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Tax: Understanding Income Tax for Expatriates in Portugal

Blevins Franks – February 2006

Once you have retired to Portugal and lived there for 183 days during any Portuguese tax year (the calendar year), you become a Portuguese Tax resident and liable to pay Portuguese tax on your worldwide income, including your UK state pension.

In Portugal, the first €7,500 of pension income per person is tax exempt. However, where an individual’s pension income is above €40,000 per year, the exemption is reduced by 20% of the excess over €40,000. So, if your annual pension income is €77,500 or above, no deduction is available.

National insurance retirement pensions fall within the Portuguese ‘tax net’ and are exempt from UK tax. Private pensions and annuities are taxed according to residence, so if you live here they are liable to Portuguese income tax and should be included in your local tax return, and again, are not taxable in the UK.

However, if a personal pension can be argued to be an annuity, only 35% of the pension is taxable. An annuity purchased solely by the individual (or where it is possible to distinguish between personal and other contributions) may be divided into capital and income when paid, with only the income element being subject to tax in Portugal. If the capital element cannot be determined, it is deemed to be 65% of the payment.

As with other aspects of the Portuguese tax code, this was drafted in a way which assumes a ‘closed’ tax system, i.e. it does not deal with a situation where the annuity is coming from outside Portugal. The same principles should apply, however.

If you have a UK Government Service pension, however, it is taxable ONLY in the UK and exempt in Portugal, even if you are tax resident in Portugal.

Claims to relief from UK income tax at source on UK pension income must be submitted to the Portuguese tax authorities at S.A.I.R. – Direccao de Servicos de Beneficios Fiscais, Relacoes Fiscais Internacionais, Av. Eng. Duarte Pacheco No.28 – 1000 Lisboa. Apartado 10062 – 1018 Lisboa Codex using Form DT/INDIVIDUAL. This form can be downloaded from www.hmrc.gov.uk.

Married couples resident in Portugal are taxable on the aggregate income of husband, wife and dependent children. The income is then divided by two and the tax rates applied to this half share. The resulting tax liability is then multiplied back up by two to determine the total income tax payable. Unmarried heterosexual couples living together for more than two years may opt to be taxed as married couples.

Interest income on current or saving accounts from Portuguese banks is taxed at a fixed rate of 20% on both residents and non-residents.

Interest arising in the UK payable to Portuguese residents is taxable in Portugal (as that is where the owner is resident) and also in the UK (as that it is where it arises), unless the ‘excluded income’ treatment is claimed on the income, which can only apply if you are not claiming your UK personal allowances i.e. if you have no other UK-source income other than bank interest and dividends. You would not usually forgo your UK personal allowance if you had a UK Government Service pension or UK rental income, for example.

'Excluded income' includes:

income from National Savings & Investments (usually paid gross – no tax deducted at source)

Interest paid on UK bank and building society accounts is taxed at source at a rate of 20%. However, under the terms of the UK/Portugal Double Taxation Treaty, if you are resident in Portugal, this deduction should be limited to 10% at source. The limitation of the tax deducted at source does not affect the UK tax liability arising on the income – if you are a basic rate taxpayer in the UK (e.g. because you have other UK-source income taxable in the UK, such as rental income), you will still have to pay the difference (20% tax due less the 10% tax deducted at source) on the interest income in the UK by the 31st January following the UK tax year in which the income arises. Double tax credit relief is available in Portugal for any UK tax paid on the income, although this relief will always be limited to the lower of the UK or the Portuguese tax due on the income.

In practice, this restriction of the amount of tax to be deducted at source if you are Portuguese resident is unlikely to be an issue because if you are liable to UK tax at the basic rate, the UK tax liability will be satisfied by the 20% deduction of tax at source, and therefore, this is likely to be the easiest method of paying that tax liability.

Alternatively, if you are claiming the ‘excluded income’ treatment on your UK source investment income, the UK tax liability will be satisfied by the tax deducted at source from the UK interest, which may be reduced to nil if you have completed Form R105, which allows the income to be paid to you gross of tax in the UK (available from HM Revenue & Customs office or the website at www.hmrc.gov.uk).

For residents of Portugal, rental income is subject to tax at the normal scale rates. The new non-resident’s withholding tax rate of 15% from 2005 means that the tax administration does not now have to chase after returns as the Portuguese tax retention accounts for the tax (although tax is also likely to be due in the country of residence).

Portuguese residents are taxed on their worldwide income at rates up to 42%. Capital gains are added to income. The income tax rates for 2006 are:

€0 – €4,451 – 10.5%

€4,452 – €6,732 – 13%

€6,733 – €16,692 – 23.5%

€16,693 – €38,391 – 34%

€38,392 – €55,639 – 36.5%

€55,640 – €60,000 – 40%

Over €60,000 – 42%

Tax returns must be filed by 15th March of the year following the tax year in question. Portuguese tax year is the calendar year.

Unless your financial affairs are very simple it would be advisable to seek the advice of an accountant or tax adviser with comprehensive and up to date knowledge of both the UK and Portuguese tax laws. You may be able to use legitimate structures like an offshore insurance bond or an offshore trust to reduce your tax liability significantly. A little time and effort now taking expert advice could reap some financial reward.

© Blevins Franks 2006

This article is reproduced with the kind permission of Blevins Franks.

For information and advice on tax issues, contact the Blevins Franks Tax Advisory Service on +44 (0) 207 015 2126 www.blevinsfranks.com

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