In the realm of global financial landscapes, Portugal has recently become a focal point for individuals considering relocation, and consequentially bringing tax payers that might need guidance regarding the taxation of their trusts.
As of 2024, the non-habitual resident (NHR) regime, previously instrumental in attracting international residents seeking favourable tax conditions, has ended. With the conclusion of the NHR regime, attention now shifts towards understanding how the intricacies of trust taxation in Portugal will serve as a guidance, with or without the benefits of the NHR, particularly concerning the treatment of settlors and beneficiaries.
Considering Portuguese local law is also relevant for the intended purpose. The country, operating under civil law principles, lacks a comprehensive set of well-established legal rules governing trusts, a common structure in the anglophone common law system. However, noteworthy changes in tax legislation were introduced in 2015, bringing intelligibility to certain trust-related scenarios by addressing income and gains from fiduciary structures. As individuals continue to consider Portugal as a potential home, despite the recent changes, the spotlight is increasingly on navigating the complexities of trust taxation.
How Portugal Taxes Distributions from Trusts
The taxation framework in Portugal concerning income distribution from foreign trusts revolves around categorizing it as investment/capital income, typically taxed at a 28% rate, according to the Article 5(2)(t) of the Personal Income Tax Code (CIRS). In cases where trusts hail from blacklisted jurisdictions, an elevated tax rate of 35% may be levied on distributions. Relevant to say that the legislation doesn't explicitly differentiate between income distributions and returns of capital. It’s also worth mentioning that the location of effective management, aligning with the trustee's domicile, normally indicates its source.
Do the Benefits of The NHR apply to Distributions from Trusts?
Although the NHR has been repealed from Portuguese law as of 2023, with only a transitional period in 2024, many taxpayers still have the status and can consider the taxation of the fruits of their trusts in Portugal, combined with the benefits of the NHR.
In this regard, it should be noted that income derived directly from trust distributions is considered to be income from capital obtained abroad and will be exempt from taxation in Portugal if the relevant treaty with the country of the trust's jurisdiction allows such income to be taxed or, in the absence of a treaty, if the Model Convention grants such rights. It should be stressed that Portuguese legislation does not require the actual taxation of such income, but rather that there is a legal possibility under the relevant treaty.
The key issue is to first understand how trust distributions are qualified under the treaties themselves, in order to know with certainty whether they guarantee taxation rights to the country of origin, i.e. where the trust is domiciled. This is not a one-size-fits-all answer.
The first possibility is that the payment to the beneficial owner preserves its original nature. Which means that if the trustee has received a dividend from a particular jurisdiction, the payment to the beneficial owner will also be regarded as a dividend from a company in that jurisdiction. A second possibility is that the payment to the beneficial owner is not covered by one of the specific Articles (i.e. Articles 6 to 20) of the OECD Model, but is covered by Article 21 (Other Income).
The key difference between these two positions is that, if the income retains its character, it will most likely be considered a dividend under the Treaty, so it will most likely also be exempt in Portugal under the NHR. If the income falls into the category of "other income", the general tendency is that the income can only be taxed in the country of residence of the recipient, i.e. without taxing rights in the country of origin, which will not allow the benefits of the NHR to be applied.
This is problematic in that not all treaties specifically mention trusts - very few actually do, notably the US and the UK (and the latter doesn't differentiate in its treaty with Portugal).
If no distinction is made, Portugal tends to take the position that this is income classified under the residual item "other income", which in theory indicates a non-exemption from the NHR. Interestingly, Portugal's treaty with the US and Brazil, for example, states that even the "other income" can be taxed in the country of origin. Thus, even in this scenario, income from US trusts still has the potential benefit of the NHR. In the case of the UK, only on the assumption that the trust has a local permanent establishment in the UK, which can be uncertain and depends on a case-by-case analysis.
It should be noted that trusts domiciled in blacklisted jurisdictions are unlikely to benefit from the NHR on their distributions and will be taxed at a rate of 35%.
How Portugal taxes the gains derived from the termination, extinction, or revocation of trusts
Taking the Trusts matters into a different approach, while the tax burden on distributions is borne by the beneficiaries, Portugal differs in its treatment of income arising from the termination, extinction, or revocation of trust structures. There are differences depending on whether the income reaches the settlor or a non-settlor beneficiary.
In the case the beneficiary is also the settlor, a chargeable capital gain tax arises, computed as the difference between termination proceeds and the value contributed to the trust. Such gains attract income tax at rates of a standard 28% or 35% for trusts domiciled in blacklisted jurisdictions. Conversely, if a non-settlor beneficiary receives the proceeds, they remain exempt from income tax. Instead, they are deemed gratuitous transfers subject to a 10% Stamp Tax, contingent on meeting specific territorial criteria linking the transaction to Portugal. This is due to the fact that the Stamp Duty Code in Portugal, in its territorial regulations, stipulates that gratuitous transfers shall be subject to stamp duty when the donated assets are situated in Portugal. However, in empirical reality, this circumstance is seldom encountered.
Another factor to be taken into consideration is that, while transmissions by way of donation or inheritance are exempt from stamp duty in Portugal when originating from ascendants, descendants, or spouses, this exemption is unlikely to apply in the case of trusts. This is due to the legal perspective that identifies the transmitter as the trustee, not the settlor.
Income from a company in trust and the application of controlled foreign company’s rules
When it comes to profits that haven't been distributed yet in trusts, we need to carefully look at how Controlled Foreign Corporations (CFC) rules might apply. These rules depend on the type of trust and the regulations it follows. It commonly applies to Companies inside a Trust incorporated in a Black Listed Jurisdiction.
Within the legal framework of Portugal, as stipulated by Article 66, paragraph 1, of the Corporate Income Tax Code, Controlled Foreign Corporations (CFC) rules are potentially applicable to income arising from trusts. This implies that if a trust is situated in a jurisdiction that adheres to CFC regulations, signifying either its blacklisting under Portuguese law or its taxation of corporate profits at a rate less than half of the prevailing Portuguese standard rate (currently 21%), these rules may be invoked.
These rules are usually important for trusts because the people who benefit from them or create them can still control the financial structure and even the existence of the trusts, thanks to their ability to revoke them. On the other hand, if a trust is irrevocable, it's less likely to be subject to these rules since it's considered to be beyond the control of the settlor or the beneficiary.
Conclusions
Thorough scrutiny is crucial when incorporating trusts within a legal framework, particularly when the beneficiary is resident in civil-law jurisdictions, like Portugal, where the focus transcends mere tax implications. The US treatment of trusts, focused on inheritance matters, especially probation, shows that establishing trusts frequently is driven by unrelated tax considerations. It becomes imperative to examine these facets diligently, venturing into alternative avenues apart from trusts. This exploration may encompass options such as life insurance products or other financial instruments, particularly if the Non-Habitual Residency (NHR) status remains applicable to your circumstances.
