One of the most frustrating revelations for people moving to other countries is the fact that the employment relationship that they have can rarely continue as such.
Why employment doesn't work?
The main reason that employment relationship rarely works is the sense that the common arrangement in tax treaties between countries is that people are liable to pay taxes (both income tax and social security) in the country where they reside. As a result, in order to legally employ someone in a different country, the employer needs to register with the authorities in that country and deduct taxes for the other country.
In addition to this practical difficulty, having an employee in another country risks the creation of a Permanent Establishment or in other words, risks that the country of residence of that employee will seek to attribute some of the profits of the company to the employee and tax such profit.
EOR - a solution?
To resolve this problem, there are companies that act as a de-facto employer and take on the administrative tasks related to employment, including payroll processing, benefits administration, and compliance with labour laws. These are called "Employer of record" companies (EOR) and they allow companies to legally employ in other countries.
Employers of record are a practical and compliant solution for employers seeking to employ in other countries but are, in our opinion, the worst possible option for people moving to Portugal.
The costs of an EOR in Portugal
EOR don't come free and incur some setup costs. The costs can vary between hundreds or thousands of Euros per employee per month.
However, it is not the EOR costs as much as the it is the employment taxes that are the main issue.
Income tax
Employees who work for international companies in Portugal are often paid salaries that are considerably higher than the average salary in Portugal. The sliding scale of taxation in Portugal is designed around the local population and it therefore rapidly reaches 45% in addition to a potential further 2.5-5% solidarity tax.
Many people working in a high value activity under the NHR scheme enjoy a reduction to a 20% flat tax rate.
So far so good.
Social security
This is where the real trap is. Social security is levied at a 23.75% over employers in Portugal (including EORs). In addition, the employee pays 11%. The total social security burden is therefore 34.75% (!) There is no social security ceiling so any amount suffers the 34.75%.
Overall tax burden
Together, the tax burden of employing via an EOR is approximately 50% taking into account the 20% preferential tax rate.
For people not in high value activity, the tax rate could be as much as 70%.
For many companies, this is a prohibitive rate.
Self-employment
A reasonable alternative to using an EOR is creating a contract relationship and having the employee register as self-employed in Portugal.
Portugal encourages freelancers and the tax benefits under the NHR scheme work better for freelancers.
Income tax
The 20% special tax rate is further reduced by the application of the simplified regime, allowing for taxation of only 75% (in most cases) of the income (and achieving approximately 15% tax rate).
Social security
Self-employed individuals pay 21% social security but this is further reduced by the application of a the simplified regime by taxing only 70% of the income, leading to an overall rate of approximately 15%. In addition, there is a waiver on social security for the first year and a cap of approximately 1,200 Euros a month.
Overall taxation
The overall taxation of high value activities of freelancers therefore starts at around 15% and doesn't go over 30%. This is a reasonable tax rate.
Indeed, using the self-employment mechanism leaves employers exposed to a hypothetical risk of the creation of a PE, but this risk could be mitigated considerably by avoiding a physical office and not awarding the freelancer a signing authority. We are not aware of a single case in Portugal, ever, where the risk had been more than theoretical.
Working via a company
Another option is for the employee to set up an entity - either in Portugal or outside of Portugal and bill the employer via said entity. This option reduces the risk of a PE further and could lead to varying taxation depending on the exact structure chosen.
