Portugal US Tax Treaty: How to Analyze the Treaty Rules

Portugal US Tax Treaty

Portugal US Tax Treaty 

Portugal US Tax Treaty: The United States and Portugal entered into a tax treaty back in 1994. The tax treaty is very important on various international tax issues involving investment income, earnings, and pension. By claiming tax treaty benefits, a resident of one of the contracting states may be able to limit or avoid certain taxes. But tax treaties can be very complicated to analyze and evaluate — especially in light of the fact their tax treaties involve a saving clause — which essentially provides the IRS carte blanche to take the position they want on the articles of the treaty impacted by the saving clause (not all articles are impacted by the saving clause). Let’s take a walk through some of the basics of the Portugal and US tax treaty to get an idea of how the tax rules work depending on country of residence.

Individual vs Company

Our analysis will focus primarily on how the tax rules impact individuals. When it comes to businesses, the tax rules get even more complicated depending on whether or not the company has a permanent establishment in the other country. For general purposes, when you have not established a permanent establishment in the other country, then the tax rules are much more beneficial — noting of course that various limitations, exceptions and exclusions do apply

Residence (Article 4)

• • • For the purposes of this Convention, the term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature. However, this term does not include any person that is liable to tax in that State in respect only of income from sources in that State.

    • Where by reason of the provisions of paragraph 1, an individual is a resident of both Contracting States, then his status shall be determined as follows: (a) he shall be deemed to be a resident of the State in which he has a permanent home available to him: if he has a permanent home available to him in both States, he shall be deemed to be a resident of the State with which his personal and economic relations are closer (center of vital interests); (b) if the State in which he has his center of vital interests cannot be determined, or if he does not have a permanent home available to him in either State, he shall be deemed to be a resident of the State in which he has an habitual abode; (c) if he has an habitual abode in both States or in neither of them, he shall be deemed to be a resident of the State of which he is a national; (d) if he is a national of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.

• • •  Where, by reason of the provisions of paragraph 1, a person other than an individual is a resident of both Contracting States, the competent authorities of the Contracting States shall endeavor to settle the question by mutual agreement. If the competent authorities are unable to make such a determination, the person shall not be considered to be a resident of either Contracting State for the purposes of enjoying benefits under this Convention.

What does this Mean?

Essentially it means, that in order to be considered a resident of a particular country you have to have domicile in that country (the intent to remain in that country at the time — not necessarily forever).  the subsequent paragraphs clarify that if it looks like the taxpayer may have residents in both Portugal in the United States, there are various factor to determine where the taxpayer should be considered a resident for tax purposes.

Real Property (Article 6)

• • • Income derived by a resident of a Contracting State from immovable property (real property), including income from agriculture or forestry, situated in the other Contracting State may be taxed in that other State.

    • The term “immovable property” or “real property,” as the case may be, shall have the meaning that it has under the law of the Contracting State in which the property in question is situated. The term in any case shall include property accessory to immovable property (real property), livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of immovable property (real property), and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources, and other natural resources. Ships and aircraft shall not be regarded as immovable property (real property).

    • The provisions of paragraph 1 shall apply to income derived from the direct use, letting, or use in any other form of immovable property (real property). 4. The provisions of paragraphs 1 and 3 shall also apply to the income from immovable property (real property) of an enterprise and to income from immovable property (real property) used for the performance of independent personal services.

What does this Mean?

This is one very important aspect of tax treaties — the difference in the use of the term may and shall. Article 6 refers to the fact that income derived from real property may be taxed in the other state. In other words, a person may be subject to tax in both countries — although the double taxation aspect of the treaty would prevent double taxation. Other treaties use the word shall and usually clarifies it with the term “only,” as in shall only be taxable in country…

Business Profits (Article 7)

• • • The business profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on or has carried on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on or has carried on business as aforesaid, the business profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment.

    • Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on or has carried on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the business profits which it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment and with any other associated enterprise.

    • In determining the business profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment, including research and development expenses, interest, and other similar expenses and a reasonable allocation of executive and general administrative expenses, whether incurred in the State in which the permanent establishment is situated or elsewhere.

    • No business profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise.

    • For the purposes of the preceding paragraphs, the business profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary.

    • Where business profits include items of income that are dealt with separately in other Articles of the Convention, the provisions of those Articles shall not be affected by the provisions of this Article.

What does this Mean?

Let’s use a basic example: If a company operates only in Portugal, then it is not going to be taxed in the United States. Even if business is conducted in the United States, if there is no permanent establishment in the United States the profits are generally still not be taxable in the United States. But, if a Portuguese company operates through a permanent establishment in the United States, then the portion attributed to that permanent establishment may be taxable in the United States.

Dividends (Article 10)

• • • Dividends paid by a company that is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

    • However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident, and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed 15 percent of the gross amount of the dividends. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of this limitation. This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.

    • Notwithstanding the provisions of paragraph 2, if the beneficial owner is a company that is a resident of the other Contracting State and that, for an uninterrupted period of 2 years prior to the payment of the dividend, owns directly at least 25 percent of the capital (capital social) of the company paying the dividends, the tax so charged shall not exceed: (a) with respect to dividends paid after December 31, 1996, and before January 1, 2000, 10 percent of the gross amount of such dividends; and (b) with respect to dividends paid after December 31, 1999, the rate that Portugal may apply to such dividends paid to residents of European Union member states, provided, however, that the applicable rate shall not be less than 5 percent.

    • Paragraph 3 shall not apply in the case of dividends paid by a United States Regulated Investment Company or a Real Estate Investment Trust. In the case of dividends from a Regulated Investment Company, paragraph 2 shall apply. In the case of dividends from a Real Estate Investment Trust, paragraph 2 shall apply if the beneficial owner of the dividends is an individual holding a less than 25 percent interest in the Real Estate Investment Trust; otherwise, the rate of withholding applicable under domestic law shall apply.

    • The term “dividends” as used in this Article means income from shares, “jouissance” shares, founders’ shares, or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights that is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident. The term “dividends” also includes income from arrangements, including debt obligations, carrying the right to participate in profits, to the extent so characterized under the law of the Contracting State in which the income arises. In the case of Portugal, the term also includes profits attributed under an arrangement for participation in profits (associaç|o em participaç|o).

    • The provisions of paragraphs 1, 2, and 3 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on or has carried on business in the other Contracting State, of which the company paying the dividends is a resident, through a permanent establishment situated therein, or performs or has performed in that other State independent personal services from a fixed base situated therein, and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 (Business Profits) or Article 15 (Independent Personal Services), as the case may be, shall apply.

    • Where a company that is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State.

What does this Mean?

The portion of the Portugal US tax treaty on the issue of dividends is very complicated. In a nutshell, using a basic example: If a Portugal company pays dividends to a resident of the United States, the US can tax that income. Portugal may also tax the dividend, but if the beneficial owner of the dividend resides in the other state (US), then the tax that Portugal charges is limited.

Interest (Article 11)

Interest arising in a Contracting State and derived by a resident of the other Contracting State may be taxed in that other State.

1. 1. • However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other Contracting State, the tax so charged shall not exceed 10 percent of the gross amount of such interest. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of this limitation.

      • Notwithstanding the provisions of paragraph 2, interest arising in one of the Contracting States and beneficially owned by a resident of the other Contracting State shall be exempt from tax in the first-mentioned State, provided that: (a) the debtor of such interest is the Government of that Contracting State, a political or administrative subdivision thereof, or any of its local authorities; or (b) the interest is paid to the Government of the other Contracting State, to a political or administrative subdivision thereof, or to any of its local authorities, or to an institution or organization (including financial institutions) wholly owned by them; or (c) it is interest on a long-term loan (5 or more years) granted by a bank or other financial institution that is a resident of the other Contracting State.

      • Notwithstanding the provisions of paragraphs 2 and 3, interest arising in one of the Contracting States that is determined by reference to the profits of the issuer or of one of its associated enterprises and that is beneficially owned by a resident of the other Contracting State may be taxed in the State in which it arises, and according to the laws of that State, but the tax so charged shall not exceed the rate prescribed in paragraph 2 of Article 10 (Dividends).

      • The term “interest” as used in this Convention means income from debt-claims of every kind, whether or not secured by mortgage, and, subject to paragraph 5 of Article 10 (Dividends), whether or not carrying a right to participate in the debtor’s profits, and in particular, income from government securities, and income from bonds or debentures, including premiums or prizes attaching to such securities, bonds, or debentures, as well as all other income assimilated to income from money lent by the taxation law of the State in which the income arises.

      • ‘The provisions of paragraphs 1, 2, and 4 shall not apply if the beneficial owner of the interest, being a resident of a Contracting State, carries on or has carried on business in the other Contracting State, in which the interest arises, through a permanent establishment situated therein, or performs or has performed in that other State independent personal services from a fixed base situated therein, and the debt-claim in respect of which the interest paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 (Business Profits) or Article 15 (Independent Personal Services), as the case may be, shall apply.

      • For purposes of this Article, interest shall be deemed to arise in a Contracting State when the payer is that State itself or a political or administrative subdivision, local authority, or resident of that State. Where, however, the person paying the interest, whether a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base and such interest is borne by such permanent establishment or fixed base, then such interest shall be deemed to arise in the State in which the permanent establishment or fixed base is situated. 8. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest, having regard to the debt-claim for which it is paid, exceeds the amount that would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of the Convention.

What does this Mean?

The taxation rules for interest follow the same general rules as dividends. For example, if a person from Portugal resides in the United States, the United States can tax them on the interest income. Likewise, if the company paying the interest is a Portugal company, then Portugal can tax them as well — but the interest rate is limited to 10%. Therefore, for example if Martha is from Portugal and moves to the United States and receives interest income from a Portugal company, the United States can tax her on the interest income.

If the company paying the interest is based in Portugal, then the company can tax her as well — but it is limited to 10% (Martha should be able to apply foreign tax credits paid in the US to offset the interest tax she’s paying in Portugal)

Capital Gains (Article 14)

Gains derived by a resident of a Contracting State from the alienation of immovable property (real property) situated in the other Contracting State may be taxed in that other State.

• • • For the purposes of paragraph 1, immovable property situated in Portugal includes stock, participations, or other rights in a company or other legal person the property of which consists, directly or indirectly, principally of immovable property Situated in Portugal; and real property situated in the United States includes a United States real property interest.

    • Gains from the alienation of movable (personal) property forming part of the business property of a permanent establishment that an enterprise of a Contracting State has or had in the other Contracting State, or of movable property pertaining to a fixed base that is or was available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or such a fixed base, may be taxed in that other State.

    • Gains derived by an enterprise of a Contracting State from the alienation of ships or aircraft operated in international traffic or movable property pertaining thereto shall be taxable only in that State.

    • Gains described in the last sentence of paragraph 3 of Article 13 (Royalties) shall be taxable only in accordance with the provisions of Article 13. 6. Gains from the alienation of any property other than property referred to in paragraphs 1 through 5 shall be taxable only in the Contracting State of which the alienator is a resident.

What does this Mean?

When it comes to Capital Gains for property (immovable), it may be taxed in both countries. Property also includes stock.

Independent Personal Services (Article 15)

• • • Income derived by a resident of a Contracting State in respect of professional services or other activities of an independent character shall be taxable only in that State except in the following circumstances, when such income may also be taxed in the other Contracting State: (a) if he has or had a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities; in that case, only so much of the income as is or was attributable to that fixed base may be taxed in that other State; or (b) if his stay in the other Contracting State is for a period or periods amounting to or exceeding in the aggregate 183 days in any 12-month period commencing or ending in the taxable year concerned; in that case, only so much of the income as is derived from his activities performed in that other State may be taxed in that other State.

    • The term “professional services” includes especially independent scientific, literary, artistic, educational, or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists, and accountants.

What does this Mean?

In general, the income derived by a resident of one country for personal services (Independent) is only taxable in that country – exceptions, exclusions and limitations apply.

Pensions, Annuities, Alimony, and Child Support (Article 20)

• • • Subject to the provisions of Article 21 (Government Service): (a) pensions and other similar remuneration derived and beneficially owned by a resident of a Contracting State in consideration of past employment shall be taxable only in that State; and (b) social security benefits and other public pensions paid by a Contracting State to a resident of the other Contracting State or a citizen of the United States may be taxed in the first-mentioned State.

    • Annuities derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State. The term “annuities” as used in this paragraph means a stated sum paid periodically at stated times during a specific time period, under an obligation to make the payments in return for adequate and full consideration (other than services rendered).

    • Alimony paid to a resident of a Contracting State shall be taxable only in that State. The term “alimony” as used in this paragraph means periodic payments made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support, which payments are taxable to the recipient under the laws of the State of which he is a resident.

    • Periodic payments for the support of a minor child made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support, paid by a resident of a Contracting State to a resident of the other Contracting State, shall be taxable only in the first-mentioned State.

What does this Mean?

Pension tax law is complicated. This is due to the distinction between contributions, growth and distributions. Pensions that are earned by a resident of one country in consideration of past employment, shall only be taxable in that country. This rule does not apply to social security and public pensions (which may be taxable in the first country aka non-resident country)*.

Public pensions are taxable only by the country it was earned in, unless certain limitations are met.

Savings Clause

• • • Notwithstanding any provision of the Convention except paragraph (c) of this provision, a Contracting State may tax its residents (as determined under Article 4 (Residence)), and the United States may tax its citizens, as if the Convention had not come into effect. For this purpose, the term “citizen” shall include a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of 10 years following such loss. For the application of the preceding sentence to a resident of Portugal, the competent authorities shall consult under Article 27 (Mutual Agreement Procedure), upon request by the Portuguese competent authority, on the purposes of such loss of citizenship.

    • The provisions of the preceding subparagraph (b) shall not affect: (i) the benefits conferred by a Contracting State under paragraph 2 of Article 9 (Associated Enterprises), under paragraphs 1(b) and 4 of Article 20 (Pensions, Annuities, Alimony, and Child Support), and under Articles 25 (Relief From Double Taxation), 26 (Non-Discrimination), and 27 (Mutual Agreement Procedure); and (ii) the benefits conferred by a Contracting State under Articles 21 (Government Service), 22 (Teachers and Researchers), 23 (Students and Trainees), and 29 (Diplomatic Agents and Consular Officers), upon individuals who are neither citizens of, nor have immigrant status in, that State.

What does this Mean?

Countries reserve the right to circumvent these rules and tax the income anyway, but certain aspects of the tax treaty cannot be circumvented with the Saving Clause.

The Portugal US Tax Treaty is Complicated

In conclusion, analyzing tax treaties can be very difficult. Depending on the residence of the taxpayer and the type of income, it may result in the Taxpayer being able to avoid tax, reduce the applicable tax rates, or apply foreign tax credits.

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