Capital gains from sale of real estate in Portugal. EU Conundrum or Opportunity?
The Budget Law for 2022 in Portugal is close to be presented and we might still be on time to discuss the issue of capital gains taxation from the sale of real estate assets by individuals. The Budget Law 2022 is expected to solve the EU conundrum after the Court of Justice of the European Union (CJEU) judgement in the MK case (C-388/19). The objective of this brief is not to discuss the legal reasons that lead the CJEU to consider that the Portuguese tax rules are discriminatory between residents and non-residents but to attempt to make the leap and address wider policy and technical issues of the taxation of capital gains from the disposal of real estate that the Portuguese legislator faces.
The EU Law issue
Portugal taxes differently resident and non-resident individual taxpayers on the disposal of real estate located in Portugal in several instances. Let’s compare:
Residents Main Rule: 50% of capital gains arising from the disposal of real estate by tax residents in Portugal is taxed at the marginal progressive rates varying between 14.50% and 48%.
Residents Exception Nº 1: Capital gain may be wholly or partially exempt if the proceeds refer to the taxpayer's primary residence and such proceeds (not the gain) are reinvested in the acquisition, improvement, or construction of another primary residence in Portugal or within the EU/EEA within 36 months from the sale or in the period of 24 months previous to the disposal.
Residents Exception Nº 2: Capital gain may be wholly or partially rolled-over if taxpayer is retired or aged over 65 and reinvests proceeds from primary residence disposal in an eligible life insurance contract or qualifying pension fund within 6 months of sale.
Non-residents Main Rule: The full capital gain from the disposal of a property located in Portugal is taxable at a flat 28% rate but the taxpayers have the option to opt for the regime applicable to residents (in the tax return).
For any practitioner that follows attentively EU Law developments, one would immediately anticipate that some differences in treatment could lead to potential unlawful discrimination that would extend beyond EU/EEA and would also impact taxpayer’s resident in third countries.
It therefore came as no surprise that on March 2021, the Court of Justice ruled that the Portuguese taxation of capital gains realized by non-resident individuals is contrary to EU law and hence confirmed what was already the position of the Portuguese Supreme Court in prior cases. In short, setting an option to chose 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. The impact is that non-resident individuals (including resident in third countries) that have disposed of real estate in Portugal and were taxed under the main 28% flat rate rule in the past four years may raise a claim in Portuguese courts.
The Tax Policy issue
Taxation of household capital plays a crucial role in terms of economic efficiency of the tax system and specially when it comes to disposals of owner-occupied housing the policy decisions are critical. At present, the taxation of immovable property is not harmonised at EU level and remains largely within the competence of each Member States. EU law only prevents from introducing measures which discriminate, directly or indirectly, against non-nationals or against nationals who have exercised their fundamental freedoms. Therefore the first policy question is how to fix the discrimination issues?
In simplistic terms, the options are the following:
Taxing residents and non-residents all at the 28% flat rate on 100% of the capital gains;
Taxing residents and non-residents on 50% of the gains at progressive rates; or
Reforming the system and adopting a different long-term and short-term tax rates equally applicable to residents and non-residents disposing real estate and possibly addressing also the rollover relief for primary residences.
The first option is the simplest to enact, but it may lead to an increase in tax for certain households as 28% tax may even be considered a high tax rate, unless specific deductions are put in place to tackle regressivity (lower income cases). The second alternative raises complexities on the cross-border application of progressive rates to non-residents and lacks strong basis from a comparative perspective. The third alternative is adopted widely in Europe and would potentially have the advantage to simplifying the regime by adopting a simple holding test favouring long-term holding vs more speculative transactions. This differentiation between long-term and short-term holding could also address the issue of inherited/donated property that currently faces the cadastral tax value as the acquisition value for future disposals, regardless of the years of holding by the taxpayer. We call this the “hidden donation tax” in Portugal.
The Primary Residence issue
Generally speaking, the application of a more favourable tax regime (lower rates and deductions) for immovable propriety used as principal residence by the taxpayer does not infringe EU law but there could be an opportunity to address some open policy points of this rules.
The primary residence exemption or roll-over regimes are widespread in Europe and they are critical to incentivize household savings. The rollover relief in Portugal would benefit from some adjustments. For example, the obligation to reinvest the full proceeds from the sale raises difficult issues when families downsize their property and face a considerable tax impact. Another issue is the limited scope of the option to reinvest in life insurance or pension funds (here we have another potential discrimination issue) and the mixing of both options. Another issue is the irrelevance of the holding period. A further issue would be tackling discrimination arising from the non-application to a taxpayer disposing of his main home shortly after the taxpayer moved to another EU member state. Finally, one could also potentially link this issue with the current transfer tax rules for main residence versus second residences to determine if we are correctly incentivizing owner-occupied housing.
Conundrum or Opportunity?
Would like to see an open debate on the policy alternatives in such a critical aspect of household capital. We believe this debate needs to occur now because the recent increase in prices may have a large lock-in effect that can distort decisions on sales (people not selling due to the tax effect). Plus the recent limitations to residential golden visa may have unexpected impact on prices and statistics indicate a large dependence on property within household savings. Hence, getting right the interaction of income tax with property transfer and holding taxes is critical. Lets use the EU Conundrum and transform this in an opportunity to aim at a better tax regime of real estate in Portugal.
© Kore Partners, 2021
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