Portuguese Tax Authorities ("TA") have recently published a binding information, on Procedure No. 1239/2007 by decision of the General Sub Director of Taxes, of July 18, 2008, regarding article 46 of the Corporate Income Tax Code ("IRC") (elimination of economic double taxation), where number 11 of the referred article is interpreted, and that we believe to be erroneous (or at least capable of being interpreted in an erroneous way, as its redaction is not clear enough).

The referred number 11 establishes that the deduction applicable to the distribution of dividends "is reduced to 50% when the income arises from profits that have not been subject to an effective taxation, unless the beneficiary company is a holding company".

Based on this rule, TA considered that "when the profits from a holding company ("SGPS") (Portuguese holding company) are not subject to effective taxation and said SGPS distribute those profits to a resident entity, that is not a holding company, and the conditions established in paragraphs a), b) and c) of article 46 No. 1 of the Corporate Income Code are fulfilled, the latter can only deduct 50% of those profits, in order to compute its taxable profits".

What is the sense of this understanding? Distinction must be made between the profits accrued by a SGPS that are normally exempted from taxation at the SGPS level, as article 31, No. 1 of the Tax Benefits Code states that SGPS companies benefit from a total deduction of the profits accrued by them, regardless of the requirements stated on No. 1 of article 46 of the Corporate Income Tax Code concerning the percentage or value of said participation. But the referred Tax Benefits Code does not release SGPS from the obligation of holding those participations during an uninterrupted period of, at least, one year, in order to benefit from the total reduction of the profits accrued on its taxable basis. So, there may be cases, even infrequent, where the profits accrued by a SGPS cannot be deducted from its taxable basis, as the temporal requirement is not fulfilled. Those profits, on the other side, will be partially taxed at the SGPS level and the SGPS will only be able to deduct 50% of said profits.

Literally, it seems that what TA are saying in the binding information is that only in the last situation, where the SGPS distributes profits that where already taxed at its level, the partners will be able to completely deduct the profits accrued from their taxable basis. But the regime will be different in the remaining situations, in which "profits (from the) SGPS where not subject to effective taxation (...)".

If our interpretation of what is stated by the TA is right, it means that in most of the situations where a SGPS distributes profits to its partners, they will only be able to deduct 50% of those profits. This means that the SGPS might create a situation of economic double taxation for the profits, despite that it is our opinion that the Law intended to adopt exactly an opposite solution.

Let us imagine a situation where an economic group, headed by a company that is not a SGPS, decides to structure its participations in other companies (financial or not) through a SGPS. When the SGPS receives profits from its subsidiaries from over a year, it is able to deduct them from its profitable base, so that it is not subject to any effective taxation. But when it distributes profits to the Parent company, this one – according to the TA – will not be able to completely deduct the profits – despite the holding of a dominant position in the SGPS from over an year –, therefore being taxed on 50% of those profits. Well, should the Parent Company hold participations in the other companies – at least those corresponding to 10% or more or an acquisition value that exceeds twenty million euros – directly, instead of holding them trough a SGPS, then there is no taxation in the moment of the distribution of profits.

In our opinion this was not the solution that the legislator intended to achieve with No. 11 of article 46 of the Corporate Income Tax Code. When said article refers that the 100% deduction is reduced to 50% should the income arise from profits that were not subject to effective taxation, it is our opinion that it refers to an objective condition – the profits –, and not a subjective condition – the company that distributes profits. The same is to say, regarding the binding information under analysis, that we believe that is not correct that deduction shall be reduced to 50% "when the profits of a SGPS were not subject to effective taxation" (our underlined), because the law only refers to profits, and the profits that the SGPS accrued where already subjected to effective taxation at the level of its subsidiaries, that is, were already taxed.

However, one could raise the question of the taxation of the profits distributed to a SGPS by its exempt subsidiaries (subjective exemption), or where the profits where, for any reason, totally exempted (objective exemption). But even in those cases it seems to us that no. 11 of art. 46.º of the Corporate Income Tax Code only limits the reduced deduction, in one hand, to the complete absence of taxation of the profits accrued – that is, this reduction shall not apply to situations of partial exemption of the distributed profits –, and on the other hand, to the non perception of the profits by a SGPS – without requiring the last beneficiary to be, or not, a SGPS. Contrarily to TA understanding, we believe that the rule established in No. 11 only applies to the first distribution of profits, and not to others, and our understanding is as follows:

  1. If the company that distributes the profits has benefited from a total exemption on the distribution of those profits and the receiver of the profits is not a SGPS, it cannot deduct them in more than 50%;
  2. If the company that distributes the profits has benefited from a total exemption on the distribution of those profits and the receiver of the profits is a SGPS, it can deduct 100%;
  3. If the company that distributes the profits is a SGPS, that received them from a company that benefited from a complete exemption on those profits or from any other company, the receiver of the profits can deduct 100%, as long as the conditions established in paragraphs of No. 1 of article 46 of the Corporate Income Tax Code are met.

We believe that an understanding different from the one above, does not have, any connection with the wording of the law.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.