What is the best way of structuring a rental property investment in Portugal by a non-resident individual or corporate investor, so as to mitigate tax on rental income and future capital gains?
The Portuguese real estate market is currently attracting many foreign investors in view of the current financial crisis, which is creating excellent opportunities in terms of both rental yields and capital growth. This article describes a way of structuring a rental real estate investment in Portugal so as to minimise tax on both rental income and future capital gains.
Individual vs. corporate ownership
Individual ownership of Portuguese rental real estate has the following inconvenient. As regards rental income, this is taxed at 25% and the only tax-deductible costs are documented maintenance/repair expenses and annual municipal property tax (“IMI”); i.e. management charges, depreciation and financial costs are not deductible. Then, upon the disposal of the property, there is no way out of paying 28% tax on the capital gain, unless the property is the owner’s main residence and the proceeds are used to purchase another main residence in the EU. But if a non-resident special purpose corporate vehicle (SPV) is used instead to buy and own the property, then the SPV itself can be sold in lieu of the property with no liability to Portuguese capital gains tax.
In the absence of a permanent establishment in Portugal, ownership by a non-resident corporate entity is treated for rental income purposes in essentially the same way as individual ownership. But if the foreign corporate owner has a branch in Portugal that rents the property, then, just like a Portuguese company, it will be allowed to deduct all costs in connection therewith, including unlimited management charges, depreciation (as a rule, 1% per annum on 75% of the property value) and financial costs (capped for 2013 at either EUR 3m or 70% of a business’s EBITDA, whichever the greater amount, this percentage to be progressively reduced each year, until it reaches 30% in 2017). Furthermore, operating losses may be carried forward (but not back) during 5 years as long as losses used in one financial year do not exceed 75% of the taxable profit for the same year.
50% of capital gains concur to the calculation of the taxable profit of a resident corporate entity, but under certain circumstances such gains may be exempt if the disposed of assets were held for at least one year and the total proceeds are reinvested. On the other hand, 50% of capital losses are deductible from the taxable profit.
The rate of corporation tax for 2013 is 25% (unless a reduction takes place as announced by the government, but this looks unlikely to occur before January 2014). In addition, a surtax of 3% applies to profits between EUR 1.5m and EUR 7.5m, and of 5% to profits over this latter amount. A municipal surcharge of up to 1.5% on profit may also be levied and thus the maximum aggregate tax rate may reach between 25% and almost 31.5%.
Taxation of dividends and capital gains
Withholding tax generally applies at 25% to the payment of dividends, interest or fees made by Portugal-resident entities to non-resident entities, unless reduced or eliminated under a double tax treaty or an EU Directive. However, no tax applies to the remittance of a Portuguese branch’s profits to its parent.
Unless eliminated under a double tax treaty, capital gains made on the disposal of a Portuguese company will be taxed at 28%.
Type of corporate vehicle
Entities based in an officially listed tax haven are tax-wise highly penalised in Portugal and should therefore be avoided.
The recourse to a Portuguese company is not ideal, given that the certificates that are demanded by the Portuguese tax authorities in order for a non-resident owner to benefit from an EU Directive or a double tax treaty are often difficult to obtain.
A non resident special purpose vehicle having a branch in Portugal will in general constitute the best structure to invest in Portuguese rental real estate. Depending on the particular circumstances of the ultimate owner or owners, such SPV may advantageously be tax transparent, for example a UK LLP or a US LLC.
The suggested investment structure is tax efficient and very popular among foreign investors for this reason. However, it is not the only available solution and other solutions may be more appropriate for very substantial investments (more than €10M, say). On the other hand, investing in a residential property for the owner’s private use will most likely not justify the use of a corporate structure unless the investment exceeds, say, €1M. In any case, the above is necessarily of a general nature and investors should seek individual advice fitting their specific circumstances, which they can do through Belion Partners.