US LLCs are one of the most common and attractive tax planning structures in Portugal and particularly for benefiting from the NHR scheme.
The extensive use of US LLCs as a tax planning vehicle in Portugal can be traced back to a binding ruling that was requested by a taxpayer quite some time ago (processo 2360/2016).
Case 2360/2016
It is important to remember that such a ruling is limited to the facts of the matter and that it can change in the future. However, the ruling provided important information on the manner in which the Portuguese tax authorities view US LLCs.
In that ruling, the relevant LLC was taxed as a partnership and it was a finding of fact that it was not managed or directed from Portugal.
The Portuguese tax authorities considered the fact that an LLC is a transparent entity in the United States and that income passes to the members but arrived in the conclusion that only companies that are professional societies or companies for simple administration of assets could be tax transparent in Portugal, as these are the type of companies that can be transparent under Portuguese law.
It follows that for companies that are not one of the above structures (not professional companies or holding companies), an LLC will not be considered transparent.
Flowing from there, the income from the LLC was classified as "other income" that both countries have the right to tax and the taxpayer was charged at a 28% tax. Importantly, the taxpayer in that case have not benefit from the NHR scheme. Had the NHR scheme been applied, the outcome of the fact that both countries have the right to tax the income would have been zero tax in Portugal.
This case led to an avalanche of tax planning using US LLCs, taking advantage of the different tax treatment (transparent/pass-through in the US, opaque in Portugal) and taking full advantage of the Portuguese NHR regime.
Case 26925 (2024)
In December 2024, a new ruling has been published, following the same conclusion of the earlier ruling, but providing significantly more details.
In the new decision, we have a lot more information - the subject is a US LLC incorporated in Delaware and taxed as a partnership. One of the members is a US citizen based in the US and the other member is based in Portugal and enjoys NHR status. The company is split 50:50 between the members. The nature of the work is IT services, with both members contributing to the profit.
The authorities repeated with agreement the conclusion in processo 2369/2016 that the transparent treatment if US LLCs cannot be replicated into Portugal unless it is a case of a professional society, that the nature of the income is capital income from a foreign source that is not a dividend but other income. The authorities further clarified that NHR status can be used to claim the full exemption from tax in Portugal.
This decision provides much needed clarity to many taxpayers in Portugal who have been relying on a much older and imperfect precedent. The manner to report the income guided by the ruling is precisely the way we report LLC income in Portugal and have always been doing so.
Interestingly, the ruling does not address the issues of effective management or permanent establishment, but it should be read alongside the previous ruling which did address them, i.e. the income can only be considered income outside of Portugal if the management of the entity is outside Portugal.
FRESH Portugal Comments
It is important to remember, however, that the cases are limited to the specific circumstances . It is our view that LLCs that are used as a vehicle for income from work done in Portugalcould be taxed in Portugal under a number of doctrines, but the risk profile of different cases is on a very wide spectrum.
How can Portugal tax LLC income?
Risk 1 - interpretation changing
One option is that the tax authorities will change their interpretation. We believe that this is now extremely unlikely. There has been much speculation that if a similar case is presented with NHR, the outcome would be different, but this has now happened and the outcome has been the same.
Furthermore, the finding that an LLC is not a transparent entity is a fairly common finding and the same finding has been reached in a number of other countries, including the UK.
Risk 2 - different treatment for single person disregarded entities
The relevant cases dealt with a partnerships. Many LLCs are single-person pass-through entities. Whilst a single person pass-through entity is still an LLC, it is not required to have an EIN (employer identification number) and is not required to file a separate tax return. These factors could weigh against considering a single-person LLC as a company in a similar manner as a partnership was considered to be a company. However, hypothetically a single-person LLC that is not member-managed is more likely to be deemed a company than a member-managed LLC.
Risk 3 - the LLC is a resident in Portugal
In the first case, there was a finding of fact that the company was neither managed not directed from Portugal. In the second case, the issue was not discussed, but there was significant presence outside of Portugal. Accordingly, if a company is managed from Portugal it would be deemed a tax resident in Portugal.
There is no single definition of the "place of effective management" but some guidance is offered in paragraph 24 in the Commentary on Article 4 which was included in the 2000 Update to the Model:
“24. …The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the enterprise’s business are in substance made. The place of effective management will ordinarily be where the most senior person or group of persons (for example a board of directors) makes its decisions, the place where the actions to be taken by the enterprise as a whole are determined; however, no definitive rule can be given and all relevant facts and circumstances must be examined to determine the place of effective management. An enterprise may have more than one place of management, but it can have only one place of effective management at any one time.”
Different factors that have been taken by courts over the world have been:
− Place of incorporation.
− Place of residence of shareholders and directors.
− Where the business operations take place.
− Where financial dealings of the company occurred; and
− Where the seal and minute books of the company were kept.
Risk 4 - permanent establishment
Even if effective management of the company is not in Portugal, the income associated with a permanent establishment could be taxed in Portugal. Permanent establishment is often created when there is a permanent physical office in Portugal (an office will typically be seen as permanent if it exists for more than 6 months) or where a director with the ability to bind the company in contracts resides in Portuguese territory.
However, with the second ruling, this risk now seems to be significantly diminished. We know that in the second ruling, one of the owners (50%) made a significant contribution from Portugal to the company, and there was no finding of permanent establishment.
Risk 5 - Portuguese-sourced income
Even if a company is managed from outside of Portugal and does not have a permanent establishment in Portugal, there is still a path to taxation. A country can still tax income sourced in its territory. However, the burden of proof is on the tax authorities.
Again, this risk is now significantly diminished with the second ruling.
Defending LLCs from Portuguese taxation
As can be seen above, there are multiple ways for tax authorities to try and tax income. In practice, authorities would rarely carry out an FBI-style enquiry and would normally focus on relatively "low hanging fruit".
For our clients who are considering LLC structures, we often offer the following advice:
- Partnerships are more defensible than single-person-disregarded entities.
- An overseas management reduces the risk dramatically. Management should be documented properly.
- An office in Portugal or a manager in Portugal with the right to bind the company in contracts increases the chances of a permanent establishment.
Many people trade from LLCs and are oblivious to the risks and to the ways to mitigate them. So far, the Portuguese tax authorities have not been cracking down on LLCs but we always prefer to be ready because things are good until they are not.
It is important to remember that when a structure is created purely for tax optimisation, it often looks just like what it is, whilst genuine partnerships between people in different countries are much easier to defend. We therefore always advise on trying to work with real relationships.
