Following increased pressure by the Finnish Government for Portugal to ratify the revised treaty between the two countries, on April 30, 2018 the Finnish Parliament voted in favor of denouncing the Portugal-Finland tax treaty signed on April 27, 1970 (the Old Treaty). As a result the Old Treaty will be terminated effective as of January 1, 2019, in accordance with article 30.º of that treaty. If Portugal does not ratify the revised treaty by December 1, 2018, Finnish domestic legislation will apply, and private sector pensions sourced in Finland and paid to Portuguese residents will be subject to tax in Finland from January 1, 2019.
Under the Portuguese Non-Habitual Residents (NHR) Regime, approved in 2009, foreign pensioners who become tax residents in Portugal are not taxed on their foreign source pension income for a period of ten years. In fact, pensions received by a NHR are exempt from Portuguese personal income tax provided that these are (i) not considered to be Portuguese source income, or (ii) are subject to tax in the source country under the applicable double tax treaty. Under domestic legislation pensions paid by entities with no head office, effective management or permanent establishment in Portugal are not considered Portuguese sourced. Accordingly, these pensions are not subject to tax in Portugal under the NHR regime.
At the same time, the Old Treaty allocates the right to tax private sector pensions only to the residence State. As a result, private sector pensions received by Portuguese NHRs from Finnish sources are not taxed in either of the two Contracting States during a ten-year period.
The Old Treaty framework follows closely Article 18 of the OECD Model Convention (including the new version approved in 2017), under which private sector pensions received by a resident of a Contracting State in consideration of past employment can only be taxed in the beneficiary's State of residence. Since Portugal has adopted the OECD model in almost all its treaties, the mismatch in pension taxation that results in double non-taxation is not limited to the Finnish pensioners.
On November 7, 2016, following Finnish disapproval of the treatment of pensioners under the NHR regime, Portugal and Finland signed a revised treaty that would extend the source country´s taxing rights over private sector pensions. Under the revised treaty, which has not entered into force yet, a private sector pension sourced in Finland and paid to a resident in Portugal would be subject to tax in Finland, and any taxes paid in Portugal on such income would be credited against the Finnish tax. The revised treaty establishes a transitional period of three years during which the provisions of the Old Treaty would continue to apply, provided that the country of residence taxes the pension.
To provide some context, according to unofficial sources, by 2017 there were 500 Finnish pensioners living in Portugal under the NHR regime.1 Considering the limited number of Finnish pensioners transferring their residence to Portugal, the imminent termination of the Old Treaty may well be too radical as a solution. Besides the impact on pensioners, if the revised treaty does not enter into force in time, cross border transactions between Portugal and Finland will be significantly impacted with limited safeguards against double taxation, and increased withholding taxes at source.
Amid pressure from other countries, the Portuguese Budget Law for 2019 is expected to include changes to the NHR regime, including the introduction of a minimum taxation for foreign-sourced pensions, even though NHRs who are already in the regime are unlikely to be affected.
In this context, the solution adopted in the revised treaty, when it becomes applicable, may result in an increased compliance burden as the individuals will have to comply with the tax rules of both jurisdictions regarding pension income. Bearing in mind also that the NHR is temporary, after the term of the regime, Finnish pensioners residing in Portugal will be faced with double taxation, coupled with a system of source country tax credit, that may well result in an unnecessary burden with little or no taxes due in Finland.