Preferential treatment for newcomers
Portugal is a wonderful country that offers a lot to its residents. The political climate is stable and the economy is gradually evolving into a modern economy.
The tax rates for typical long-term residents are traditionally one of the highest in Europe and in turn, provides extensive social services (albeit not in-line with some other high tax rate European countries).
Whilst “typical” residents pay very high tax rates, the government of Portugal wishes to attract talented foreigners and their capital. The popularity of Portugal has been consistently growing over the last few years, but with the changes of lifestyle triggered by the pandemic, remote workers, entrepreneurs and many other foreigners are attracted to Portugal and are moving to Lisbon, Porto, the Algarve and Madeira in increasing numbers. Portugal made it relatively easy for earners of foreign income to immigrate and settle and is also offering a favourable tax regime for new residents. The regime is called the Non-Habitual Residency tax regime (NHR).
Newcomers to Portugal are people who have not been tax residents in Portugal in the last 5 years. The benefits are not obtained automatically.
The NHR “status” must to be actively requested but it is easy and free to obtain it so far that it is done on time. The deadline is the 31st of March the year following the year a person became a tax resident. The status is in force for 10 years and cannot be extended.
The entitlement to be taxed as a non-habitual resident in each year of the above mentioned period, depends on being, in that year, considered resident in Portuguese territory. However, if for whatever reason the relevant person is not a resident in Portugal for a particular year within the 10 years period, the entitlement is only lost for that year and can be enjoyed in following years, until the expiry of the 10 year period. One common myth is that in order to obtain an NHR status one must have a high value profession.
This has been, to an extent, true in the past, but it is not true today. The NHR status does not require a person to have any particular type of profession or work at all.
The benefits of NHR
The NHR provides three primary benefits.
- Reduced tax rate for income earned in Portugal
The first is a reduced tax rate of 20% for income earned in Portugal in a list of trades/professions that Portugal seeks to attract (i.e. high value professions). The reduced tax level is approximately 20% in the first year and up to 35% in later years, made from a 20% income tax and up to 15% national insurance contribution, with an exemption on the first year’s contributions, 25% discount on the second year and a cap of €1125 a month.
|Employment income under NHR in a high value profession|
|First year||Income tax||National Insurance|
|Second year||20%||11.175% up to €1,125|
|Third year plus||20%||14.9% up to €1,125|
- No income tax for foreign-sourced income
The second is a further reduced tax rate on foreign-sourced self-employment income in a the same list of trades/professions that Portugal seeks to attract, provided the country where the income was obtain may tax the income. In this case, in qualifying conditions are met, there is no income tax and the tax-payer only pays national insurance at a maximum rate of 15%.
|Foreign sourced self-employed income|
|First year||Income tax||National Insurance|
|Second year||0%||11.175% up to €1,125|
|Third year plus||0%||14.9% up to €1,125|
What is foreign-sourced income?
Foreign-sourced income is income earned outside of Portugal. There is some debate as to whether income earned by a person when that person is in Portugal from a client who is overseas is Portuguese-sourced or foreign-sourced. Such income, in our view, would normally be Portuguese-sourced. However, each case is decided on its specific circumstances. When the income is obtained, for example, during visits to other countries or using employees or sub-contractors in other countries, the matter becomes more and more complicated.
- Exemption on foreign profits
The third is full exemption from taxation on income derived from foreign sources so far as the foreign country where the income is obtained is allowed, under the relevant Double Taxation Income (DTT), to tax the income (even if the income is not in fact taxed). This includes investment income, royalties, dividends from companies etc. Such income does not normally include capital gains unless these are from property (and are therefore taxed in the country where the gains are made) or if they apply to US citizens (since the US taxes on a citizenship basis).
Portugal holds a list of “black-listed” countries and income obtained from such countries cannot benefit from the NHR regime.
Tax payers must declare all their global income even if it is not taxed in Portugal.
The tax treatment of income from services to foreign companies
The categories mentioned above inevitably overlap - most foreigners that have a strong income are in fact receiving it from clients overseas but the income is often received as a result of work done by individuals in Portugal.
Here, if the income is classified as employment income, it will be taxed in Portugal either at the preferential rate (if the trade is in the list) or the full rate (if it is not). If it is received from self-employment, it will be taxed like employment if it’s locally sourced or at a maximum of 15% subject to qualifying conditions if it is foreign-sourced. If it is received as a dividend from a foreign company, it will normally not be taxed in Portugal at all, provided that the agreement to avoid the double taxation between the country where this income was generated and Portugal allows the other country to tax the income (which is the case in most of the relevant agreements) There is therefore great importance to the classification of the income and diligent newcomers who wish to reduce their tax burden should carefully consider how should income be classified in the most tax-efficient way. Needless to say, classifying income also has impact in the country where that income is sourced and the key to diligent tax planning is to consider the rules in all relevant countries. One may conclude that the mere creation of a foreign entity therefore leads to a complete exemption from taxation. This is not the case, unfortunately.
A foreign entity that is effectively managed from Portugal may be treated by the Portuguese tax authorities as a Portuguese entity.
The treatment of U.S.-based LLCs
One common vehicle for receiving income is a U.S. LLC. U.S. LLCs are a unique U.S.-structure that does not have obvious equivalents in other countries. The LLC can decide whether to be taxed liked a corporation (which is equivalent to a company in Europe) or whether the income passes to the members of the LLC. A structure that divides the income between the members resembles a European-style partnership, but it is not the same. In a partnership, the partners have a proprietary right to part of the profits whilst in an LLC the right is contractual – the LLC generates profit and then the partners have a right to participate in the distributions based on the operating agreement. The importance of this distinction is that the profits of an LLC can more easily be attributed to the business. There is great importance to this classification – whilst business profits are taxed by default at the country of incorporation, income from professional services is taxed by default at the country of residency.
There are some precedents but no clear guidelines in Portugal how to treat a US LLC, giving the members some leeway how to classify their income. Under NHR, income classified as business profits will not normally be taxed in Portugal. Since the profits pass to the members, it will also not be taxed in the U.S. Again, it is important to pay attention to the fact that if a U.S. LLC is fully owned and is effectively managed by the taxpayer from Portugal, the Portuguese authorities could ignore the place of incorporation and treat the LLC as a Portuguese entity.
The bottom line - when a US LLC is not managed by the tax-payer from Portugal and distributes revenue its members in Portugal, the member has a reasonable position that no tax is due anywhere.
For U.S. citizens who live in Portugal, the situation is even preferable, so far as they earn less than approximately 112,000 USD a year. U.S citizens are taxed in the U.S. on their global income but they do have an exception for foreign earned income up to approximately $112,000 every year, so for U.S. citizens earning less than that amount, it is exempt from the U.S. but the US’s right to tax the global income is arguably sufficient to avoid taxation in Portugal even if the income is considered professional income.
A U.S. LLC is very easy to create and maintain and the cost of doing so is usually negligible compared to the potential savings. At FRESH, we offer such solutions that involve the creation of an LLC that is not effectively managed by the tax payer.
The treatment of UK Limited Companies
UK limited companies are another beneficial structure to holders of Portuguese NHR. UK limited companies pay tax at 19%. This tax rate will rise to 25% in 2023 but companies with profits lower than £50,000 will continue to benefit from a 19% tax rate. Dividends from a UK company to an individual residing in Portugal are exempt under NHR since the double taxation agreement allow the UK to tax dividends but in practice it does now. It is therefore also exempt in the UK.
An often-unknown fact is that the UK corporation tax could be dramatically reduced in the event that a company is a research and development company undertaking R&D activities.
Profitable companies can claim up to 230% of their qualifying R&D expenditure as expenses, thus considerably reducing and sometimes eliminating any corporation tax liabilities.
Further information For an initial assessment of your taxes in Portugal and the opportunities to optimise them, contact email@example.com