeal to the Portuguese Constitutional Court, which even accepted suspending the return of the tax to the taxpayer.
From a tax policy perspective both cases may have several solutions to remedy a breach of EU Law.
- On the case of the withholding tax, in times when access to foreign capital is fundamental to the economic growth and other tax policy measures are in place to limit interest deductibility or even favour equity capitalisation it is difficult to conceive that Portugal remains one of the few EU countries with a withholding tax on interest income. On top of that, we all should know that the lender (tax) costs are passed onwards to the borrower so effectively what a withholding tax on interest results in many instances is besides being a barrier of entry to competitive financial institutions it is also an increase of the cost of borrowing for the Portuguese taxpayer. In addition, the practice of implementing specific exemptions applicable in very narrow situations leads simply to an “imperfect” market when the large transactions will find a way to achieve a tax efficiency and smaller transactions do not occur.
- On the case of the capital gains on real estate, especially in times of significant price shifts and need to find opportunities of release some tax pressure to households a debate urges on the policy alternatives. The EU discrimination to be corrected could be transformed in an opportunity to aim at a better tax regime of real estate in Portugal.
Other examples could be mentioned as potentially raising EU and requiring a review, such as withholding tax on investment funds, stamp tax on certain foreign lenders or tax on second-hand motor vehicles imported from other Member States.
In any case, this note is not designed to address what should be done but simply to urge Portugal to act and reflect on what lessons can we learn from such inaction.
From the EU level, if Portugal fails to amend the tax legislation, the Commission may bring a further action under Article 260 TFEU against the Member State seeking the imposition of a fine. In practice, the EU Commission acts upon complaints but the EU Commission is not directly concerned with the rights of taxpayers. Monitoring of implementation of tax decisions is also not easy for an EU institution.
On the domestic level, taxpayers are therefore sometimes “toothless” when the Member State votes with the feet and delays amending the tax legislation and continues levying tax against EU Law. Domestic remedies such as filing claims in Portugal are subject to the “pay first and fight later” principle, which benefits the State. The tax litigation costs and the time to achieve tax justice are further limitations on the taxpayers side.
On the damages side, even if the Francovich and Brasserie du Pêcheur case-law of the Court of Justice requires Portugal to compensate for loss and damage caused to individuals as a result of breaches of EU Law, this requires proving that such failure to act is sufficiently serious and there is a direct causal link between the breach and the damage suffered by the taxpayer.
In a moment when we are approaching general elections in Portugal, it should be also time to consider novel approaches to reduce tax litigation and encourage early compliance with judgements of the Court of Justice and effectively protect taxpayer rights.
The role of academics, tax authority and tax practitioners should also be guided to preserve the Rule of Law and enhance legal certainty via the effective application of EU law and Treaty freedoms. The inaction or failure to act also undermines EU integration.
One approach could involve the establishment of a multidisciplinary taskforce composed of academics, tax authority and tax practitioners to assess the constant flow of case law on direct taxes and secondary EU tax rules and test whether the exercise of taxing powers by Portugal remains in line with EU law. Review process on the legislative process is critical to achieve more quality and clarity to the rules and such consultive taskforce could assist on recommendations aimed at reducing tax litigation on cross-border issues.
The reason for this proposal is simply because inaction is always a serious matter when taxpayer rights are at question.
Tiago Cassiano Neves
Managing Partner at Kore Partners