Split year and NHR - what it means and practical issues
Double residency issues for individuals are always an area of concern as cases when they happen (and they do in practice) may lead to complex implications sometimes leading to long enduring litigation or mutual agreement procedure.
In many situations, those conflicts arise in the year of arrival or departure and hence careful planning is highly recommendable. The split year or partial residence applied in Portugal may play an important role.
Experience has showed that the split year approach has simplified and reduced situations of potential dual residency conflicts in the year of arrival or exit but some points deserve a deeper look. The briefing aims to clarify main concerns and at the same time address some difficult questions.
Split year or partial residence rule in Portugal
Until 2015, Portugal was amongst the countries that did not split its tax year for tax residency purposes, so if one would arrive in the first half of a year, the taxpayer would become tax resident from 1st January that year. If one would arrive on the second half of the year, there could be basis to argue that the taxpayer remained non-resident to the extent taxable in the departing state.
This approach changed with the adoption of the split year or partial residence rule with effect from 2015. For those arriving or leaving Portugal, the tax year is now split into periods of residence and non-residence.
Split year and 10-year NHR period
The 10-year period of the NHR is continuous and not subject to renovation. Since the domestic rule to become tax resident is very broad, regardless of the month of arrival or losing the status of tax resident in the country of exit, the conservative advice has been to register upon arrival as tax resident and effectively use one of the ten years of the NHR regime. Likewise, on the exit moment, even if one ceases to be resident in the first months of the taxable year, it is likely the tax authorities will consider that one full year of NHR was used.
Split year does not mean step-up upon arrival
Pre-entry capital gains planning is generally recommended as financial assets held by a newly tax resident individual do not receive a step-up in basis to the fair market value at the time such individual becomes tax resident in Portugal.
Split year has therefore nothing to do with the tax basis. Any future capital gains tax payable in the event of a taxable disposal (generally taxed at 28% when not exempt under the NHR) will be based on the historical acquisition cost.
In situations where exit taxes apply in the former country, it is important to mention that Portuguese tax law does not provide any specific rules on whether there is a step-up if and when such exit tax crystallizes.
Split year and dual residence situations
In practice, dual residence cases may arise in two different contexts:
The first situation arises from continuous presence in two countries leading to a person being considered as resident during the same period under the domestic laws of each country.
The second situation is where a person is consecutively resident in the two countries by moving from one country to the other part way through the tax year and as a result being resident in both states but at different times.
Further complexity may arise when tax years of two countries overlap – for example when some countries follow the calendar year approach and others follow a financial year approach (April to April like the UK).
Naturally, if those two countries adopt split year, the cases of dual tax residence on arrival or exit are largely reduced. In any case, experience indicates that in many cases it is necessary to resolve potential disputes based on tax treaties.
Resolving dual resident issues
The resolution of dual residence via tie-breaker rules in tax treaties is far from uniform between jurisdictions even when those treaties are all based on the OECD Model.
The tie-breaker serves to break the “tie” and assert which country is the “winner” and taxes on a worldwide basis. The other is the “loser” retaining taxing rights on territorial basis.
Tie-breaker rules are inherently based on facts and circumstances and the tests start by considering the location of permanent homes that are available to the individual, followed by the individual’s personal and economic relations (centre of vital interests), followed by the habitual abode, and nationality, before relegating the issue to the competent authorities to determine the individual’s residence by mutual agreement.
In dispute situations and as many terms of the tax treaty are not defined, it is critical to have an overview of national and international judicial decisions that may provide invaluable guidance on the application of these tie-breaker rules.
Sometimes there is even no tax treaty or a tax treaty is not applicable to a wide category of residents (for example the case with the UAE). Outside a situation of a tax treaty, there is increased potential of unrelieved double taxation. Even if the treaty network of Portugal is rather wide, there is no tax treaty with Argentina, Australia, Finland and Sweden (as from 1 January 2022).
Split year and Exit Tax
For individuals exiting Portugal, their unlimited tax liability in Portugal ends as of the day of their actual relocation. Income and assets linked to Portugal remain subject to tax, such as, for example, Portuguese real estate or corporate entities.
The relocation of an individual’s tax residence out of Portugal is generally not subject to exit taxation. There is a targeted exit tax rule, according to which the tax deferral granted to a shareholder of a company participant in a tax neutral reorganization may be withdrawn when that shareholder changes its tax residence out of Portugal to another country. No payment deferral (only instalments) is granted and future decreases are not taken into account in this exit tax.
There is also a trailing tax rule for Portuguese nationals that relocate their tax residence to a blacklisted jurisdiction, where they may continue to be regarded as tax resident in Portugal on the year of exit plus four years, unless they prove that the change is for defensible reasons.
Kore takeaways
The 5 key conclusions from this briefing are the following:
Split year for tax purposes facilitates arrival and departure from Portugal;
There is no (financial) step-up upon arrival as a NHR resident in Portugal;
Dual residency situations remail relevant to monitor regardless of the split year rules;
Tie-breaker application is not uniform; and
There is in most cases no exit tax in Portugal and trailing taxes are limited to nationals.
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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 Download the Private Client Briefing