Budget Proposal for 2022 - Kore Takeaways

NOTE: Due to the rejection of the Budget Proposal for 2022 in the Parliment the proposals below will no longer be enacted and new general elections are scheduled for January 30th. The text below is maintained only for information purposes.

The Portuguese Budget Proposal for 2022 was presented to the Parliament on 11 of October 2021 and will now enter a phase of parliamentary discussion for the next weeks to arrive to a final text. We summarize the Kore Takeaways with specific impact for private clients, which, if approved, are expected to apply as from 1 January 2022 onwards.

The specific measure that is raising attention due to its scope and the potential distortions it may cause is the so-called taxation of short-term capital gains (i.e. those held for a period less than 365 days) as from 1 January 2022 at the progressive rates up to 48% (plus surcharges), when the taxpayers have total taxable income higher than €75.009.

This rule will impact not only tax residents under the general regime but also those under the special NHR regime. For non-habitual residents, the progressive rates are mostly not applicable as the income when not exempt is either taxed at flat rates of 20% for active value added activities or 28% for passive income. With this rule of taxing at progressive rates the short-term gains, those rates and impacts become important to review.

In a recent insight, we dealt in detail with the taxation of foreign capital gains from a perspective of the NHR (see here). The 28% flat tax on capital gains already comes as a surprise for many NHR and this is because the basic rule of NHR regime provides that foreign-sourced capital gains are only exempt from tax in Portugal whenever the capital gains may be taxed by the source state according to the provisions of a tax treaty with Portugal or the OECD Model. Since most Portuguese tax treaties (with the exception, for example, of the tax treaty with Brazil) allocate exclusive taxing rights to Portugal when it comes to disposal of shares, the 28% flat rate has become an issue that most NHR have become familiar with or have planned ahead.

In Portugal, the top progressive rate of 48% currently applies to taxable income above €80.882 (to be lowered to €75.009) and an additional solidarity surcharge is also levied at 2.5% on the annual taxable income between €80.000 and €250.000 and 5% on the annual taxable income exceeding €250.000. Therefore, technically for a short-term capital gain of €300.000 the maximum rate may change from 28% to an effective rate close to 48% (applying the progressive income and surcharges). This represents an increase of almost 20% of the tax payable in comparison with the flat rate of 28%.

The proposal, by changing the general tax regime of capital gains, may impact therefore non-habitual residents whose non-exempt income would become taxed in the same way as income of ordinary resident taxpayers. Even if in prior cases of NHR regime changes a grandfathering of existing NHRs has been secured under the law, the truth is that this is absent of this Budget Law proposal. For this reason, it is very convenient to look closely at the proposal and what could be the alternatives to consider.

The scope for short-term gains taxation for shares and securities is limited to transactions with a holding period lower than 1 year and covers: (i) gains from sale, redemption and amortization of shares; (ii) gains from non-tax neutral mergers, demergers and exchange of shares; (iii) gains from repayment of bonds; (iv) gains from redemption of fund units or liquidation of funds (not taxed at flat rates); and (v) gains from liquidation, revocation or termination of fiduciary structures by the settlor. The progressive rates will also apply to short-term gains sourced in blacklisted jurisdictions that are currently taxed at a higher 35% rate.

This proposal is attracting a significate public debate. Some of the policy shortcomings have already been identified.  First, there apears to be no clear tax policy motive underlying a position of taxing short-term gains in Portugal. Second, there is no EU benchmark indicating this format of taxation would lead to adequate results. Third, there are no tax reasons to treat equivalent passive income in very different formats. Fourth, the capital markets in Portugal are already under pressure due to its limited scale and do not need a further limit.  Fifth, this will likely add further complexities and compliance costs not leading to any significant tax revenue. Finally, this measure creates tax uncertainty and also represents one more change affecting NHR that chose Portugal to reside under a 10-year tax regime.

From a technical perspective the measure also faces some challenges. There are several situations of Portuguese-source capital gains that will likely remain taxed at final flat rates (e.g. redemptions of Portuguese-based funds) and this may lead to unlawful EU-based discrimination if similar redemption of foreign funds are taxed at progressive rates (when held for less than 1 year).  Under Portuguese tax law, losses may be carried forward for 5 years when there an option to tax at progressive rates is exercised. If short-term gains are taxable then the other side of the coin is that losses may also be carried forward for 5 years. The open question in this new proposal will be offsetting a long-term loss against a short term gain and vice versa. Something that was relatively simple to explain to taxpayers - “you are taxable on the balance of the gains and losses of a particular tax year” - has everything to become a nightmare. Just consider that particular losses of securities linked to blacklisted jurisdictions are disregarded (this raises other issues but we will not go into detail here) and if the gains become taxable at progressive rates we may see extreme situations where income is taxed at abnormal effective tax rates. Finally, the additional solidarity surcharge which was intended to apply only to 2012 and 2013 has perdured in time (like many transitory taxes in Portugal). 10 years have passed and there is nothing of transitory in this measure. In addition, the surcharge was designed to apply to active income and with the design of the short-term capital gains provision the results are increased progressivity.

The impact of this measure may be mitigated with adequate planning ahead. This will require a closer dialogue between tax counsel and financial advisors for year-end planning on short-term positions and consider possible financial products outside the progressive tax rule. This may include shifting assets from capital gains generating to income-based generating, such as distributing based funds instead of accumulating funds. Reinforcing positions on favourably taxed financial products or unit-linked life insurances may also be considered. Ultimately, this measure, if adopted, may incentivize taxpayers to review from a holistic perspective their financial investments to better adjust to the tax changes.  

At Kore Partners we will be monitoring closely the outcome of the budget negotiations, which will be enduring until 25 November, the day of the final vote.

Download our Budget Kore Takeaways