ATAD Express # 2: amendment of the CFC rules (imputation of profits or income of controlled non-resident entities)
SÉRVULO PUBLICATIONS 18 Sep 2019
In this update, we address the major changes to the rules for imputation of profits of non-resident affiliates – known as the CFC (“Control Foreign Company”) rules provided for in article 66 of the Corporate Income Tax (“CIT”) Code.
These rules foresee that income from foreign entities, which are subject to a privileged tax regime, should be subject to tax at the level of their resident shareholders, for tax purposes, in Portuguese territory if they hold, directly or indirectly (even through a trustee), at least, 25% of the shares, voting rights or rights in the income or assets of such entities.
The purpose of these rules is to prevent the absence of taxation on profits made by such entities.
Among the main changes now included in the legislation, the concept of CFCs (non-resident affiliates) has been broadened, as well as the taxable base for the income allocated to the Portuguese tax-resident shareholders.
There are also greater demands for being able to exclude the application of these rules.
a) Broader concept of CFC entities
The following are considered subject to these rules:
- Non-resident entities whose income tax in the country of residence is less than 50% of the tax that would be due under the CIT Code.
The rules previously in force were applicable if the (nominal) tax rate in the country of residence was less than 60% of the 21% CIT rate in Portugal (i.e. less than 12.6%).
Moreover, while the previous wording of the rules referred to nominal tax rates, the new wording now speaks of "tax effectively paid."
- Alternatively, and as was the case in the past, even if taxation exceeds this minimum threshold, the rules remain applicable if the non-resident affiliated entities have tax residence in a country, territory or region with a privileged tax regime, included in the list approved by Ordinance no. 150/2004, of February 13th.
That is, even if an entity is resident in a territory that does not have a privileged tax regime, it may still fall under the CFC rules if the tax paid, in its territory of residence, is less than 50% of what would be due in Portugal. It should be noted this new wording, combined with the new conditions to exclude the application of this regime, may imply the application of these rules to jurisdictions that have so far been outside its scope, such as Malta.
However, it is no longer foreseen that when, at least, 50% of the shares, voting rights or rights to income or assets are held, directly or indirectly, even if through a trustee, by CIT or Personal Income Tax residents in Portuguese territory, the percentage referred above (25%) for imputation of the CFC entity’s income would be reduced from 25% to 10%.
b) Extension of the taxable base
Under the previous rules, resident shareholders, for tax purposes, in Portuguese territory should consider, at their level, the profits of non-resident subsidiaries in proportion to the latter’s net income for the period, as determined according to the accounting rules of their country of residence.
Currently, although such imputation should still be based on the amount of profit or income obtained by the non-resident entity, it should be determined according to the CIT Code, and not based on the accounting rules of the country of residence of the same.
The criterion of imputation in accordance with the proportion of capital or rights to income or assets held in that entity remains unchanged.
Nonetheless, it is now possible to deduct tax losses generated by non-resident subsidiaries but calculated according to the CIT Code, which may be deducted, in proportion to the control exercised in the entity, in one or more of the following five tax periods.
However, such a deduction is limited up to the income attributable to the Portuguese tax resident shareholder.
Finally, it is still possible to deduct the income tax on profits or income paid according to the tax regime applicable in the non-resident subsidiary's place of residence.
c) Exclusion from the CFC rules
CFC rules will not be applicable provided the sum of the income of the non-resident affiliate arising from one or more of the following categories does not exceed 25% of their total income:
i. Royalties or any other income generated from intellectual property, image rights or similar rights;
ii. Dividends and income from the disposal of shares;
iii. Income from financial leasing;
iv. Income from banking activity (even if not developed by credit institutions), insurance activity and other financial activities, carried out with entities considered to be related parties;
v. Income from invoicing companies that earn sales and services income from goods and services purchased from and sold to associated enterprises, and add no or little economic value;
vi. Interest or other capital income; and, still
vii. Where the non-resident affiliated entity is (i) resident or established in another EU Member-State or a Member-State of the European Economic Area, in the latter case provided that that Member-State is bound by administrative cooperation in the field of taxation equivalent to that established within the EU and (ii) the Portuguese tax-resident shareholder demonstrates that the incorporation and operation of that entity are based on valid economic reasons and that it carries on an economic activity of an agricultural, commercial, industrial or service nature.
Although this last exclusion already existed, it is now demands that the entity available assets, equipment, personnel and facilities.
d) Other amendments
The new legislation also introduces the possibility of deducting the sale price obtained on the sale of CFC entities, whose results have been allocated to the Portuguese tax-resident shareholder.
Finally, the rule which foresaw the imputation of results of entities resident in Portugal but subject to a special tax regime was revoked; this rule aimed at covering entities licensed to operate in the Madeira Free Zone.
Teresa Pala Schwalbach
Rita Botelho Moniz
