Property Tax News in Portugal

STORM CLOUDS OVER A PLACE IN THE SUN

The volte-face by the Portuguese government in reforming property taxes has caused alarm and despondency throughout the ex-pat community in Portugal as well as to the Portuguese and others who have utilised offshore companies to acquire property in Portugal.

A Blind Eye to Property Development ? Portugal has over the last 40 years either encouraged or closed a blind eye to property development in Portugal through offshore vehicles. One can speculate on the reasons for this but it was thought that it encouraged inward investment. It should also be remembered that prior to 1 January 1989 the Portuguese did not levy Capital Gains Tax on properties. Therefore using offshore companies encouraged individuals to purchase property in Portugal, enabled them to legally avoid Stamp Duty (SISA) and, since 1989, avoid Capital Gains Tax. This is achieved because the purchaser acquires shares in a company rather than property. Therefore the property does not change hands, merely the shares. The Portuguese may have thought this a reasonable trade off by encouraging a building boom and a large influx of tourists. It also has to be said that since the Portuguese government closed a blind eye to this that over time there arose an accepted practice of under declaring property values, which were usually not challenged. Typically land would be registered in an offshore company and SISA would only be paid on the value of that land. The subsequent development on that land bore no additional tax. In recent years it has become almost impossible for anyone who wanted to buy a property on a new development in the Algarve to do so, other than through an offshore company. Typically the developer would place each plot of land earmarked for development into an offshore company to limit the amount of SISA payable. A prospective buyer therefore had little option other than to acquire the offshore company and effectively deal with the construction costs through that company.

Writing on the wall for Offshore Companies Property Tax Position

The writing was already on the wall in 2002 when the Portuguese government started looking at the property tax position for offshore companies and raised the municipal taxes from 1% to 2%. The taxes were based on the rateable value called the Valor Patrimonial. In many cases whilst a valuation should have reflected costs in practice it did not. This was especially so when land had been purchased in the first place and then subsequently a property was constructed upon it. Whilst the land and construction were valued for municipal taxes this did not reflect the true costs. In other cases the Valor Patrimonial had been unaltered since the original acquisition. At the same time the Portuguese government introduced a notional rental profit for offshore companies based on 1/15th of the Valor Patrimonial. The effect of these increases did not greatly concern those who owned properties through offshore companies since as the Valor Patrimonials were based on a very low figure an increase of 100% resulted in a relatively small extra amount to pay.

These increases demonstrated that the Portuguese government were concerned with the number of properties owned by offshore companies, principally because of the black economy in Portugal itself. Foreign tourists account for many of the properties being developed or acquired in tourist areas, and significant numbers of properties are owned by the Portuguese themselves through offshore companies. In many cases it is believed that these represent black money which has not been subjected to taxation and is hidden from the view of the Portuguese taxing authority.

Therefore whilst the 2002 increases were seen as a mere inconvenience, my impression when talking to ex-pats and when lecturing in Portugal in 2002, was that they were more concerned with the decisions in Dimsey & Allen (2001) STC1520 and STC1537 coupled with the implications of the Secretary of State for Trade and Industry v Deverall (2001) 1ch.240. These decisions highlighted a possible tax charge for UK residents who were shareholders of an offshore company which owned property in Portugal because they might be regarded as a shadow directors of the offshore company and thus chargeable to benefits in kind on their occupation of the property.

Property Tax Reforms However, it is now evident that the 2002 legislation was a mere appetizer for 2003 when on 29 August 2003 the Portuguese government introduced their property taxation reforms. These proposals replaced SISA by IMT(Imposto Sobre Transmissoes) and municipal tax by IMI (Imposto Municipal Sobre Imoveis) the introduction of these new taxes was coupled with higher rates of tax on properties regulated in jurisdictions considered fiscally privileged by the Portuguese government, in other words offshore companies. These jurisdictions are found in a list (the offshore list) published in 2001 which shows over 80 such jurisdictions, including the Channel Islands, Gibraltar and the Isle of Man. According to the Financial Times it is guestimated that there are 100,000 properties in Portugal held by offshore companies of which 60,000 are in the Algarve. The Almancil Business Association did a survey in 2003 which showed that of the 4,028 tourist properties in their area, 2,147 were registered in offshore companies. It is therefore not difficult to see that the Financial Times guestimate maybe near the mark. It is thought that of the properties registered in offshore companies in the Algarve, 90% of these are in the Channel Islands, Gibraltar and the Isle of Man. Indeed there is a whole industry in Gibraltar based on offshore companies owning properties in Portugal.

The New Tax Rates cause Panic

The new rates proposed for offshore companies were an uplift in IMI from 2% to 5% as well as keeping the 1/15th tax on notional rents. However, the bombshell was that there was going to be a revaluation so that the properties which had an unrealistically small rateable values were going to be uplifted to a current market value which, in many cases, would result in a 50 fold or more increase. This revaluation is to take place over a 10 year period. It is not yet known precisely when it will start or whether there will be transitional arrangements based on inflation over the years. However, it is thought the prime tourist areas such as Quinta do Lago and Val do Lobo will be the first in the firing line. 

These announcements caused panic among the ex-pat community which persists today since it remains unclear as to how the Portuguese government will implement the changes. 

When the legislation was proposed there were very strong rumours circulating that it would only apply to properties purchased after 2000 or 2001. This has largely been discounted but it has been replaced by a further rumour that as a concession the Portuguese will base the 2004 municipal tax of 5% on the old rateable values un-enhanced by inflationary increases. 

Confusion benefits Portuguese Lawyers and Accountants

One would have thought it would have been comparatively easy to check this but whilst most lawyers, tax consultants and accountants have a view they seemingly are unable to establish the truth. This may partly be due to the "a manaha" (Portuguese for mañana) of yesteryear although today Portugal is striving to become a modern, efficient and well run society. However, the confusion only adds to the anxiety of individuals that the new taxes will affect them. It is true to say that Portuguese lawyers and accountants have benefited considerably from this unease and many proposals have been formulated on how to combat the new legislation. Part of the problem is that there is no answer which fits everybody and some of the proposals being made are seen as impractical, too expensive or possibly subject to further changes in Portuguese law. 

Re-Domicile It is considered by some that the cheapest route to overcome these problems is to re-domicile. This could be achieved with the Channel Islands and Gibraltar relatively easily but it was not until early January that it was possible to re-domicile a normal Isle of Man company. Since re-domiciliation had to have been effected prior to 31 December in order to avoid the 2004 increases this caused consternation among owners who held properties in Isle of Man companies.  The favoured territories for re-domiciliation were Malta, New Zealand and Delaware. There are many others since all that is required is a favourable double tax treaty which has an exchange of information section. Rumour has it that the Portuguese will sanction re-domiciliation provided they can obtain information under the double tax treaty to find out who owns the offshore properties to help combat their black economy. However, the downside of re-domiciliation is that many believe the Portuguese will, on seeing the exodus from black jurisdictions into so called white jurisdictions, add these so called white jurisdictions to their black list. However, such action would no doubt precipitate a tidal wave of litigation from all the aggrieved parties who have re-domiciled.  Another possibility is to re-domicile the offshore company to Portugal itself and whilst this is guaranteed to work it is considerably more expensive than merely re-domiciling, say for example, a Gibraltan company to Delaware.

Purchasing property from offshore company and Capital Gains

Others proposed that the individual should purchase the property from the offshore company prior to 31 December and utilise a favourable valuation. One argument runs that the Portuguese introduced legislation to enable them to examine the price paid for the property and that legislation was not effective prior to 31 December 2003, after which it would be possible for the Portuguese authorities to examine the price paid and if necessary replace it with the true market value. The problem with purchasing the property from the offshore company was that it crystallised a Capital Gains Tax liability since in Portugal non-residents are charged 25% Capital Gains Tax. There would of course also be the Stamp Duty charge of 6% on the transaction.

Others have suggested a gift which would result in a stamp tax charge by the Portuguese of 10% but would avoid CGT and IMT. Whilst this is initially attractive, Portuguese law does not recognise a gift by a company to an individual and notaries in the Algarve will not currently accept such transactions. Notaries in Lisbon will. The Portuguese do not recognise Trusts and therefore offshore companies which hold properties as bare Trustees, so that they are merely acting as nominee for the true owner, is a concept not reflected in Portuguese law. Consequently in a Portuguese court ruling it has been held that Portuguese companies have a duty of care so that they should not give away their assets. However, since the companies to which this applies are not Portuguese companies it is considered that the applicable law is that of the country where the company is established. 

Change Place of Property Management and Control

Another suggestion is that it was not necessary to physically re-domicile a company, merely to change its place of management and control, so for example a company which is registered and incorporated in Gibraltar could change the place of its management and control to, say, the United Kingdom. Unfortunately although the Portuguese law suggests there is this possibility the Portuguese tax authorities discount this and confirm that it will be necessary to re-domicile physically. Whilst doubt exists nobody will spend money or time in clarifying this through the Portuguese courts.

The scramble amongst ex-pats and others to re-domicile before 31 December 2003 (and typically it was left to the last minute before this decision was taken), resulted in many disappointed individuals since all the notaries were booked up and they refused to accept any further appointments until after 31 December. However, those disappointed individuals at least have the opportunity of seeing the dust settle before deciding which path to take. The coming year may well see the Portuguese government offering the carrot of an easier route for offshore companies. e.g. Greece, in introducing comparable legislation, offered a period of time in which properties could be transferred to personal ownership without Capital Gains Tax and at a reduced rate of transfer tax. This may well be more palatable to the Portuguese government than a further bout of negative publicity. 

Gibraltar in EU or black list ? 

There is also a very strong rumour circulating that as Gibraltar is part of the EU., it was wrong to include Gibraltar on the black list in the first place. However, thus far there is no tax treaty between Gibraltar and Portugal but it has been confirmed by the European Court of Justice that Gibraltar is part of the EU other than for VAT and Customs. It is thought that increasing pressure will fall upon the Portuguese tax authority in the course of the year to delete Gibraltar from the blacklist. 

The upheaval that has taken place in Portugal regarding offshore companies and the ownership of properties has, and is continuing, to cause pain to ex-pats in Portugal. However, the new Portuguese tax laws do make the country a very attractive area for new buyers to acquire property. Stamp Duty has been reduced from around 10% to 6% and Inheritance Tax on transfers between spouses are totally exempt from January 2004. If the buyer is a Portuguese tax resident and the property is his principal residence, then when he comes to sell there will be no Capital Gain if the proceeds are reinvested within 2 years into another Portuguese property.

CONCLUSION

In conclusion, whilst the transition is painful for ex-pats who already own property via offshore companies, there is an opportunity for people buying property in their own name to actually benefit from these changes. The uncertainty that exists in the Algarve at the moment regarding property has effectively put a dampener on prices and in some cases properties are being offered at a 20% or 30% discount to their value a year or two ago.

Gary Axe is a partner at Spencer Fellows Associates and can be reached on +44 (0)1428 608930 or alternatively by email: garyaxe@spencerfellows.co.uk

Technical aspects of Portuguese law have been vetted by John Duggan a partner in PriceWaterhouseCoopers in Lisbon.