Taxation of Foreign Pension Income in Portugal – Avoiding the Pitfalls of Non-Compliance with Category H

A lack of understanding and compliance with Category H (Retirement) income has left clients with significantly higher tax bills than they expected, irrespective of their classification as Non-Habitual Residents (NHR).

This has arisen from the presumption that: i) all foreign pensions are seen as pensions in Portugal, and ii) the benefits paid by foreign pensions will be classified as retirement income.

As with most tax systems, nothing is ever as straightforward as it seems. However, with the benefit of several tax rulings by the Autoridade Tributária e Aduaneira and consistent interpretation of critical parts of Portugal’s Personal Income Tax Law, there is now significantly better guidance on when foreign retirement income is taxed under Category H (Retirement) as opposed to Category E (Investment).

Given this position, it is vital to understand how the Portuguese tax authority determines the treatment of foreign pension income.

Such determination includes consideration of the structure, purpose, and regulatory standing of the foreign pension. It also takes into account the type of benefit, method of calculation, and method of payment. The rest of this article explores these aspects in more detail.

Key Points to Consider in Respect of Category H Income:

• Purpose of the Pension: The pension should be regulated as such in its host country and be expressly designed to provide retirement income, rather than serving as a flexible investment or savings vehicle. Therefore, it is essential that any benefits paid demonstrate a clear link between the benefit and the pension or retirement plan.
• Retirement Annuity Payment: Whether structured as a lifetime or term annuity, retirement benefits should follow a fixed and predictable schedule, with no provision for ad hoc withdrawals or early access to capital from the funds supporting the annuity. The annuity should maintain a defined term, ideally exceeding 10 years or continuing for life, to reflect typical pension structures.
• Actuarial Calculation: Annuity payments must be calculated on an actuarial basis, incorporating key economic indicators such as the risk-free rate and inflation, and cannot be a mere simulation.
• Inflation Protection and the Income Ladder: The annuity should be designed to preserve the client’s purchasing power over time. This is often achieved through an income ladder approach, where payments increase annually to offset inflation, rather than remaining flat or being based on fixed drawdowns.
• Regulatory Compliance: Any annuity should align with the required standards, such as Regulatory Standard No. 12/2023-R, which mandates a minimum rate of return for annuities in Portugal, as per the requirements of the Insurance and Pension Funds Supervisory Authority.
• Tax Reporting: Pension providers should supply detailed reporting to Portuguese residents that addresses the above criteria and demonstrates compliance with the requirements for Category H income.

Case Law and Regulation

Case law in Portugal (4220/2017) confirms that regulated retirement plans from territories including Guernsey are recognised as foreign pensions.

However, the operation of such pensions should comply with Article 21 of CIRS to ensure that benefits paid are not classified as Investment Income (Category E), which does not qualify as tax-exempt or tax-favoured income under the NHR regime or standard residency rules.

This was confirmed by the ruling (19986/2023), which established that lump sums and accelerated annuities can be taxed as investment income.

However, where the conditions of Article 21 of CIRS are met, pension benefits paid by annuity may benefit from an exemption on the capital element. If the capital element cannot be calculated, the annuity payment is only subject to an inclusion rate of 15% for tax purposes, in accordance with Article 54 of CIRS.

Conclusion

With the growing number of retirees in Portugal and the increasing body of case law, ensuring that retirement income qualifies as such for tax purposes is becoming ever more important.

OTAP offers a range of bona fide international retirement and pension products for individuals resident in Portugal, with the following features:

• Investments, including funds supporting an annuity, are managed by the Adviser.
• Adviser fees are payable on the total value of the pension assets.
• Term annuities comply with the standards set out in Portuguese Regulatory Standard No. 12/2023-R with respect to annuities.
• Unused annuity capital is preserved within the plan upon the member’s passing, ensuring no loss of value on death.
• Benefits are actuarially calculated based on recognised economic indices and aligned with Portuguese standards.
• Annuity payments are indexed to preserve the member’s purchasing power throughout the term.
• Detailed reporting is provided to meet Portuguese tax requirements.

Contact Us

If you need further clarification, tailored guidance on our products, or would like to discuss specific client scenarios, please contact us on +44 (0) 3333 078888 or +27 (0) 21 851 5584 or via email at advisers@trustandpension.com.