A tax conundrum for Portuguese and foreign insurers - International Law Office

The tax regime for insurance contracts under the EU rule on the free provision of services appears to have become more advantageous than the regime applicable to such contracts under Portuguese law.

A Portuguese resident who concludes a contract with a Portuguese insurer can choose between ordinary taxation of the income derived from the investment or a lower flat rate of withholding tax. The latter is unavailable to residents who conclude an insurance contract with a foreign insurer that is not established within the Portuguese territory.

This difference in tax treatment is not only a consequence of the law. Rather, it is a result of the conditions for reporting income, as determined by two annexes to the personal income tax return: Annex E on income exclusively from Portugal and Annex J on income derived from foreign sources.

Until recently, the form for declaring non-resident income did not allow income received abroad from a life insurance contract to be treated in the same way as income derived from a Portuguese source; instead, such income was added to the taxpayer's overall income. As a result, if the insurer was not resident in Portugal and did not have a Portuguese branch, such income was subject to rates as high as 42% (instead of the withholding tax rate of 20%), because the insurer could not withhold the income in order to allow the recipient to enjoy the flat rate.

Taxpayers were required to declare income from life insurance contracts concluded abroad in Annex J, but the annex has no specific section for reporting income from insurance-related sources, which had to be included in the section on capital income.

Neither non-resident insurers nor their tax representatives could withhold the tax in question, as there was no legal basis for an insurer or its tax representative to do so or to pay such tax to the authorities.

The EU authorities were aware of the problem, as insurers had asked the European Commission to take action to ensure that the Portuguese market was open to all EU service providers, particularly given the European Court of Justice's decision against Denmark on tax differentials.

On April 28 2010 the State Budget legislation changed the wording of the applicable rule and established a flat rate of 20% for income that is earned abroad and is not subject to withholding tax in Portugal by a resident paying agent. This rule had previously applied only to dividends and interest, but it now refers to "investment income as defined in Article 5".

As a result, income derived from investments in insurance policies paid abroad is subject to a flat rate of 20% - the fact that it is not subject to withholding tax does not prevent this treatment. Thus, the discriminatory treatment of insurance investments abroad was abolished.

On June 30 2010 several tax rates were raised to 21.5% in an attempt to remedy the poor state of Portugal's public finances. The taxes thus affected included the rate for investment income derived from Portuguese and foreign sources subject to withholding tax. However, the rate applicable to investment income as defined in Article 5 remains at 20%.

This gives an incongruous result. The unequal, negative treatment of income generated by non-resident insurers acting under the EU free provision of services regime has apparently been replaced by positive discrimination, as insurers established within the Portuguese territory now bear a heavier tax burden.

However, fiscal issues are rarely simple in Portugal and taxpayers must consider the procedures required to make tax rules effective. Income from investments under the free provision of services regime is not subject to withholding tax, for which reason such income must be declared in Annex J of the tax return. If the tax authorities do not adapt the form to reflect the new rule, the change will be ineffective.

For further information on this topic please contact Ricardo Peão or João Espanha at Espanha e Associados sociedade de advogados RL by telephone (+351 21 353 8705), fax (+351 21 314 3704) or email (ricardo.peao@espanhaassociados.pt or joao.espanha@espanhaassociados.pt).