Sweden follows Finland to terminate tax treaty with Portugal
Sweden announced the intention to unilaterally terminate tax treaty with Portugal as from 1 January 2022.
The reason advanced by Sweden for termination of the tax treaty is that Portugal (and also Greece) introduced targeted tax rules that essentially allow individuals moving from Sweden to these countries to pay low or no tax on, for example, occupational pensions and capital gains originating from Sweden.
On 16 May 2019, Sweden and Portugal had already signed a protocol that included several changes, including an amendment to Article 18 to remove the possibility for individuals to withdraw income from private pension schemes without paying tax on the income in Portugal, while also claiming an exemption from tax on the income in Sweden under the treaty. Not being the priority legislation, that protocol has not been yet ratified by the Portuguese Parliament.
As a result of the termination notice (if approved), as from 1 January 2022 income will become to be taxed according to the domestic tax rules of Portugal and/or Sweden with limitations arising from the EU tax directives and fundamental freedoms in place within the EU.
This short note examines the tax consequences of the termination of tax treaty both for corporate entities and individuals deriving Portuguese-source income.
For corporate entities deriving Portuguese-source income
Certain services sourced in Portugal and rendered by Swedish resident companies become subject to withholding tax (WHT) in Portugal at the rate of 25%. Relief of double taxation will depend on Swedish domestic relief rules.
Dividend income sourced in Portugal and received by Swedish resident companies will only become subject to withholding tax at 25% rate if the domestic participation exemption implementing EU Parent Subsidiary Directive would not be applicable (i.e. only for situations below a 10% qualifying shareholding and below a 1 year holding period).
Interest and royalty income sourced in Portugal and received by Swedish resident companies will become subject to withholding tax at 25% rate, when the domestic exemption implementing the EU Interest and Royalty Directive is not applicable (i.e. below 25% direct and indirect shareholding and 2 year holding period).
Capital gains sourced in Portugal and derived by Swedish resident companies will become subject to the domestic tax treatment applicable to non-residents. The Portuguese domestic tax treatment provides generally for exemption of capital gains but gains derived from the sale of real-estate rich companies are taxable at 25%.
For individuals deriving Portuguese-source income
Interest, dividends, and royalties sourced in Portugal and derived by Swedish resident individuals will become subject to the domestic tax rates, namely 28% in the case of Portugal.
The tax treaty rule that provided that private “pensions and other similar remuneration (…) shall be taxable only” in the country of residence of the recipient ceases to apply. As a result, private pensions paid out from Sweden or Portugal will become taxable under the domestic rules of each country.
For Portuguese non-habitual tax residents receiving pension income from Sweden, this termination will mean that any tax levied in Sweden will be credited against Portuguese tax on the pensions, if any (namely the 10% flat tax rate for foreign pensions applicable to new Portuguese tax residents as from 1 April 2020).
Kore Comment
Even if countries retain the right to unilaterally terminate tax treaties, subject to certain procedural rules, the termination is rarely used and is sometimes viewed as a last resort tool or step towards renegotiation.
With the termination of the tax treaty, Sweden follows the route taken by Finland in 2018. The case has similarities in the sense that both countries pushed initially towards a renegotiation of the tax treaty and move towards the termination due to lack of swift ratification by Portugal.
The termination by Sweden of its tax treaty with Portugal (and likely also of the one with Greece) may result in several unforeseen tax consequences beyond the intended motivation, which may lead to higher effective tax rates or even double taxation in some cases.
Based on our experience, the termination of a tax treaty is also likely to open areas of potential conflict, namely:
Lack of a tie-breaker rule for dual residence situations.
Expanded domestic definition of a permanent establishment in Portugal may lead to increase tax exposure for Swedish businesses operating in Portugal.
Potential withholding tax issues on certain non-qualifying participations and/or service fees (including management fees) which become subject to withholding tax without full relief in the resident country.
© Kore Partners, March 2021. This note 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. Queries or comments regarding this including joining our mailing list can be directed to kore@korepartners.com