Digital nomads and NHR – challenges and issues ahead
The pandemic brought us a fresh perspective on the future of work with the emergence of remote work or work from home (WFH) and digital nomads. The new normal raises novel perspectives from both a legal and tax standpoints related to mobile workforce and this interacts with how the Portuguese NHR regime will operate.
Digital nomad used to be a term (once upon a time) reserved for startup entrepreneurs, freelancers or employees in tech space. With the digitalization of the economy, it gained a momentum of its own and several countries (such as Estonia, Croatia and Greece) followed with measures to attract this new breed of skilled workers.
When NomadList, which ranks the best places for remote workers, sets Lisbon as top ranked city this means a trend is perhaps being set and we should stop to understand the key challenges from a tax perspective.
A digital nomad is generally a self-employed (not with fixed employment contract) and when traveling to a country like Portugal has to juggle with many issues, from personal tax issues, employment law, social security to immigration visas to smoothly work remotely. To add to that, the companies they collaborate with may also have to juggle with potential corporate tax liability arising from permanent establishment (PE) considerations.
We will assume a digital nomad resident for tax purposes in Portugal as NHR and providing digital based services to foreign entities or persons. The briefing attempts through a dynamic Q&A clarify the application of NHR regime to self-employed remote workers and at the same time address some key questions.
What are briefly the international tax rules for taxing self-employed remote workers providing cross-border services?
Most countries have domestic provisions to levy a source tax via a withholding tax to tax income earned/derived by foreigners from their country. The tax treaties (modelled under the OECD Model or UN Model) then divide the taxing rights and provide rules to eliminate double taxation:
Self-employed persons are only paying income tax in their residence country, unless they have a PE in source country (Article 7 OECD Model or Article 14 UN Model). This means that services rendered by a self-employed resident in Portugal rendered to a foreign country generally will not have any withholding tax in the other country.
If a self-employed resident in Portugal operates their business through a PE or fixed base in the foreign country, they must pay tax in that foreign country on all the income attributable to that PE or fixed base. It will be a case-by-case analysis.
Special rules apply for performing artistes and sportsmen, where the tax treaty allocates taxing rights to the country of performance, regardless of the general rules for self-employed persons. This means, artistes and sportsmen resident in Portugal that perform activities abroad will pay income tax also on the source country regardless of having a PE/fixed base in such foreign country.
Will a self-employed remote worker be subject to 20% flat income tax under the NHR regime?
Assuming that the self-employed remote worker is billing service fees to companies outside Portugal, the NHR tax treatment depends on (i) whether these fees are effectively subject to tax in the source/foreign country; and (ii) whether the services qualify as high-value added activity (See list of professions qualifying for the HVA test).
On point (i) of taxes being levied abroad - we already concluded that international tax rules set out that the source country (or recipient of the services) will in most cases not be able to tax the service fees charged by the digital nomad unless there is a PE/fixed base in the source country. In absence of the PE/fixed base, this will mean the foreign income generated by the digital nomad is not tax-exempt under the NHR rules.
If not tax-exempt in Portugal, emphasis will then be on point (ii) – i.e. qualification as HVA activity performed by the digital nomad. This HVA test is largely a case-by-case analysis, based on the codes used and function description of Portuguese Classification of Professions (CPP).
If the answer is yes to HVA test, the flat 20% rate will apply. If by any chance the services do not qualify for the HVA test, the fees derived from abroad will be subject to Portuguese general progressive rates (up to 48%) with simplified regime being applicable for turnover below €200.000. This simplified regime provides for automatic deductions, from the tax base from 25% to 75% (depending on the type of services).
Does a self-employed remote worker in Portugal create permanent establishment risk for the foreign company in Portugal?
The current COVID-19 environment leading to temporary displacement of workers has given rise to concerns of unintentional PE issues from mobile workforce.
The existence (and risk) of a PE for foreign companies will largely depend on the factual background of the activity of the self-employed and foreign company paying for the services. Typically, the PE will be determined based on domestic rules and tax treaty (if applicable) and will arise where the foreign entity has (i) a fixed place of business in Portugal; or (ii) a dependent agent in Portugal.
The Portuguese Budget Law for 2021 has brought substantial amendments including a service PE targeting provision of services (including consulting services) that last in Portugal for more than 183 days within a 12-months period. This provision would not apply if the respective tax treaty in force with Portugal does not have equivalent Service PE rule. More relevant is the widening under domestic law of the cases where the active role of non-independent agents may give rise to a PE in Portugal.
Most self-employed structures will operate in a manner that none of the PE conditions is met. For example, a self-employed person will work from home or be itinerant, without formal office being leased and with a role and responsibilities that do not trigger a dependent agent relationship.
The trend is towards a more tax-disruptive environment and this may be said to increase scrutiny of PE issues and foreign companies should monitor the risk.
What is the social security framework for a self employed remote worker?
When providing work to several foreign jurisdictions, in most cases the connection to Portuguese social security will be triggered when a “substantial part” of activities - at least 25% of all the self-employed activities - is pursued in Portugal.
This will mean that such self-employed are obliged to pay social security contributions after the expiry of the one-year initial exemption. The rate of 21,4% will be charged monthly on the 70% of the gross amount invoiced and contributed each trimester with a financial cap. This is equivalent to 15% rate for services (with lower rates applicable to activities in production and sale of goods or touristic sphere).
Conversely, social security for remote workers with employment contracts is significantly different (and with no cap) and stricter even in situations where work is exercised in different countries.
What about VAT aspects of self-employed remote worker?
Services rendered by self-employed are generally subject to 23% VAT if the annual supplies exceed the €12,500 threshold.
For B2B services rendered to value added taxpayers registered within other EU states, VAT will be assessed by the recipient of the service. For services rendered to clients in non-EU member states, generally no VAT will be levied.
Value added tax returns should be submitted and tax paid quarterly in case of annual supplies of less than €650.000. Input value added tax may be deductible, subject to specific rules and limitations for carrying individual self-employed business.
Key takeaways
1. Portuguese NHR digital nomads raise new tax challenges that require careful evaluation;
2. Most foreign income derived by digital nomads is only taxable in Portugal as NHRs would not have foreign PE/fixed base;
3. Application of 20% flat tax rate depends on fulfilment of the HVA test;
4. PE risk in Portugal of foreign companies with long-term self-employed personnel should be carefully managed; and
5. Social security and VAT are additional set-up elements that are important for digital nomads providing services from Portugal.
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© Kore Partners, 2021
This briefing provides for general information and is not intended to be an exhaustive statement of the law. Although we have taken care over the information, this should not replace legal advice tailored to your specific circumstances. This briefing is intended for the use of Kore Partners clients and is also made available to other selected recipients. Queries or comments regarding this including joining our mailing list can be directed to kore@korepartners.com