Did Portugal recklessly scared the international PE funds out of the Portuguese real estate market?

This difficult question deserves to be raised as Portugal included in the Budget Law for 2021 an anti-abuse rule that sets a RETT aggravated rate directed to companies acquiring Portuguese real estate that may have in their corporate chain entities located in blacklisted jurisdictions under Portuguese Law.

We should start with a look at the new RETT rule and how this operates in practice.

• Aggravated Rate: 10% RETT rate may apply to corporate "asset deal" transactions of Portuguese real estate property instead of the standard 6.5% RETT rate, with no possibility to apply for exemptions or reductions.
• Scope: the aggravated 10% RETT rate will become due whenever a corporate entity acquiring Portuguese property qualifies as an entity dominated or controlled, directly or indirectly, by an entity with tax residence in a jurisdiction included in the Portuguese blacklist.
• Control Link: To apply the rule it is necessary to establish a relationship of “dominating influence”, which is for example presumed to exist when the blacklisted company holds (directly or indirectly) the majority of capital of the voting rights of the Portuguese company (following principles of Article 486 of the Portuguese Companies Code).

The timing of this rule is rather bizarre when Portugal is looking to position a rebound from the COVID economic downturn and so the political decision may be said to be questionable as the rule raises several uncertainties on how it will be interpreted and applied in practice.

What is clear is that the potential impact may rest on certain large institutional investors, for example private equity real estate funds (PE funds). There are no exact numbers of what represents the stake of the largest PE real estate firms in the Portuguese real estate transaction value. What is known is the increasing amount of public investment into private equity funds, with for example PERE’s ranking of 100 largest private equity real estate firms pointing to a jaw-dropping amounts raised in 2020 close to $494 Billion. This means these PE funds are here to come and their firepower increasing in the last years.

The question of why now is a complex question but I personally fear that the Parliament was not fully aware that drafting shortcomings could potentially even contaminate liquidity of the market.

I raise three issues that deserve tackling:

• First, I believe there is clearly a lack of understanding of what international PE funds are and their use of limited partnership structures. The external investors in PE funds are known as limited partners (LP) and their liability is generally limited o the amount of capital that they agree to contribute to the partnership. A PE fund generally incorporates a company, often resident in a low tax jurisdiction (Cayman is for example commonly used), which performs the functions of the LP's general partner (GP). This GP has in principle unlimited liability for the LP's dealings. From a tax perspective, this LP structure is generally regarded as a partnership that is transparent for tax purposes (meaning the partners/investors are generally treated as making the investment directly on the underlying assets on their countries of residence). On the tax side, it is important to mention that the “winners” of this structures being sometimes offshore are largely tax-exempt entities, such as charities, pension funds, endowments and exempt mutual funds that are able to invest without an additional layer of tax beyond the tax already due on the operational level (on the country where the PE fund invests). Taxable investors and investment fund managers will ultimately be taxable on their jurisdiction of residence when their income crystalizes.
• As a second point, I would raise that we may have witnessed the political risk of falling on the “popular opinion trap” arising from some high-stake transactions pushed towards newspaper headlines.
• The third point is that I also strongly believe there is a public misconception in Portugal of the role and importance of the real estate investment either in the recent past and also years to come on much-needed (and partly achieved) urban transformation of our cities.

This being said, we apparently have now to cope (permanently or temporarily) with such anti-abuse rule, that is potentially increasing the “cost of entry” in the real estate market for certain large institutional investors. In my view, the impact of this provision will rest on the following technical issues:

1. Flexibility of the institutional investors such as PE funds to set-up alternative structures without any shareholding link through blacklisted entities. It is true that there is a global trend for certain funds to move onshore but this process for established funds is far from simple and expedite.
2.  Capacity to argue that even if there is blacklisted indirect shareholder in the chain, if the UBO (when this is deemed to exist) is resident in a non-blacklisted jurisdiction the rule should not stop there but should move up to the beneficial owner (as defined in EU Law).
3. Ability to contend that even if there is blacklisted indirect shareholder in the chain, the inclusion of this entities in jurisdictions with either a Tax Treaty or Tax Information Exchange Agreements in force with Portugal should lead for this rule not to apply. Principles of treaty non-discrimination based on foreign ownership of the capital of a domestic enterprise may be relevant to limit the application of this rule. More challenging is determining the effects of the exchange of information instruments available and the justification of such measure for the territories with a TIEA such as for example Bermuda, Gibraltar, Cayman Islands or Jersey.
4. Capacity to claim that even if there is blacklisted indirect shareholder in the chain, the mere absence of a rule for companies to prove the economic reasons justifying such link and the substance underlying such structures would itself contravene the EU principles and infringe EU freedom of capital.

Defensive measures such as this one against taxpayers with corporte link to a blacklisted country (framed under a wider domestic list rather than the more constricted EU list) may well be considered disproportionate specially when there is no reference to the artificiality of the arrangements put in place (like in this blanket rule). To be proportionate, the Portuguese tax authority should be required to provide (even prima facie) evidence of the absence of valid commercial reasons or evidence of tax avoidance. In addition, the taxpayer should be always given the possibility to prove the contrary.

In conclusion, the outreach of this specific provision - as approved in Parliament and set to apply as from 1 January 2021 - raises more questions than answers but definitely this rule seems to be imprecisely drafted and is likely not able to resist legal scrutiny for certain bona-fide investors in the Portuguese real estate market. 

12 December 2020

Tiago Cassiano Neves

 "Opinions expressed are solely my own and do not express the views of any law firm or organization to whom I am affiliated"