Pension income and the NHR benefits
The favorable taxation of cross-border pensions was perhaps the most emblematic issue of the NHR regime when it was first enacted 10 years ago, but with “fame” came controversy.
In this briefing, we give a brief look to the debate that led to the 2020 change of rules on pension income and its practical application.
To understand the debate, it is important to bear in mind that many developed countries implemented favorable domestic regimes to facilitate household savings via deductible contributions to pension plans and provide tax deferral until actual retirement and pension becomes available.
The adoption back in 2010 by Portugal of a 10-year tax exemption on foreign pensions derived by an NHR combined with the fact that most tax treaties provide for exclusive residence taxation on occupational or private pensions, created a disparity as it allowed for those effectively transferring their residence to Portugal to receive temporarily tax free those pensions.
Portugal was not the first. Israel has long before implemented a similar pension rule to attract new residents to Israel. Greece and Italy followed recently with a low rate.
In tax treaties, most of the countries (like Portugal) have followed the recommendation from the OECD to allocate the exclusive taxing rights to the country of residence at the time the pension is paid. Only more recently, some countries started deviating from this rule by securing taxation rights to the state of origin/source (like a salary payment).
The reality is that the outcome under the NHR led to endless discussions with several countries, the termination of two tax treaties with Sweden and Finland and ended with Portugal conceding to change the regime towards a 10% flat tax rate as from 2020 onwards.
The 10% flat tax on foreign pension income and elimination of the option for full exemption was put in place as from 1 April 2020.
What is relevant to understand from those changes?
To the extent that the pension is not sourced or territorially linked to Portugal, the low rate will apply regardless it is paid via annuities or similar payments – e.g. lump sum.
A foreign tax credit will be available against Portuguese tax for taxes effectively paid on the pension income (if and when such tax treaty allows for such tax to be withheld).
The flat 10% tax rate is applicable to new Portuguese tax residents arriving after April 2020.
For prior residents, a grandfathering rule applies that allows NHR tax residents at the time of the entry in force of the law and that made their decisions under the old law, to opt to apply the prior rule until the original 10-year timeframe elapses.
With these new rules in mind, it is critical to identify where source taxation may exist under a particular tax treaty. Let’s see some practical examples:
Case 1 – Recently arrived NHR receives an occupational pension in the form of periodic income payments sourced in Canada and relating to past work only exercised in Canada
Outcome: Under Article 18 of the tax treaty between Portugal and Canada, pensions arising in Canada and paid to a Portuguese tax resident may be taxed in Canada - but tax shall not exceed “15% of the gross amount (…) exceeding twelve thousand Canadian dollars”. This means that Canada may tax up to a maximum 15% withholding tax and Portugal will give a tax credit against that taxation (which in many instances will mean no further tax is due in Portugal). Note that lump sum payments are expressly considered excluded from the 15% withholding tax limitation set out under the tax treaty.
Case 2 – Recently arrived NHR receives lump-sum payment from a UK approved pension scheme and such income is sourced in the UK and relates to past work exercised in the UK
Outcome: Under Article 18 of the tax treaty between Portugal and UK, “any pensions and other similar remuneration” paid to a Portuguese tax resident in consideration of UK past employment shall be taxable only in Portugal. If one applies the OECD Model Commentaries, it is stated that “a lump-sum payment in lieu of periodic pension payments that is made on or after cessation of employment may therefore fall within the Article”. Under this approach, this would mean that Portugal should tax the pension payment at 10% rate.
Case 3 – NHR that arrived in 2015 receives a periodic pension payment from a Finish private pension scheme sourced in Sweden and relating to past work only exercised in Finland
Outcome: Since the NHR arrived before 1 April 2020, the taxpayer may still opt to benefit from full exemption on pension income sourced outside Portugal. In any case, Finland has terminated the Portuguese tax treaty with effect as from 1 January 2019 and the new tax treaty negotiated between the two countries has not been ratified yet by Portugal. In absence of a tax treaty, Finland may fully tax the pension income according to its domestic law. Under the tax treaty pending ratification (if that enters into force), Finland may also tax the pension income if it has granted tax relief (i.e. deductions) for the pension contributions during the accumulation phase. Credit in Portugal should be available against any source taxation in Finland.
Ultimately these are merely simple practical cases dealing with cross-border pensions. One should always take care on the qualification of the income under foreign and Portuguese tax law to frame this as pension income (Category H of the Personal Income Tax Code).
A final note to highlight that Portugal is not alone on the trends to tax foreign pension income of expatriates moving inward. Italy and Greece adopted recently a 7% tax on pension income.
Key takeaways
Determine the type of pension income (i.e. government/occupational/private);
Beware that the NHR tax regime for pensions has changed in 2020;
Evaluate carefully the qualification and applicable tax treaty provisions;
Any source taxation on pensions should be creditable against 10% Portuguese tax; and
Lump-sum commutation payments may require careful interpretation of provisions.
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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