With rising interest rates, we have seen banks offering interest rates in excess of 4% or even higher with 1-year fixed terms. This coupled with the perceived risk of investment markets and the constant stream of negative news has left many wondering whether staying in cash is best.

Short term goals
Cash certainly has a place as an emergency “buffer” to allow for life’s unexpected events, and it is also sound financial planning to set aside sufficient for your short-term needs. Likewise, holding cash as part of an investment portfolio is important and it can help reduce the effects of volatility often seen in markets.

Cash as a long-term investment
Interest rates offered by banks to customers rarely beat inflation, so using this as a long-term savings strategy is not ideal.

Even with rising interest rates, the returns from cash are still negative when you consider that inflation currently sits at 7.9% in the UK, so investors are not getting any real returns. As an example, the negative effect of a modest 2% inflation on £100,000 over 10 years is £82,035 and £67,297 over 20 years.

However in the longer term, interest rate cuts are likely as the Bank of England is starkly aware that keeping interest rates high risks triggering a recession and destabilising the UK housing market. Central banks globally are also now close to pausing and then reversing recent rate hikes.

Protect yourself against inflation
Investing in high-quality company shares has been shown to offer inflation protection. Looking at long-term figures, Credit Suisse show that over a 123-year period starting in 1900, shares in developed equity markets have generated returns of 5.1% above inflation and emerging equity markets have achieved 3.8% over inflation.

The Credit Suisse figures also show that shares have outperformed cash (and bonds) in every one of the 21 countries its data covers over that 123-year period. This is quite remarkable given this period covers two world wars, two global pandemics, the great depression, the 2000 dot-com bubble, and the 2008 global financial crisis.

Opportunities elsewhere
Falling interest rates will provide opportunities elsewhere. For example, bond prices move in the opposite direction to interest rates so a future fall in interest rates is likely to result in capital gains on bonds, or holding shares allows investors to not only benefit from the increase in share price over time but income from dividends too.

If we look at the top 100 shares in the UK, analysts are expecting a dividend yield of 4.1% this year and 4.4% in 2024 and with the possibility for share buybacks added into the mix, this could be as high as 6% for 2023.

Tax considerations
Always consider the net interest rate you will earn. For example, a relatively attractive rate of 5% becomes a somewhat mediocre return of just 3.6% for a standard Portuguese tax resident who must pay 28% tax.

Also be cognisant that some of the more attractive rates being offered by banks in Guernsey and Jersey will have a higher tax rate applied of 35%, even if you are a Non-Habitual Resident.

The solution – balance
We believe a balanced approach of cash and investments makes most sense. The split however really comes down to your short- and long-term goals.

In short, cash is still king for short-term needs but for meeting longer-term income and growth objectives, stack the odds in your favour by using a sensible and well-diversified portfolio of shares, bonds and property. Coupling this with effective tax planning can lead to even more savings.

Lastly, Warren Buffet’s advice as one of the world’s most successful investors is, “The one thing I will tell you is that the worst investment you can have is cash. Cash is going to become worthless over time but good businesses are going to be worth more over time”.

You are probably quite au fait with your home country’s investment structures, options, and practices, but what happens when you move abroad? Just because your investments are tax efficient in one country does not mean that the tax advantages will transfer to another.

Mark Quinn and Debrah Broadfield look at the taxation of typically held investments in Portugal and what options are open to residents looking to legally shelter from taxation.

Bank accounts

All bank interest is reportable and potentially taxable in Portugal, irrespective of where the account is located or if you use it or not.

If you have Non-Habitual Residence (NHR), interest earned on foreign accounts is tax-exempt, unless the account is held in a blacklisted jurisdiction such as Guernsey, Jersey, or the Isle of Man, in which case it is taxed at 35%.  So, if you are still holding large sums in these ‘tax havens’ you should consider restructuring this.

If you are a non-NHR, all bank interest earned on foreign accounts is taxed at 28%. Similarly, interest from Portuguese bank accounts is always taxed at 28%, irrespective of your NHR status.

Dividends

We usually see individuals with dividends paid from their own companies, directly held shares, or investment portfolios. This is a great source of income if you are a NHR as these are tax-free in Portugal during the 10-year period.

It is worth thinking about what you are doing with the income once received. If you are not spending it all and it is accumulating in a bank account earning little or no interest, you should consider investing this in a tax-efficient manner to get your money working for you.

For normal residents, dividends are taxed at 28% but there is the potential for tax savings if you can restructure.

Property

Foreign-sourced property income is reportable in Portugal but is tax-exempt during NHR. Post-NHR, this income is taxed at scale rates (up to 48% plus solidarity tax at 2.5%/5%) with a credit given for tax paid in the country where the property is located (if there is a double tax treaty).

NHR does provide a unique tax-saving opportunity when selling a foreign property. Usually, 50% of any gain on sale is taxed in Portugal at scale rates, but if sold during the NHR period there is no tax to pay. Do note however that tax may still be due in the country where the property is located.

Striving for tax efficiency

One of the most common and tax-efficient ways to save is within an ‘offshore investment bond’. Such structures are recognised throughout most of the EU and in the UK.

Unlike a standard investment portfolio, that attracts capital gains and income tax as it arises, gains within an investment bond grow free of both income and capital gains tax. This is also known as ‘gross roll up’ and works in a similar way to a pension or a UK ISA.

The other main advantages over directly held investments are:
– You can control the timing of taxation. With standard investment holdings, when income or dividends are produced, they are deemed paid (whether actually paid out to you or not) and are taxable on an annual basis. With a tax-sheltered structure, income and gains are only taxable when a withdrawal is made.

– Withdrawals are very tax efficient. Withdrawals are split into capital and growth and tax is only payable on the growth. Although the tax rate on the growth element starts at 28%, you enjoy a 20% tax reduction after 5 years and a 60% tax reduction after 8 years.

It is worth knowing that this preferential tax treatment is enjoyed by both NHRs and standard Portuguese tax residents. And because the structure becomes more tax efficient over time, these are great long-term planning tools for those with NHR who intend to remain in Portugal once they are subject to the standard rates of tax post-NHR, or for long-term residents without NHR.

– These structures offer a unique tax planning opportunity for those who might return to the UK in the future. Under UK rules, only investment growth generated whilst resident in the UK is taxable. So, for those who have spent many years abroad in Portugal, this can create the opportunity for very advantageous tax planning on a return to the UK.

Lastly, choosing the right jurisdiction and provider is essential to ensure compliance in Portugal. You will also want to avoid jurisdictions with withholding taxes and bonds located in tax havens, as these are punitively taxed at 35%.

One of the most confusing aspects for expats is establishing where they should be paying tax after they have left the UK. Many just assume that there is no UK liability after they have left.

UK property
Tax on income and gains from UK property is always taxed in the UK, even if you live in Portugal with or without NHR status. You do still have your UK annual personal allowance and capital gains tax allowance to offset against any taxable income or gains as a non-UK resident.

You must also declare this in Portugal and will receive a tax credit for the tax paid in the UK to offset any Portuguese tax liability.

UK government pension income
The taxing right remains with the UK in respect of former government service pension income, and you have your UK personal allowance to offset against this.

Government service pension schemes are not the same as the UK State Pension. The State Pension is not taxable in the UK, can be paid out to you gross and is taxable in Portugal.

UK private pension schemes
Private pension schemes are taxable in Portugal. Again, the income can be paid out to you gross by your pension provider. However, in practice, some people still find themselves having tax deducted at source on UK pension income and must reclaim it. If you complete a DT/individual form, available from HMRC’s website, and follow the submission process you will be able to receive your pension free from UK tax at source.

UK dividend & interest trap!
The UK has the right to tax UK-sourced dividends and interest under the treaty rules between the UK and Portugal but an interesting quirk of the rules is that when you submit your UK tax return HMRC will automatically calculate the best outcome for you; either to not tax your UK dividends and interest and in turn, you lose your UK personal allowance (this is called disregarded income treatment) or to tax them and preserve your personal allowance to offset against other income e.g. rental.

Special care must be taken if claiming split-year treatment – this is when you leave the UK partway through the tax year and you are only taxed in the UK from 6th April to the date you leave. A real-life example: an individual who left the UK in July subsequently took a large dividend in the same UK tax year. As a result, the dividend was taxed in the UK (even though they were no longer UK resident) and this resulted in a hefty tax bill. Had they waited until after the following 6th April, HMRC would not have taxed this.

Exceeding your UK day count
Another scenario where you could find yourself a UK tax resident, even though you have moved abroad, is when the relevant day count allowance is exceeded. The UK Statutory Residence test clearly sets out the rules and the allowable number of days to avoid getting yourself into this grey area. The day count can be as little as 16 days and as much as 182 days depending on the number of ties and connections you have.

UK Inheritance Tax
Another context when you can still have a UK liability is in respect of succession and inheritance tax. This is a complicated area, and we will dedicate next week’s article to exploring this topic.

Many British business owners may not have considered selling their UK business as a Portuguese tax resident, and whilst the UK rules for selling business are generous, we have seen several business owners enjoy better outcomes here in Portugal.

Opportunity
Non-Habitual Residence (NHR) status allows those in receipt of foreign-sourced dividends to receive them free of tax. This has proven to be a great opportunity for UK business owners who can enjoy the luxury of running their businesses at arm’s length.

But most owners do not want to run their businesses forever, and what many may not have realised is that selling their business whilst Portuguese tax resident could be highly tax efficient and, in some cases, provide a better result than the UK.

Real-life example
We recently worked with a business owner who had agreed to sell their UK-based business, but the sale would take some time to complete.

They knew what their tax liability on the sale would be in the UK but were keen to move to Portugal quickly, rather than wait for the sale to complete whilst they were resident in the UK. They were understandably disappointed to learn that the potential tax liability in Portugal would be markedly higher, at 28%.

However, on reviewing the structure of the business and how the sale was arranged, we were able to advise on a position where the couple could move to Portugal immediately with a resulting zero tax liability. Additionally, working with a local accountant, it was possible to create an accounting loss for them to use against future gains in Portugal.

In addition, we presented a highly diversified and managed risk solution to preserve and grow their wealth, whilst also future-proofing them for the end of their NHR status and a possible return to the UK.

The position turned out to be better for them selling as Portuguese tax residents, rather than UK tax residents, and they got to get on with their new life in the sun sooner than originally planned.

Replacing business income
The most important step following a sale or after drawing large dividends is finding an appropriate new home for the cash – you do not want it sitting in the bank being eroded by inflation, invested in inappropriate structures, or held tax-inefficiently going forward.

Whether you want to replace the income you once enjoyed, or preserve wealth for future generations, the key is structuring correctly for your goals. This must take into account several factors, such as where you and your ultimate beneficiaries are resident and the associated tax implications, flexibility in access and appropriate investment strategies, to name just a few.

Explore your options
We regularly work with business owners’ UK accountants, tax advisers and other trusted parties to explore restructuring and selling options. We are also on hand for clients to ensure that the advice is coherent, viable and implemented correctly from a cross-border perspective.

We also work with clients to put longer-term plans in place to ensure ongoing tax efficiency, compliance, and wealth preservation here in Portugal. If you would like to explore your options, please contact us for an initial discussion.

It’s been a rough time recently for financial markets with many falling in 2022. 

We’ve experienced a once in a hundred-year combination of events, with the global pandemic, recession fears, rising inflation and interest rates, the war in Ukraine and the farcical situation of five changes of British Prime Minister in just six years!  

With that backdrop, it is no wonder markets have struggled, but there are several interesting statistics to show that now may in fact be a good time to invest if you are holding excess cash.

1. Falling markets mean the growth outlook has improved
The first point is counterintuitive, but the 2022 market declines have actually improved growth expectations.

For example, Vanguard, the second largest fund manager in the world, has recently revised its growth forecasts upwards and believes that investors will now be better off over the next decade than if 2022 had not occurred.

Vanguard’s growth forecasts for global equities are now 7.4%-9.4% over the longer term.

The fall in bond prices in 2022 has similarly resulted in better growth expectations, as lower prices mean new investors are now enjoying higher levels of income yield.

2. 2022 was very rare in investment terms
Bonds and shares/equities tend to move in different cycles i.e. if shares are falling in value, investors seek the relative safety and income of bond investments and this causes bond prices to increase in value.

However, this relationship broke down in 2022, being one of only three years in the last 45 where shares and bonds were down at the same time – the chance of this happening going forward is low.

3. Two consecutive years of stock market falls is rare
Data from NYU shows that the chance of having two consecutive years of stock market declines (as measured by the US S&P 500 index) is low. The chance of 2023 being negative is just 9% based on this data.

4. Short periods to recover losses
Figures from Gugenheim have examined previous market falls of between 20 and 40% and found that the average time to recover the losses is just 14 months.

With global markets starting their declines in late 2021, based on this statistic we would be nearing the end of the downturn in markets.

5. Equities outperform cash over different time periods
Some investors perceive cash as more secure than shares. However, data from Blackrock shows that shares (S&P 500) outperform cash (Treasury bills) over many different time periods, even short time horizons.

The statistics I found particularly interesting are that, even on a short-term basis, shares would outperform cash holdings, for example 64% of the time over one month and 81% over one year.

6. Time is on your side
Data from Macrobond covering the 1971 to 2022 period shows that time is on your side with investments.

Over any one-year period, the chance of generating a positive return is 72.8%, but if you extend the period to 10 years the chance of a positive return increases to 94.2%.

These statistics of course are not a guarantee that markets will recover in 2023, but the convergence of all these factors is, for some investors, a positive indicator for the direction of equity returns for the year or two ahead.

More important though is that short-term market events should not be a distraction when implementing a long-term investment strategy.

We can guide you on how and where to structure your investments efficiently as a Portuguese tax resident, whether or not you are a Non-Habitual Resident, and how to futureproof these investments from changes in your personal circumstances.

Whether you are living in Portugal or thinking about a move, you will have heard lots of tips and tricks from friends and done your fair share of Googling. Here we list some of the most common planning mistakes so you can avoid them.

1. Planning too late
Most people tend to be reactive rather than proactive when it comes to sorting out their finances. Planning ahead of your move will allow you to take full advantage of all the windows of opportunity and the tax savings Portugal has offer. But if you have already moved and have not made plans yet, it is not too late to improve your long-term position. Don’t put it off.

2. Syncing for a different system
Some people do not review their assets and are of the view that their planning has worked just fine up to now. But Portugal’s system is markedly different from the UK and you could unknowingly be doing yourself out of benefits and tax breaks, or even worse, creating further (unnecessary) tax liabilities.

3. Not applying for Non-Habitual Residency (NHR)
Applying for NHR is generally a financial “no-brainer”. Just because you think you don’t need it now, does not mean it may come in handy in the future. You only have a small window of opportunity to apply for NHR once you become a resident of Portugal, so do not miss out. It could save you thousands in taxes in the long run.

4. Withdrawal strategies
Taking money from the wrong place, at the wrong time or at an inopportune time can be expensive and create tax liabilities that could otherwise be avoided. If possible, you should plan at least 12 months in advance and take advice if you are not sure of the best way forward.

5. Not paying attention to fees and charges
Charges can profoundly affect returns but can be disguised by good market performance and/or ‘clever’ advisers. Read the small print, ask questions and shop around to find out if you are really getting a good deal.

6. Focusing on return and not risk
Many investors focus solely on headline performance and do not consider investment returns in the context of risk. This is important, particularly if you are a balanced or cautious investor. If two portfolios generate an average of 5% a year but one is very high risk and the other is very low risk, clearly one portfolio is better than the other.

7. Not knowing your ‘number’
Do some cash flow planning. Many are unaware of how much they can safely spend based on their current wealth, pension provision and the need to plan for unforeseen expenses. They either spend too much and jeopardise their future lifestyle or worry unnecessarily and underspend, possibly missing out on a lot of fun!

8. Not reviewing enough or reviewing too much
We suggest you review your finances at least every 12 months. Times change and as new solutions become available, costs usually go down. But equally micro-managing and frequent changes are also counterproductive as it usually involves cost and stress. Get the right balance.

9. Not shopping around
If you meet a professional you like, that is great. However, shop around. Meet others and stress test the advice and proposition. Just because someone seems nice, does not mean they are the best person for the job.

10. Not planning for UK Inheritance Tax
Many believe that once they are out of the UK inheritance tax will not apply. This is wrong as it will always apply if you are UK domiciled. Moreover, you could also have a Portuguese tax liability meaning there could be double taxation. Ensure that you address estate planning as early as possible.