Understanding income tax for expatriates .jpg

Understanding income tax for expatriates

ONCE YOU have retired to Portugal and/or live 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 pensions.

The first 7,500 euros of pension income received per person is exempt from tax in Portugal. This is increased by 30 per cent for disabled people. However, where an individual’s pension income is above 40,000 euros per year, the exemption is reduced by 20 per cent of the excess over 40,000 euros. So, if your annual pension income is 77,500 euros or above, no deduction is available.  

UK national insurance 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.

However, if a personal pension can be argued to be an annuity, only 35 per cent 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 Portuguese tax. If the capital element cannot be determined, it is deemed to be 65 per cent of the payment.

The Portuguese tax code does not deal with a situation where the annuity is coming from outside Portugal. The same principles should apply, however. So if you can argue that your pension is in the form of an annuity (income drawdown can also be presented this way), then only 35 per cent is taxable.

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.

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 are applied to this half share. The resulting tax liability is then multiplied back up by two, to determine the total income tax payable. Unmarried couples living together for more than two years can be taxed as married couples.

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

Interest arising in the UK, payable to Portuguese residents, is taxable in Portugal (since that’s where you’re resident) and also in the UK (since that’s where it arises), unless the ‘excluded income’ treatment is claimed on the income. This only applies if you are not claiming your UK personal allowances, for example, 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.

‘Excluded income’ includes:

• interest from banks and building societies

• dividends from UK companies

• income from unit trusts

• income from National Savings and Investments

Interest paid on UK bank and building society accounts is taxed at source at a rate of 20 per cent.  However, under the terms of the UK/Portugal Double Taxation Treaty, if you are resident in Portugal this deduction should be limited to 10 per cent. 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 (for example, because you have other UK-source income taxable in the UK), you will still have to pay the difference (20 per cent tax due less the 10 per cent tax deducted at source) on the interest income in the UK. Double tax credit relief is available in Portugal for any UK tax paid on the income, limited to the lower UK or Portuguese tax due on the income.

In practice, this restriction of the amount of tax to be deducted at source, if you are a 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 per cent deduction of tax at source. 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.  

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

up to E4,451 10.5%

E4,452 to ¤6,732 13%

E6,733 to E16,692 23.5%

E16,693 to E38,391 34%

E38,392 to E55,639 36.5%

E55,640 to E60,000 40%

Over E60,000 42%

Only 50 per cent of dividends paid by Portuguese and qualifying EU companies to residents in Portugal are liable to Portuguese income tax.  Dividends paid by other companies are liable to income tax and should be disclosed on the annual tax return.  Tax paid on any overseas dividend income may be offset against the Portuguese tax due on that same income.

Unless your financial affairs are very simple, it would be advisable to seek the advice of a 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 trust to reduce your tax liability significantly. A little time and effort taking expert advice could reap some financial reward.

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