The Binding Ruling explains how income from a U.S.-based S-Corporation or LLC is taxed in Portugal. The key points are as follows: Profits from these entities, which are reflected in the U.S. citizen’s personal federal tax return, are classified as “Other Investment Income” in Portugal and subject to a 28% tax, with any foreign taxes paid in the U.S. credited against the Portuguese tax liability. However, if the taxpayer holds Non-Habitual Resident (NHR) status in Portugal, they are exempt from taxation on this income in Portugal.
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BINDING RULING
DOCTRINAL STATEMENT
Regulation: Income Tax Code for Individuals
Article/Item: Art. 81 – Elimination of International Double Taxation
Subject: NHR – Taxation of results attributed to a shareholder by a U.S.-based S-Corporation
Process: 23980, with decision of 2024-09-11, from the Deputy Director-General of the Tax Management Area – IR, by delegation
Content: The applicant, a resident of the United States of America, seeks binding information regarding the tax framework that will apply to him concerning the distribution of profits from a company located in the United States of America.
To clarify, the applicant states the following:
- The applicant is a U.S. and Portuguese citizen, with tax residency in the United States of America.
- He is considering, in the short term, establishing his residency in Portugal and later enrolling in the Non-Habitual Resident (NHR) tax regime, as he has not been a tax resident in Portugal for the last 5 years.
- He holds shares in XXX, a company domiciled and residing in the United States of America, structured as an S-Corporation (hereinafter referred to as “S-Corp” or “Company”), a partnership-like entity formed and governed by U.S. law, classified as a transparent entity in that country.
- In this context, in the U.S. jurisdiction, the results generated by the S-Corp are attributed to its shareholder as professional and business income, taxed at progressive rates under U.S. corporate tax law. That is, the results of the S-Corp are allocated to its shareholder based on his ownership proportion and are taxed in his hands as professional and business income, regardless of their actual distribution to the shareholders.
- With the possible establishment of the applicant’s tax residency in Portugal in the short term, and considering that the company does not meet the criteria set forth in Article 6 of the Corporate Income Tax Code to be considered transparent for tax purposes in Portugal, there could be a conflict in the taxation of the applicant’s income, given the involvement of two states (i.e., the source state of the income related to the aforementioned shareholding — the United States of America — and the state of residence of the taxpayer — Portugal).
- It is considered essential to confirm that, under national tax law, the distribution of S-Corp profits to the applicant, a citizen intending to establish tax residency in Portugal and benefit from the Non-Habitual Resident (NHR) tax regime, will be exempt from taxation during the period of application of this regime in his hands.
- It is understood that, in Portugal, a tax event will only occur upon the potential distribution of income that may result from an actual profit distribution by the company, which, under Portuguese law, would classify it as capital income, namely dividends.
- In this regard, it is relevant to point out that the Portuguese Tax Authority (AT) has already issued an opinion on a similar case, as stated in doctrinal statement no. 2360/2016, with the Director-General’s agreement on December 20, 2017, where the AT concluded that the tax transparency regime applied to partnerships under U.S. law cannot be applied in Portugal in the same manner.
Tax Transparency Under Portuguese Legislation
- Finally, it is noted that the Portuguese Tax Authority (AT), in the aforementioned doctrinal statement, considers that these earnings should qualify, under domestic law, as dividends. However, as noted by the AT, “this type of company (LLC) is covered by the exclusion provided in paragraph 3 of the Protocol to the Double Taxation Treaty (DTT) between Portugal and the U.S., and as such, these earnings are not treated, for the purpose of assigning tax jurisdiction, under the rules defined for ‘dividends,’ but rather under the provisions of Article 24 of the DTT [Other Income], which implies shared tax jurisdiction, i.e., both States may tax these earnings.”
- It is further stated that the Administrative Arbitration Center (CAAD), in Process No. 684/2020-T, dated March 28, 2022, when analyzing the terms of the saving clause between Portugal and the United States of America, ruled that the taxpayer (a U.S. citizen — like the applicant — benefiting from the NHR regime — as will apply to the applicant) could be subject to taxation in the U.S., even in specific cases where the tax rights are granted only to the State of residence (i.e., Portugal). Thus, the CAAD considered that the condition required to apply the exemption method in Portugal on the taxpayer’s income was met. In this regard, the CAAD understood that “the Protocol, which is part of the U.S. Convention, reserves the right of the U.S. to tax its nationals (citizens) ‘as if the Convention had not come into effect,’ i.e., to tax their income on a worldwide basis according to its domestic law, commonly referred to as the ‘saving clause’ — see Article 1(b) of the aforementioned Protocol.”
- Considering that the applicant, should he change his tax residence to Portugal, will register under the Non-Habitual Resident (NHR) tax regime, he requests the following:
a) The income should be classified as other income under the terms of the Double Taxation Treaty (DTT) to avoid Double Taxation, and the Treaty establishes shared tax jurisdiction between the two States (Portugal and the United States of America);
b) It should be confirmed that he will benefit from the application of the exemption method under Article 81 of the IRS Code, with the profit distribution exempt from taxation in Portugal, considering that the exemption method will apply to this income in the applicant’s hands (naturally, only during the validity of this regime), as its taxation is foreseen in the source state under the DTT with the United States of America.
INFORMATION
1- A check of the AT’s computer system shows that the applicant was a resident abroad at the time of the request for binding information.
2- Regarding the type of company in question, it is clarified in advance that business activity in the U.S. can take various structural forms, each corresponding to a specific tax regime. One of these structures is the “S-Corporation,” which, like LLCs (Limited Liability Companies), limits the liability of shareholders to their shareholdings. These companies are required to meet certain requirements and have a specific tax regime (different from the taxation regime applicable to “Corporations,” as these are independent tax entities, filing their own annual income declaration and subject to taxes on profits).
3- “S-Corporations” are companies that cannot have more than 100 shareholders, all of whom must be U.S. citizens or permanent residents, and their profits must be distributed to shareholders.
4.They are allocated to the shareholders in proportion to each one’s interest in the business, similar to “partnerships” (with the advantage that their personal assets are not liable for any debts or liabilities).
5- The income is taxed in the same way as in “partnerships” through “pass-through taxation,” meaning the profits and losses are passed on to the shareholders and taxed or deducted directly in their tax returns, avoiding double taxation on the profits.
6- Considering that the applicant intends to reside in Portugal, he will be subject to taxation under IRS on a personal or subjective basis, which means that IRS will apply to all of his income, including income obtained outside of Portugal.
7- If the applicant meets all the requirements for applying the tax regime for non-habitual residents, repealed by Law No. 82/2023, of December 29 (see the transitional regime provided in paragraphs 3 to 5 of Article 236 of this Law), and assuming that the regime is granted to him, he will be subject to the special regime for such residents, specifically regarding the exemption method provided in paragraphs 4 and 5 of Article 81 of the IRS Code (CIRS), in its previous wording.
8- Regarding the classification of income (taxable amount attributed) earned as a “shareholder” in a company qualified as an “S-Corporation,” residing in the U.S., as previously mentioned, it is subject in that state to a similar tax transparency regime, as provided in the Corporate Income Tax Code (IRC) and the IRS Code, where the results (taxable amount) are not taxed at the company level but are taxed exclusively in the shareholder’s legal capacity.
9- However, this does not mean that this tax transparency regime can be considered, in comparative legal terms, as equivalent to the tax transparency regime under Portuguese law, i.e., as provided in Article 6 of the Corporate Income Tax Code (IRC).
10- In effect, the allocation of the taxable amount of the “S-Corporation” to the respective shareholder residing in Portugal constitutes a capital income classified as profit, under Article 5 of the IRS Code (CIRS), and is subject to autonomous taxation at the special rate of 28%, according to subparagraph d) of paragraph 1 of Article 72 of the IRS Code, without prejudice to the option for inclusion, as provided in paragraph 13 of the same article.
11- According to the Double Taxation Treaty (DTT) between Portugal and the U.S., and given that the entity is subject to a tax transparency regime in the U.S., it falls under the exclusion provided in paragraph 3 of the Protocol annexed to this DTT. Consequently, the income earned by the shareholders who are not residents in the U.S. does not qualify as dividends under the DTT and is subject to the provisions of Article 24 (Other Income).
12- This Article 24 grants shared tax jurisdiction to both states (the source state and the state of residence). The income in question satisfies the condition set in subparagraph a) of paragraph 5 of Article 81 of the IRS Code, and thus, the exemption method provided in this provision applies, provided the applicant meets all the conditions to benefit from the previous regime for non-habitual residents and registers under this regime (see paragraphs 3 to 5 of Article 236 of Law No. 82/2023, dated 29/12 — State Budget for 2024).
13- Notwithstanding the above, if the taxpayer wishes, they may opt for the tax credit method under paragraph 8 of Article 81 of the IRS Code (CIRS).