The Portuguese real estate market has been quite active in the last couple of years and the interest of worldwide investors has been constantly growing. This has led to a considerable increase in real estate market prices, which raises investors’ awareness to the relevance of considering a tax structure that is adequate to the type of investment they look after (e.g. project development, short-term rental, hotel and accommodation services, property refurbishment, etc.) and that allows them to profit from the various tax incentives that were enacted to attract domestic and foreign investors.
This article addresses the most relevant tax incentives available for real estate investments, as it also goes through the most common investment structures. On this second section the authors also discuss the impacts of the Portuguese and international developments affecting the taxation of capital gains in the context of the (direct or indirect) sale of real estate companies.
General Real Estate Tax Incentives
Given the relevance of the real estate sector for Portuguese economy, a wide range of tax benefits have been enacted by the Portuguese legislator in respect of different types of real estate related activities, namely regarding property trading (compra para revenda or purchase for re-sale) and urban renovation or refurbishment (reabilitação urbana).
Pursuant to the property trading companies’ regime, a company may claim a property transfer tax (IMT) exemption provided that the asset is resold within a maximum period of three years. This benefit has a considerable impact on short to medium-term investments, taking into account that IMT is due by the purchaser and may amount up to 6.5% of the purchase price. Moreover, the IMT exemption may be combined with a three to four years tax deferral applicable to property holding taxes (municipal property tax – IMI – and the surcharge on municipal property tax – AIMI) which may represent a tax saving of circa 0.85% of the property tax value, per year. This regime relies on certain conditions that need to be complied with by the property trading company. For instance, the property tax exemptions require that the real estate asset is not subject to structural / material constructions works.
For project developments there is a new regime that boosted most of the urban renovation in Lisbon and more recently in other Portuguese major cities, such as Oporto – the urban renovation regime.
In a nutshell, the urban renovation regime foresees the following tax incentives:
With all that in mind, the Portuguese real estate market has been increasing and worldwide investors have been paying more attention not only to opportunities in the residential sector (which has led the charts in the past few years), but also in the hotel and accommodation business, and more recently on the commercial, retail and office centers sector. In this context, investors are also keen on understanding the impacts of alternative investment structures.
Structuring the real estate investment
The transfer or immovable property may be materialized in one of two possible operations: an asset deal or a share deal. Notwithstanding the fact that many times buyers opt for a (much straightforward) asset deal, relevant investments in real estate are more commonly performed by way of a share deal. This is due to a multitude of reasons, some related to economic factors – e.g. if there is already a project being developed by the real estate company –, to financing factors – e.g. if the real estate acquisition was funded through a third-party loan and there is a security package in place – but also for tax-related factors – such as the impact of property transfer taxes on the direct purchase of real estate assets.
Irrespective of the reasons underlying the decision of an investor to go for a share deal, once that decision is made, the question remains as how to structure such a transaction. In this regard, investors are naturally interested in understanding their exposure to a future capital gain on the sale of the real estate company. This chapter addresses the specific rules that Portugal has in place concerning the taxation of capital gains realized upon the sale of shares of real estate companies, including the newly enacted rules that tackle the sale of non-resident companies that hold (or held) real estate in Portugal.
Picture 1. Purely Domestic Situation
In this first scenario, a Portuguese company wishes to invest in real estate located in Portugal though a Portuguese real estate company (SPV) – in this case there is no cross-border transaction. As such, any capital gains realized upon the sale of the SPV’s shares are taxed in Portugal and subject to Portuguese Corporate Income Tax (IRC), at the level of PT Co.
It should be noted that Portugal, as a Member State of the European Union, has adopted the Parent Subsidiary Directive and its participation exemption regime which allows that dividends paid to non-resident EU companies may be tax-exempt in Portugal. Moreover, the Portuguese legislator has decided to extend the application of the participation exemption regime to purely domestic scenarios and to extend it also to capital gains and not only to dividend distributions. It follows that, provided certain requirements are complied with, dividend distribution, as well as capital gains from the sale of shares, may be fully exempt. There is, however, an exception to this rule, which refers precisely to capital gains realized upon the sale of real estate companies (i.e. companies whose assets are comprised of, in more than 50%, real estate located in Portugal). As a result, the participation exemption regime is not applicable to capital gains derived from the sale of such companies, even if the seller is a Portuguese corporate shareholder.
There is, however, and exception to the exception… According to the Portuguese CIT Code, the participation exemption may still apply if the real estate assets are used (by the SPV) for carrying out an agricultural, industrial or commercial activity, other than the purchase and resale of immovable property. This rule has a great impact on real estate deals, especially where the real estate assets will not be sold but rather exploited for commercial purposes (e.g. short-term rental, hotels, hostels and other accommodation-related activities, office buildings, shopping centers, industrial facilities…).
In brief, in a pure domestic scenario, it is still possible to benefit from a full capital gain exemption on a share deal, even if the target is a real estate company, provided that the real estate assets are used for the carrying out of an agricultural, industrial or commercial activity, which is certainly an important tax advantage and fosters the Portuguese market as Portuguese and foreign investors consider to use Portuguese holding companies for their investments.
Picture 2. Portuguese SPV held by Foreign Company
In this scenario, a foreign company wishes to invest in real estate located in Portugal through a Portuguese SPV.
According to the Portuguese CIT Code, the capital gains derived from the sale of shares of Portuguese companies are taxed in Portugal.
When it comes to real estate companies, Portugal’s right to tax is not affected by most Double Tax Treaties that follow the OECD Model Convention, as Portuguese double tax treaties generally follow Article 13(4) of the Model Convention which provides that “[g]ains derived by a resident of a Contracting State [Foreign Country] from the alienation of shares (…) may be taxed in the other Contracting State [Portugal] if, at any time during the 365 days preceding the alienation, these shares (…) derived more than 50 of their value directly or indirectly from immovable property (…) situated in that other State [Portugal]”.
However, this rule was only introduced in 2003, which means that some Double Tax Treaties that are prior to that date do not foresee this rule. In the absence of a provision with a similar effect to Article 13(4) of the OECD Model Convention, the residual rule provided in Article 13(5) of the OECD Model Convention which provides for exclusive taxing rights of the country of the residence of the investors – preventing Portugal from taxing the capital gain.
To mitigate the exposure to the taxation of a future capital gain derived from the sale of shares of Portuguese real estate companies, foreign investors often choose to structure their investment through a company resident for tax purposes in a country that entered into a double tax treaty with Portugal and which does not include a provision similar to Article 13(4) of the OECD Model Convention.
In this regard, it is important to consider that Portugal, as most countries in the world, has signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (“MLI”), which includes a specific provision addressing this issue and proposed a change into the tax treaties in force, so that source countries (or the countries where real estate is located, in this case) are not prevented from imposing taxation on capital gains realized upon the sale shares in real estate companies. Portugal has taken the decision to adopt the referred provision and said rule is expected to be included in most tax treaties entered into by Portugal. This will imply that any capital gains realized after the enactment of the MLI provision will remain subject to tax in Portugal – with a direct impact on real estate investments currently in place.
Notwithstanding the above, Portugal has several tax benefits designed to attract and retain foreign investment, one of which is a capital gains exemption regarding the sale of shares of Portuguese companies held by non-resident investors.
However, similarly to the domestic rule referred above in Scenario A, the capital gains exemption does not apply to capital gains derived from the sale of real estate companies (whose assets are comprised of, in more than 50%, real estate located in Portugal). Yet, contrasting with Scenario A, no reference is made to real estate used for the carrying out of an agricultural, industrial or commercial activity.
As a result, in a comparable situation where a Portuguese SPV is held (i) by a resident corporate shareholder or (ii) by a non-resident shareholder, the outcome of a share deal may not be the same, as the Portuguese corporate shareholder may be eligible for a tax exemption – if the real estate is, for instance, a hotel – whereas the non-resident shareholder will not be able to claim such benefit.
The authors take the view that such discrimination may well give rise to future litigation with Portuguese tax authorities, by EU-based investors, under the Freedom of Establishment, or by any foreign investors pursuant to the Free Movement of Capital, to challenge the discriminatory treatment arising from Portuguese domestic provisions – please see chapter 4 below. In fact such discrimination becomes even a more relevant fact in view of the changes that will result from the implementation of MLI and the ultimate change of more favorable tax treaties (as mentioned above).
Picture 3. Foreign SPV held by foreign company
In this last scenario, a foreign company wishes to invest in real estate located in Portugal through a foreign SPV.
Until 31 December 2017, capital gains derived from the sale of a foreign real estate company with immovable property located in Portugal were not subject to taxation in Portugal.
However, the State Budget Law for 2018 introduced a new provision in the CIT Code which is in force since the 1 January 2018, according to which capital gains derived from the sale of a foreign SPV are also taxable in Portugal provided that, at any point in time during the 365 days prior the sale of the shares, the latter derived more than 50% of their value directly or indirectly from immovable property located in Portugal.
Before this rule was enacted, Portuguese taxation would only be triggered if (at least) the SPV was a resident entity. The new provision extends Portuguese jurisdiction to tax to transactions that have no direct connecting factor with Portuguese territory.
Yet, this rule contemplates an important exception, comparable to the one highlighted in Scenario A. In fact, capital gains realized outside Portugal (as it is clearly the case in Scenario 3) are now taxable in Portugal except if the real estate assets are used for an agricultural, industrial or commercial activity, other than the purchase for re-sale of real estate. In other words, the provisions governing the taxation of capital gains derived from the sale of a foreign real estate company are comparable to those rules applicable to a purely domestic setting (Scenario 1), but are not comparable to those rules applicable to the sale of a Portuguese SPV by a foreign shareholder (Scenario 2).
By comparing the above described scenarios, it results that most likely capital gains from the sale of shares of real estate companies will usually be subject to taxation in Portugal, regardless of the investment structure the investors adopt.
That said, we have also described the important exception to this “principle” in scenarios A and C, in respect to the immovable property used for carrying out an agricultural, industrial or commercial activity. Surprisingly, we cannot find a parallel exception in Scenario B.
In other words, the capital gains realized upon the sale of a Portuguese real estate company, by a Portuguese investor, are not subject to taxation in Portugal, as the capital gains realized upon the sale of a foreign real estate company, by a foreign investor, when the immovable property is used for carrying out an agricultural, industrial or commercial activity. In contrast, the capital gains realized upon the sale of a Portuguese real estate company, by a foreign investor, are always and in any case subject to taxation in Portugal, regardless of the immovable property being used to carry out an agricultural, industrial or commercial activity.
The different treatment of these situations creates a very noticeable distortion.
But is this distortion acceptable? Portugal, as a Member State of the European Union, must exercise its powers consistently with the European Law. This provision could easily be examined in the light of the Free Movement of Capital or of the Freedom of Establishment, as the rule at issue may apply to both pure investments and investments that imply a definite influence of the foreign investors over the decisions of the Portuguese company. Also, we have already identified a differentiation in the treatment of two parallel situations: Scenario A (purely domestic situation) and Scenario B (Portuguese SPV and foreign investor). Differentiation in treatment that is undeniably unfavorable to the foreign investor comparing to the treatment conferred to the Portuguese investor, and that could mean a discrimination forbidden by the European law. Could this possible discrimination be legitimately justified? If justified, is it proportioned? Or is this another clear violation of an European Fundamental Freedom?
Until the hypothetical submission of this issue to the European Court of Justice, we can only raise this matter and emphasize the importance of a careful and advised structuring of real estate business in Portugal, in order to achieve the most tax efficient business model possible.
After going through the taxation applicable to real estate business, one may easily realize the current relevance of the real estate sector for the prosperity of the Portuguese economy and the range of tax benefits available clearly evidences that fact. Nonetheless, developments in the international setting require a careful analysis of the most suitable investment structures, in such way that investors acknowledge the impacts and limitations arising from a global change in the (tax) level playing field, including when it comes to real estate. Still, the authors are convinced, and experience shows, that this is a thriving sector where investors are eager to seize the opportunities.
 Council Directive 2011/96/EU of 30 November 2011.
 See Article 51 and 51-C of the Corporate Income Tax Code (CIRC). The participation exemption usually applies to parent companies that have a minimum holding of 10% in the capital of a subsidiary company for a minimum period of 1 year.
 At the time this rule was introduced, no reference was made to the 365 days preceding the alienation. This provision was created to mitigate the existing distortion in the taxation of asset and share deals in the context of the real estate business and to mitigate the tax planning opportunities derived therefrom.
 E.g. see Article 13 of the Double Tax Treaty entered into by Portugal and Luxembourg.
 According to the last paragraph of Article 13 of the Model Convention, “[g]ains from the alienation of any property, other than that referred to in paragraphs 1, 2, 3 and 4, shall be taxable only in the Contracting State of which the alienator is resident [Foreign Country].”
 See paragraph 4 of Article 9 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, “For purposes of a Covered Tax Agreement, gains derived by a resident of a Contracting Jurisdiction from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting Jurisdiction if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property (real property) situated in that other Contracting State.”
 Available in http://www.oecd.org/tax/treaties/beps-mli-position-portugal.pdf.
 See Article 27 of the Portuguese Tax Benefits Code.
 Law no. 114/2017, of 29th December
 See Article 4(3)(f) of the Portuguese CIT Code. This is a rule inspired by the paragraph 4 of Article 9 of the MLI.
 Which, in principle, would require the foreign SPV to register a permanent establishment in Portugal.
 Schumaker (C-282/12), Judgment of the European Court of Justice of 14 February 1995.
 Foreseen in Article 63 of the Treaty on the Functioning of the European Union.
 Foreseen in Article 49 of the Treaty on the Functioning of the European Union.
 ITELCAR (C-282/12), Judgment of the European Court of Justice of 3 October 2013. The applicable freedom may be particularly relevant, as the Free Movement of Capital also applies to the relations between Member States and Third Countries, contrarily to the Freedom of Establishment, which only applies to the relations between Member States.