NHR 2.0. and the case of foreign pension income

This week among the 1329 registered amendments to the Budget Law for 2020 (currently pending final approval in the Portuguese Parliament) we found one proposal with the number 1144C-5 that proposes amendments to the current Portuguese non-habitual tax regime (also known as NHR).

The proposal will still need to be voted in the next week according to the calendar but it’s time to look at the proposal applying the Five Ws principle.

Who?

The NHR regime was established back in 2009 and slightly adjusted in 2011 has been a rather successful regime in attracting high value expatriates to Portugal and has position itself in almost equal footing with other favorable regimes existing in Switzerland, UK, Spain and more recently in Italy. Israel also has similar tax benefits for 10 years for new immigrants and returning residents.

What?

Perhaps the most contentious element of the NHR regime applying to individuals changing their tax residence to Portugal was the application of the exemption method to foreign pension income.

The Proposal essentially will amend the regime by adopting a 10% flat tax on foreign pension income and eliminating the option for exemption (there are other minor adjustments not covered on this note). At the same time, the Proposal includes a grandfathering rule and transitional provision to limit the effect of this change to the future, thereby safeguarding current NHR residents still within the 10 year period of the tax regime.

Interestingly the definition of pension in this new provision includes expressly not only “pensions of all kinds” but also other similar payments (even non-periodic or lump-sum) to the extent they are not sourced or territorially linked to Portugal.

Why?

The contentious nature of the exemption on foreign private pension income derived essentially from the interaction of the domestic NHR rule providing for exemption with the rule set out in most tax treaties signed by Portugal.

Indeed, Article 18 of the OECD Model provides that private pensions (and other similar remuneration) are taxable only in the state of residence of the recipient, irrespective of the residence of the payer and the place where the employment was exercised. This meant that even though the state of departure or source would not exercise its taxing right, the exemption of foreign-source income would still be applicable if the income would not qualify as Portuguese-source income (i.e. not paid by a Portuguese tax resident nor the cost attributable to a Portuguese permanent establishment).

This outcome of Portugal not taxing pension income for the NHR 10 year period raised some outcry especially from treaty partners such as Finland, Sweden and France. This spat even lead to the termination by Finland of the tax treaty with Portugal. Sweden has in the meantime achieved a renegotiation of the tax treaty (pending final approval) and other important treaty negotiations are ongoing with Netherlands and UK.

But 10 years have passed from the initial NHR regime and much has changed in the international tax arena. The Portuguese move towards the 10% flat rate is therefore a sign of times (no more space for exemptions) and a response to the move by Italy to grant a 7% tax rate to foreign pensions (in Law 145 of 30 December 2018 and Implementing Rule 167878/2019).

When?

The 10% flat tax rate for foreign pensions (if enacted) will be applicable to new Portuguese tax residents – i.e. becoming tax residents after the entry into force of the 2020 Budget Law (somewhere at end of February or early March).

But the Proposal interestingly includes:

• A grandfathering rule allows NHR tax residents at the time of the entry in force of the law who made their decisions under the old law to continue to apply the prior rule, until the original 10 year timeframe runs out.
• Transitional provision which allows NHR tax residents at the time of the entry in force of the law to opt for the 10% flat tax rule.

There are reasons to expect that many current NHR may consider moving towards the 10% tax, needless to say to reinforce liability to tax test in Portugal.

Where?

The discussion in the next days will be at the Parliament. The Proposal was presented by the Socialist Party that heads the current Portuguese Government, which increases the likelihood of this being approved. If the final text coincides with the Proposal the discussion will shift to the practitioners to answer on the virtues of the amendments.

Personal Take

Back in 2010, I wrote my first in depth article on the NHR provocatively called “Sunny Welcome”. In that article when talking of potential effects of treaty mismatches on private pension income, I pointed to particular treaty partner reactions potentially jeopardizing the exemption system. 10 years later it feels rewarding to have raised a flag that may lead to a reset of the regime. Setting at 10% is good move especially if we take note of the international context and the recent unconnected action by the OECD to review preferential regimes with a tax rate lower than 10%.

NHR 2.0 hopefully will see the light and will be better than NHR 1.0.

1 February 2020

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