Preparing for the end of your NHR

Many people have been attracted to Portugal by the very advantageous Non-Habitual Residence Regime, but many are concerned about what will happen to their spending power once the normal tax rates are applied. Mark Quinn and Debrah Broadfield look at the planning you should put in place to prepare your finances for the end of NHR.

What is NHR?
NHR is a preferential tax status granted by the Portuguese government to new residents and lasts 10 years. It offers greatly reduced tax rates on foreign-sourced pensions, employment income generated from ‘highly valued’ professions, tax exemption on foreign-sourced rental income, dividends and on real estate capital gains.

What it does not do is protect from capital gains generated from stocks and shares, company sales or dividends received from funds.

What happens after NHR?
You will become subject to standard rates of tax but your tax position will be determined by the planning (if any) you have implemented during the NHR period.

How to take advantage of NHR
The benefits of NHR are not automatic and you must plan to make the scheme work for you. This might involve rearranging your assets and income sources so you can fully take advantage of the tax breaks. For example:

If you are receiving a salary from an overseas company, dividend payments are preferable as these are tax-free, but a salary is taxable at either 20% (if a qualifying profession) or standard scale rates. Additionally, social security contributions will be due on salary payments, but not on dividends.

If you have foreign property you will want to sell this during the NHR period. Whilst rental income is tax-exempt during NHR, post-NHR it is taxable at scale rates. Similarly, capital gains on sale during NHR are exempt, but post-NHR 50% of the gain is taxable at scale rates.

If you are selling a UK company, you would want to structure the sale as a dividend pay-out, rather than a share sale. The former would be tax-free and the latter would be taxed at 28%.

If you have non-Portuguese sourced savings and investments, interest and dividends from direct equities are tax-exempt (strictly, dividends derived from funds are taxable under NHR) but after NHR, they are taxable at 28%. Capital gains however are not protected under NHR. Gains realised e.g. by selling or switching your investments, are taxable – even if you do not have the gain physically paid out to you and they remain within the investment portfolio/ISA/platform. If the investment holding sold was held for more than 365 days the tax rate is 28% but if held for less, then it is taxable at scale rates of tax. The capital gains tax can be mitigated by restructuring these types of holdings within approved tax wrappers.

Pension income is taxable at 10% under NHR (or 0% if you have pre-31st March 2020 NHR). Post-NHR, generally pensions are taxable at scale rates so some individuals aim to deplete their pension over the NHR period. Just bear in mind however that this might not be suitable for everyone, as moving pension savings out will expose them to UK IHT. Do note, that QNUPS are often sold as a ‘silver bullet’ to protecting assets from UK IHT but this is not the case. There is no guarantee of tax-exempt status and HMRC are vigilant when assessing potential tax avoidance on death.

What can you do to plan?
Portugal does offer very advantageous tax breaks for those that use approved long-term savings vehicles, and it is not dependent on your NHR status. These shelter ongoing income and gains from tax and tax is only applied to gains when you make a withdrawal at 28%. Additional tax reductions apply after years 5 and 8 reducing the tax rate to 22.4% and 11.2%. Having said this the right jurisdiction must be chosen otherwise you could be subject to a punitive rate of 35%.

A particular advantage is that the tax reduction time limit is applied to the start date of the structure, not each time monies are added. This means you can start the structure with a small sum and add to it over time say, as you sell foreign property, drawdown your pension or sell a UK company.

The ideal position is to establish the structure when you are at the beginning of NHR so that by the end of the NHR period the structure is at its maximum tax efficiency.

Many individuals draw on their pensions and dividends during NHR tax efficiently and accelerate the drawdown towards the end of the 10 years to fund the tax-efficient investment. They may also sell property or companies during the NHR period and reinvest the proceeds in preparation for the end of NHR. Then after NHR, they switch the income source to the new investment and generally enjoy single-digit or very low double-digit effective rates of tax.