IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
In any undergraduate course the value of legal certainty is taught. Fiscal policy, of all policies, should be following the principle more strictly, as it is one of the basic elements for any investment decision – and investment is the basis for economic growth and job creation. But that has not been the rule in Portugal, and in fact this report would be rather different if it was written six or even three months ago. For that reason, this year’s report will focus on the most important issues of the year, without giving fully detailed account date by date, which would be tiresome and useless for the reader.
Portuguese left is so pro-spending that the government’s ?eet reduction was approved with the votes of only the government-supporting right wing parties. Portuguese left is a staunch believer in pro-growth rhetoric and claims that “austerity” is not working and that further credit spending is needed to solve the credit crisis. Despite all the evidence from the last decade, they claim that the new loans will stimulates new spending and bring the economy back on track.
Both Portuguese right-wing parties are in the government coalition under the ?nancial guidance of Vitor Gaspar, former top economic advisor for José Manuel Barroso. Mr. Gaspar had promised a budget correction based 70% on expenses; but, due to various pressures, he ended budgeting a correction based for 19% on expenses, and for 81% on an “enormous” (his word) tax hike.
Portugal’s heart is traditionally on the left, calling the right wing leaders to of?ce only in order to deal with IMF requirements – 1977/78, 1983/85, 2011/14. No surprise therefore that, over the last 40 years of democracy, the state burden has grown from 20% to 50% of GDP. The present crisis, however, is a bit different, coming after the country has absorbed a great deal of European funds in the eighties and nineties. The challenge is now to introduce changes in a country that has grown used to foreign funds – either in the form of aid, either in the form of credit expansion.
Portugal was meant to go bankrupt in June 2011. Then it was meant to “return to the markets” in December 2013. Now, the IMF no longer believes that the State can recover full ?nance independence before the end of 2014. With elections coming in 2015, this will be the ?rst time a right-wing government is called to of?ce following an IMF intervention and fails to ?x the problem before the next national elections arrives.
In last year’s report, it was said: “The Troika Program had as objectives to reduce government de?cit below € 10,068 million (5.9% of GDP) in 2011, 7,645 million (4.5% of GDP) in 2012 and 5,224 million (3.0% of GDP) in 2013 by means of ’high-quality permanent measures and minimizing the impact of consolidation on vulnerable groups; bring the government debt-to-GDP ratio on a downward path as of 2013; maintain ?scal consolidation over the medium term up to a balanced budgetary position, notably by containing expenditure growth; support competitiveness by means of a budget-neutral adjustment of the tax structure’”. The reality was different! After the € 16,982 million de?cit of 2010 (9,8% of GDP), in 2011 the de?cit reached € 7,525 million (that is 4.4% of GDP, or 8% of GDP before EU’s acceptance of the absorbing of banking pension funds into the social security). In 2012, it rocketed to 10,596 million (6,4% of GDP, as € 2,650 million in extraordinary measures were not considered by EU). Consequently, State debt rose from € 185,240 to € 204,485 million (112% to 123,6% of GDP) in just 2012; a € 19,245 million (11,6% of GDP) increase ?nanced mostly by the ECB.
As mentioned above, Portugal went through an “enormous” tax hike to ?ght the loss in tax revenue provoked by a decrease in consumption, imports and revenues in general. The main changes are presented below.
The number of brackets for residents has been reduces from 8 to 5, the new brackets being:
> Up to 7,000 EUR – rate of 14.5%
> 7,000 to 20,000 EUR – rate of 28,5%
> 20.000 to 40.000 EUR – rate of 37%
> 40.000 to 80.000 EUR – rate of 45%
> More than 80.000 EUR – rate of 48%
Self-employed residents will pay a ?at tax of 25% on 75% of services provided. Non-residents face a rate of 25% tax on all employment income, commissions and royalties. Both residents and non-residents will pay income taxes on pensions (14.5% to 48% for residents, 25% for non-residents). When visiting Portugal on a short- term assignment (less than 183 days in Portugal), the individual will qualify as tax non-resident and be liable to personal income tax only on the Portuguese- income source.
An extraordinary surtax of 3.5% will be levied on incomes that exceed the minimum wage (€ 6,790 annual income). An additional “solidarity tax” will be added to the higher bracket, with the rates of 2,5% being charged from € 80.000 to € 250.000 and 5% above € 250,000. Meanwhile, deductions, allowances and bene?ts have been greatly reduced to ful?l international obligations (memorandum with Troika), but are still possible for a myriad of expenses.
All these new rates and rules are expected to bring in 2013 a 35% increase of revenues from the personal income tax.
Rate is now 28% for all kind of capital income, namely: dividends, interest from bank deposits, interest from shareholder loans, interest from debt securities, rental income, capital gains and other investment income. Keep in mind that, only a few years ago, that rate was at 20% for most capital gains and at only 10% for capital gains on shares if the investment was done less than 12-month ago – exempt if it exceeded that time limit.
Social Security rates are 11% for employee and 23.75% for company (11% and 11.9% respectively if the employee is handicapped). For age pensioners in employed activity the rates are 7.5% for pensioner and 16.4% for company, while for handicap pensioners the rates raise to 8.9% and 19.3% respectively. Age pensioners did not pay social security until two years ago. Rates for self-employed are 29.6% for employee and 5% for the company – employee only pays after 12 months, if the gross annual income is above € 3,593, and company must pay only if 80% or more of the amount of rendered services is for that business group.
Employee must pay 34.75% if he/she would like to be also protected in the event of unemployment.
Corporate taxes are 25% in mainland and Madeira (a huge increase in Madeira, due to the region’s ?nancial situation) and 17.5% in Azores. A municipal surtax (“Derrama”) of up to 1.5% of taxable pro?t may apply, especially in mainland urban areas. A state surtax will also apply if the company has a taxable income over € 1.5 million – the surtax rates are 3% for companies with a taxable income of € 1.5 million up to € 7.5 million and 5% for companies with a taxable income of more than € 7.5 million. Deductions were reduced across the board to ful?l a compromise with Troika.
The 12.5% bracket for small companies is no longer applicable, while the state surtax for “very pro?table” companies will be introduced in 2013.
Payments on account are owed based on the CIT assessed in the previous year, net of withholding taxes incurred that cannot be either offset or refunded. For tax styear beginning on January 1 2013, the amount of payment on account due is CIT paid in 2012 minus 80% of withholding taxes in 2012 if the turnover is less than € 500,000, and 95% instead of 80% otherwise.
Companies are liable to the Special Payment on Account (“Pagamento Especial por Conta” or PEC), which in practice results in a minimum tax burden, regardless the results obtained – and remember that 70% of Portuguese companies report a loss. The formula is: 1% of the turnover of previous tax year minus payments on account of previous year. To be more precise instead of 1% of turnover the formula for Payment on account uses a minimum of € 1,000 or if larger the maximum of 1% of turnover or € 1,000 EUR + 20% of the surplus limited to € 70,000. This payment is deductible from the CIT assessed in the year and the following four years. Any part that cannot be deducted due to the insuf?ciency of tax assessed will only be refunded upon request, which immediately triggers a full tax inspection. Entities totally exempt from the tax are not required to make the special payment on account, even if the applicable exemption does not include income subject to withholding tax at ?at rates.
Additional payments on account (“Pagamento Adicional por Conta”) is due by entities subject to either payments on account or special payments on account that have reported, in the previous tax year, a taxable pro?t exceeding € 1.5 million. The rates of that additional payments are 2.5% for companies with a taxable income above € 1.5 million up to € 7.5 million and 4.5% otherwise. Companies that reported a loss in a given ?scal year have risen from two thirds to above 70%, but that does not mean that they do not pay taxes now – the assumption being that if the company is still open it must be that the owner pro?ts from that fact.
Dividends, interests, rental income, royalties and capital gains all pay 25%, except if it is capital income paid or made available to entities resident in blacklisted jurisdictions or capital income paid or made available in open accounts on the name of one or more owners but on behalf of third parties not identi?ed, in which cases the rate is 35%.
VAT tax rates are: 23%, 13% and 6% in mainland, 22%, 12% and 5% in Madeira and 16%, 9% and 4% in Azores. Again, Madeira had to adjust upward due to its very weak ?nancial situation. The reduced rate is applicable to the supplies of some basic foodstuffs, periodical publications, books, pharmaceuticals, hotel accommodations, agricultural goods and passenger transports. The intermediate rate is applicable to supplies of some foodstuffs and to admissions to concerts, shows, theatre, cinemas, circus and bull?ghting. There are movements to lower VAT on books and other cultural items, but such a change seems unlikely in the foreseeable future.
Most self-employed also pay VAT (adding a pre-tax to the 25% PIT and the 29,6% of Social Security) on their incomes – a situation very common for youngsters, ndwhich now abandon the country at a rate of 100,000 per year, the 2 highest ever (after the Colony Wars period). Exempted activities include ?nancial services, nursing services, medical and paramedical services and all earning below € 10,000 of taxable income. For this reason many self-employed opt for opening a personal company and bill the employer from the personal company.
A new rule aimed at ?ghting VAT fraud and evasion allows resident taxpayers to deduct, for Personal Income Tax purposes, 5% of the VAT incurred on certain expenses by any member of the household, up to annual limit of € 250. In 2013, the VAT paid must relate to certain business sectors, such as maintenance and repair of cars and motorcycles, hotel and restaurant bills and hairdressing. This tax incentive may be extended to other business sectors in 2014. Effective January 1st 2013, all Portuguese taxpayers (Portuguese companies or foreign companies with a permanent establishment in Portugal) must communicate by electronic means to the Portuguese Tax Administration relevant data of the invoices issued during a particular month, at the latest on the 25th day of the subsequent month. Note that the rules for the elements and comments that must be included on VAT invoices have been standardized at the EU level, and consequently several changes have been introduced in Portugal regarding the content of invoices.
Property taxes were based on the old value of the building. No longer: all the buildings are being re-valued by the state (done by self-employed architects earning € 50 for 10 evaluations), with the option for the owner to ask for a second re-evaluation if one does not agree with the ?rst one (billed € 204 if the value remains unchanged or raises).
Rates are as follow: Urban property (appraised under the former legislation “Contribuição Autárquica”) – 0.5% to 0.8%, Urban property appraised under the IMI Code – 0,3% to 0.5%, Rural property – 0.8%, Property owned by residents in off-shores (except individuals) – 7.5%.
Urban properties considered as a permanent place of residence are exempt the ?rst 10 years if three conditions are ful?lled: the property value must be below € 125,000, the buyer’s taxable income in the year prior to the acquisition was lower than € 153,300 and if he submitted an application for recognition of IMI exemptions during the ?rst 60 days following the transfer of property.
Companies realizing “relevant investment” in 2013, bene?t from IMI exemption for a period up to ?ve years, regarding real estate acquired that constitute “eligible investment”.
Real estate was a nice investment before this crisis. Now with declining home prices (-6% in 2012) and raising taxes, people are considering other investment options.
Property Transfer Tax is a municipal tax on transfers of real estate. Such transfers may also be subject to Stamp Duty. The acquisition of more than 75% of the share capital of a company incorporated as “sociedade por quotas”, which owns real estate located in Portugal, is subject to IMT.
Rates for urban properties or property units considered solely as a permanent place of residence are divided in brackets. Marginal tax rates are: up to € 92,407 – 0%; between € 92,407 and € 126,403 – 2%; between € 126,403 and € 172,348 – 5%; between € 172,348 and € 287,213 EUR – 7%; from € 287,213 to € 574,323 – 8%. Finally, above € 574,323 the rate is a single rate of 6%.
Rates for other kinds of properties are ?at rates: rural properties – 5%, other urban properties and other acquisitions for consideration – 6,5%, the acquirer is a tax resident in an off-shores (except individuals) – 10%.
There are several exemptions, namely: acquisition of properties for resale by Real Estate companies, acquisition of real estate by Open-end Real Estate Investment Funds or by closed-end of public subscription, acquisition of real estate by Real Estate Investment Funds for Residential Letting (FIIAH), operations of concentration or cooperation (such as mergers and demergers), acquisition of an urban property, object of urban rehabilitation and acquisition of buildings classi?ed as of national/public/municipal interest. Any of these exemptions imply the ful?lment of a long list of requirements.
Companies realizing “relevant investment” in 2013, bene?t from IMI exemption for a period up to ?ve years, regarding real estate acquired that constitute “eligible investment”.
Several other changes were made to the tax system, especially to tax high earners. For example a stamp duty of 20% was imposed on lottery prizes (including Euro Millions) exceeding € 5,000. Property, usufruct or surface right on urban property with tax registration value above € 1 million is now taxed at 1%.
A more subtle change concerns the purchase of a car above with value above € 50,000, the state immediately checks if the owner as earnings that allows him to buy that car. If not, an automatic tax of 20% is levied for the taxes the individual should have paid on earnings that he must have hidden. The person can then dispute the claim, after paying. For this reason, a new trend in these situations is the “technical loan”, a loan that a rich person with no need of it contracts to buy a € 50,000 car to avoid triggering an automatic state treasure investigation.
The Troika Memorandum is a complete government program, signed by PS (member of European Socialists), PSD and PP (both members of EPP), representing 85% of the political spectrum. As the Socialists lost the elections in June 2011, PSD invited PP for a majority government and both have been implementing the program ever since.
Since June 2011, the Memorandum has been the great excuse to implement some needed reforms and cuts, but also some tax hike as explained above. Memorandum reforms are generally considered a need but it has faced some obstacles, including: inability of the government to cut on public-private partnerships and other rent-seeking entities, inability of the troika members to explain some policies and deal with the press (going so far as to publicly demonstrate surprise for the unemployment rate), natural pressure on the socialist leader to “rip the aggression pact”, resistance of pressure groups to the cuts being made on their incomes and calls on the press for “growth policies” from numerous “specialists”.
These are the main changes budgetary non-?scal changes intended to put forth by the government to try to balance the budget from the expenses side.
The Constitutional Court has made the strongest opposition to the cuts. The court was silent to the repeated breaks of Article 105 of the constitution – the one that requires receipts to cover expenses – and to the build up of rights to the public sector. But now claims that the withdrawal of rights from the public sector without equivalent changes in the private sector is deemed unconstitutional because it violates Article 13 – the one on the equality principle.
Answering to the equality argument, these are the measures that the government will try to implement during 2013:
> Single wage table – Special careers on the public sector (such as judges, policemen, military, doctors, nurses, or teachers of all levels) will converge to a single wage table of civil servants. 90% of the Education Ministry costs are wages and the same applies to the Defence Ministry, so the potential savings here are huge;
> Convergence of employees and self-employed – The young generation that “entered” the public sector in the last 10 years are generally not employees, but “service providers” with much less labour rights. Those two statuses shall converge.
> Convergence of retirement age – probably to 67, up from 62.5 in the private sector and 60.1 in the public sector (interestingly, the judges of the constitutional court can retired at age 40 with 10 years of service)
> Convergence of pensions – Social Security (for the private sector) and Retirement General Service (for the public sector) pensions shall converge;
> Convergence of healthcare services – National Healthcare Service (for the private sector) and Public Sector Social Protection (for the public sector) shall converge, with the goal of eliminating the de?cit between the receipts and the expenses of the second;
> Public-private labour rights equalisation – Labour law will be change to make the two sectors converge as much as politically possible
On the ownership front, the state has sold EDP (energy) and ANA (airport management). TAP (air travel) was not sold due to the lack of buyers but it is probable that it will be sometime in 2013. RTP (television) and Águas(water distri-bution) are stopped and are slipping from the government priorities, as the opposition to their selling is too strong. Interestingly, the six big state-owned transport companies remain untouched, although they are responsible for almost all debt of the state owned companies and provide a diminishing and low-quality service when compared to private bus companies.
Public-private partnerships remain a problem, as the cuts were skin-deep at best. The contracts are so shielded that a special tax is being considered as the only way to affect those pro?ting from them. Basically, the state (or the town hall) ensures a return (generally 10% to 15%) on investment every year without risk transfer. For example, if it is a toll highway and it is running a 2% loss due to lack of usage, the state pays 12% of investment to ensure an annual pro?t of 10% to the company. The cost is estimated to have reached € 59,600 million for the next 40 years. Also note that the contracts are private and their disclosure can lead to imprisonment. This would be a great savings priority and one popular with the general public, but unpopular with lawyers and campaign ?nanciers.
Unemployment has reached 17,5%, the third highest in OECD countries and the highest ever recorded – an appalling number considering the low medium wage of the country (€ 777), that traditionally guaranteed Portugal a low unemployment ?gure (such as 4.3% in 2001). Emigration remains high – above 100,000, or 1% of population – and worrisome as it is the “best prepared generation ever” that is leaving, unlike in the sixties. On Economic Growth, the Bank of Portugal forecasted – as late as March 2013 – that GDP will fall by 2.3% in 2013, after the 3.2% drop in 2012, in both cases mainly due to a weak domestic demand.
On a positive note, the trade balance, in de?cit since 1995, has reached a surplus in 2012, due to a boost in exports and a decrease in imports. The banking sector is also de-leveraging quickly (tier 1 is now between 10% and 14% for the most important banks) and the country’s debt as a whole (public and private) is now only € 385,246 million (as of December 2012), down from over 400,000 some quarters ago, and to be compared with a GDP of € 165,387 million in 2012.
Portugal is facing the costs of its adjustment program, or, put in other words, the hard truth that it cannot sustain 2007 consumption levels with the current low volume of production while counting on foreigners to ?nance the other 10%. What would be the alternative: a de?cit of 15%? Or even 20%? Portugal is learning that the key is to boost production, not consumption. And for that Portugal needs a smaller state, savings, investment and a productivity jump. Portugal is learning it the hard way.
Ricardo Campelo de Magalhães
Financial Advisor at MetLife
A short presentation of IREF ’Yearbook on Taxation in Europe’ Series
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