State Budget Law for 2023 introduced important changes to the taxation of capital gains derived from immovable property earned by non-residents.
The Portuguese legislation has already been under the scrutiny of the European Court of Justice (ECJ) for several times on this regard.
However, it seems to continue to disregard such jurisprudence and keeps amending the Law through baby steps in so far as only to avoid penalties from the EU. And along the way, throwing some dust towards taxpayer’s eyes.
With ECJ’s caselaw «Hollmann» (C-443/06), Portugal had to eventually eliminate the existent discrimination. One would expect it to do so seizing the momentum of the Budget Law for 2023, and, in a way, it did – well, kind of.
Let us explain.
Until the end of 2022, ECJ had already ruled that article 43, paragraph 2, subparagraph b) of Singular Persons Income Tax Code was in violation of the free movement of capital when a tax resident could benefit from the reduction in 50% of the taxable base whereas a non-resident could not.
Portugal made then a first amendment to the legislation in order to foresee an optional regime for the non-residents. In this optional regime, applicable only to EU taxpayers (not third countries’ ones), one could opt for the taxation applicable to residents, i.e., the capital gain would be considered in 50% but only if you would be subject to progressive tax rates (varying from 14,50% to 48%), rather than the fixed rate of 28%.
After such amendment, the Portuguese legislation was once again put to the test in ECJ’s decision on the «MK» case (C-388/19), of 18th March, 2021, where the Court ruled that the optional regime did not eliminate the EU law violation (in fact, it might create another one).
While the legislation remained unchanged, the Portuguese Tax Authorities (“PTA”) issued an Internal Ruling where it agreed to grant non-residents the 50% reduction in the capital gain taxable base – if the taxpayer challenged the tax assessment through a tax claim, it would not operate automatically.
Several taxpayers resorted to this and presented tax claims of their tax assessments that were annulled based on the ECJ jurisprudence.
The discussion of the State Budget for 2023 finally arrived and at the last-minute changes to article 43 were introduced: now it expressly foresees that the 50% reduction applies also to non-residents.
But…oops! The tax rate applicable to non-residents is no longer a fixed tax rate of 28%. Non-residents are now mandatorily subject to progressive tax rates (not an option anymore)! And… in order to ascertain the applicable tax rate, the non-resident must fully disclose to PTA his/her worldwide income!
What to make of this?
One can argue that in this way there is no discrimination whatsoever since tax residents and non-residents are treated exactly in the same way. But… are they really?
The existence of fixed tax rates for income derived in the source state by a non-resident has a rationale (the idea didn’t come up out of the blue). The fact that non-residents ended up being taxed at an effective tax rate of only 14% (28% on 50%) should not be automatically deemed as unfair.
The principle of equality clearly states that you should treat equally what is equal and unequally what is different. And such principle is compatible with EU non-discrimination between residents and non-residents.
There’s a reason why residents are subject to progressive tax rates and non-residents are not. The first ones benefit from all the public services, goods, infrastructures, health care system, educational system, etc., that the State provides – the very reason why we pay taxes – and thus the ability to pay principle shall apply in this case and people who “take” more from the State (theoretically) should contribute more. One of the fundamental tasks of the State according to the Constitution is precisely to redistribute the wealth in order to secure the Welfare State. That’s the reason why it makes no sense to subject non-residents to progressive tax rates – they do not benefit from the Welfare State.
One thing is clear: as it stands, the criteria for taxation of capital gains derived from real estate in Portugal is set using income derived from other jurisdictions. So, the immediate question to ask is what is the legitimacy of a State to tax non-residents based on income with no connection whatsoever with its jurisdiction?
One must bear in mind that normally capital gains on real estate are subject to tax in both jurisdictions (Residence State and Source State) according to OECD Model Tax Convention (Article 13), thus, the non-resident will again be subject to tax in the Residence State (from the capital gains derived in Portugal) along with all other income in a worldwide basis and subject to (normally) progressive tax rates.
Moreover, Double Taxation Treaties mostly apply the credit method (in detriment of the exemption method) to eliminate double taxation and only up to a certain limit or threshold, so the subjection of a non-resident to progressive tax rates may have a great impact on the possibility to eliminate double taxation.
Additionally, the obligation to fully disclose the worldwide income to a Source State imposed on the non-residents represents greater burden / compliance cost in comparison to tax residents which are way more acquainted with their tax rules. This tax burden issue was already addressed in MK case.
The previous optional regime gave at least the opportunity to make a rational and economic choice, even if that ultimately meant to discourage the non-resident and promote the acceptance of the discriminatory treatment.
Currently, it seems we’ve gone totally backwards in making the subjection to progressive tax rates mandatory, while forcing non-residents to disclose their worldwide income, without any choice – it’s either that or non-compliance.
March 2023
Joana Tavares de Oliveira and Catarina Gomes Correia