Portugal: Taxation of trusts and private foundations

Definition and scope of “fiduciary structure”

The taxation of fiduciaries structures was introduced in the Portuguese personal income tax law with the reform that was promoted in the end of 2014. The law does not define this term, and we consider that in some situations it will be difficult to determine if we are, or not, in presence of such kind of structures - due to the multiple legislations, names and judicial characteristics.  

Taxation in the moment of the structure’s creation

The commission that was nominee to deal with the personal income tax reform does not analyze the taxation in the moment of the structure’s creation and its proposals do not give us any clue, neither does the final version approved by the parliament. In fact, giving a different treatment for the liquidation of the fiduciary structure to the situations were the settlor and the beneficiary are or are not the same person, the commission turned impossible to achieve a consistent way to deal with the creation of a fiduciary structure.

The personal income tax reform that applies from January of 2015 introduced the concept of taxation of fiduciary structure, that includes overseas fiduciary structures.

This reform was important to bring some legal security to tax treatment of the beneficiaries of this kind of structures, but it could have been more ambitious – the tax treatment on the level of the settlor or founder is still unclear.

The first possibility is to consider that a donation occurs between the settlor and the fiduciary structure. This donation could be potentially subject to corporate income tax[1] or stamp duty[2], or to none of them – depending on the assets that are transferred and their “location”. 

Another possibility would be to consider that an onerous transfer occurs with the operation (as if it was the incorporation of a company). In this situation there might exist potential capital gains – depending on the assets that are transferred (in this situation their location is not relevant)

Taxation during the life-time of the fiduciary structures 

The tax reform established the taxation, in the sphere of the fiduciary structure’s beneficiaries, of the amounts received by them.

In the previous version (as in this version), the income obtained by the fiduciary structure was potentially taxed under application of CFC rules (international tax transparence)[3]. In this situation any income or gain occurred inside the fiduciary structure, is attributed to the beneficiaries, even if it not distributed. In this case, there are no special tax rates applicable – it is taxed under general progressive tax rates.

In our opinion, although it was the intention of the commission to tax all as capital income with a special tax rate of 28%, this doesn’t result from the new version after the reform. In fact the CFC rules still impose this income to be subject to progressive tax rates[4].

In the previous version the distribution of income or capital from the fiduciary structure is not mentioned. Now, the new version of the law clarifies it: all amounts given by the fiduciary structure to the beneficiaries (during the existence of the fiduciary structure) are considered capital income and subject to a flat rate of 28% (the income already taxed under CFC is deducted).

This applies in both situations: if the settlor and beneficiary are or are not the same person, and to all amounts distributed (capital and income).

That might allow us to assume that this distributions occurred before this tax reform where not subject to personal income tax.

Revocation of the fiduciary structure

The revocation of the fiduciary structure is legislated in the tax reform. If the settlor and the beneficiary are the same person, it is treated as a capital gain[5] and only predicts the taxation of the post difference between the value received with the revocation (as if it was the liquidation of a company) and the amounts given to the fiduciary structure (in the creation or subsequently)

In this situation it is not possible to deduct the income taxed under CFC rules.

If the settlor and the beneficiaries are different persons there is no IRS in the revocation of the fiduciary structure, and all the amount received by the beneficiaries is potentially subject to stamp duty (flat rate of 10%) - depending on location of the assets.

Conclusion

The treatment for the distributions during the existence of the fiduciary structure is very inconsistent, and may very penalizing. It makes no sense to tax capital distributions as if they where income – at least a pro rata should have been considered.

On the other hand, not considering the relation between the settlor and the beneficiaries makes this structures much costly, compared to the “exemption” that exists in donation / inheritance to spouses, sons, etc., or credits form life insurance.