PLMJ
  July 25, 2006 - Portugal

Income Taxation in Portugal in Light of the European Community Treaty

The effects of the singular interpretation of the EC Treaty that the Court of Justice has been reinforcing for many years whilst assessing the compatibility of income tax legislation of the Member States with that Treaty, are now beginning to be felt, and to a considerable degree, here in Portugal. The latest move of the European Commission, in the wake of those decisions of the Court of Justice, concerns the Portuguese Tax Benefits Law, which enables the Portuguese State to waive tax on capital gains made by state-owned companies or by companies with which the state-owned companies are in a control relationship, in the context of privatisation or restructuring operations. The Commission views this particular tax benefit as being incompatible with the prohibition on state aid set out in the EC Treaty. One may remember that in 2005 the European Commission brought an action against Portugal regarding the income tax provision that allowed capital gains tax to be waived on the sale of a property used by its owner as its personal and permanent residence if the proceeds of the sale were reinvested in another personal and permanent residence located in Portugal. The Commission took the view that, since the waiver did not apply when the proceeds of the sale were reinvested in property located abroad, there was a violation of the provisions of the EC Treaty. In 2006 the European Commission declared war on yet another front with Portugal, viz. the tax on interest paid to non-resident companies which do not have a permanent establishment in Portugal. The Commission considered the basis on which the tax is charged, to wit, the gross interest, to be discriminatory. Strictly speaking, however, the problem raised by the European Commission is not limited just to interest payments. It may come to have an impact on all taxation levied on the gross income of non-residents who do not have a permanent establishment in Portugal. Another possible bone of contention between the Portuguese tax system and Community law, as interpreted by the Court of Justice, concerns the provision that prevents the application of the mechanisms which eliminate double taxation whenever the distributed profits derive from income to which this mechanism would not apply. This particular provision, among other things, appears to interfere with the freedom of establishment within the European Union as well as with the freedom of movement of capital, since it has an adverse effect on, for example, the tax treatment of dividends distributed by a subsidiary of a Portuguese company located in another EU country, which has participations in companies located in third countries. In fact, if these participated companies distributed their profits directly to the Portuguese company, the mechanisms for the elimination of double taxation would not operate, and it thus seems that the prerequisite for the application of the provision in question is satisfied. Quite apart from the likely incompatibility of this rule with community law, the broad terms in which it is couched present an obstacle to the essential goal for growth of the Portuguese companies in a growing world - their internationalisation.