When an individual becomes tax resident in Portugal, Portuguese Personal Income Tax generally applies to their worldwide income, including pensions received from abroad.
However, the term “foreign pension” can cover payments of a very different nature. The Portuguese tax treatment will depend on the type of pension, the paying entity, the origin of the contributions, the payment method and the Double Taxation Agreement between Portugal and the country of origin.
Why is the type of pension important?
The Portuguese Personal Income Tax Code includes within Category H, among others, retirement, old-age, disability and survivor’s pensions, certain payments made by insurance companies or pension funds under supplementary social security schemes, and temporary or lifetime annuities.
The classification used by the foreign paying entity does not, by itself, determine the Portuguese tax treatment. The origin of the entitlement and the effective characteristics of the payment must be examined.
Social security pensions
Social security pensions generally arise from contributions made to another country’s statutory social security system.
They may include old-age, disability or survivor’s pensions paid by the contributory system of the country where the beneficiary previously worked.
Their taxation will depend on Portuguese domestic law and the relevant Double Taxation Agreement. Some agreements contain specific provisions for social security benefits, while others deal with them under the general pension article.
Government service pensions
Government service pensions arise from employment performed for a State, municipality or another public-law entity.
A government service pension should not be confused with a pension paid by a country’s general social security system. Although both may be paid by public bodies, tax treaties can establish different rules for each type.
Under several agreements, pensions connected with government service are subject to specific provisions that may take into account the paying State, the State of residence and, in certain circumstances, the beneficiary’s nationality.
Occupational pensions from previous employment
Occupational or workplace pensions are established in connection with a previous employment relationship.
They may arise from:
- contributions made exclusively by the employee;
- contributions made by the employer;
- contributions made by both parties;
- defined-benefit schemes;
- defined-contribution schemes.
The origin of the contributions and the tax treatment applied while the pension entitlement was being built may be decisive for the subsequent Portuguese taxation of the pension.
Private and personal pensions
Private or personal pensions are generally arranged directly by the beneficiary with an insurance company, pension fund or another institution.
They may be paid as periodic payments, temporary annuities, lifetime annuities or under other contractually established methods.
For these products, part of the amount received may represent the repayment of capital previously invested by the beneficiary, while another part may represent the income generated by that capital.
Where the paying entity is unable to separate these two components, Article 54 of the Portuguese Personal Income Tax Code may become particularly relevant.
When capital cannot be distinguished from income
Article 54 is intended to prevent the repayment of capital invested by the beneficiary from being treated entirely as taxable income.
The provision applies to certain temporary or lifetime annuities and to payments made under supplementary social security schemes qualifying as pensions where the payment includes a repayment of capital.
Portuguese law provides for two situations:
- where the amount corresponding to capital can be identified, that component is deducted when determining the taxable value;
- where it is not possible to separate the capital component from the income component, an amount corresponding to 85% of the total annuity is deducted.
In the second situation, only the remaining 15% is considered when determining the taxable value, without prejudice to the other applicable rules.
The 85% deduction therefore operates as a statutory fallback specifically intended for cases where the paying entity does not provide a breakdown between:
- the capital previously invested by the beneficiary; and
- the income generated by that capital.
The inability to make this separation does not, by itself, prevent Article 54 from applying. On the contrary, it is the specific circumstance addressed by paragraph 2 of that Article.
Does the 85% deduction apply to every private pension?
No. The absence of a breakdown between capital and income does not mean that every private pension automatically qualifies for the 85% deduction.
It is necessary to establish, in particular:
- whether the payment constitutes a temporary or lifetime annuity or a payment from a supplementary social security scheme qualifying as a pension;
- whether the amount received actually includes a repayment of capital;
- who funded the contributions establishing the entitlement;
- whether those contributions were previously taxed in the hands of the beneficiary;
- whether any of the limitations contained in Article 54 apply.
Under paragraph 3 of Article 54, the capital deduction rules do not apply in the same manner to payments from supplementary social security schemes where the contributions were funded by another person or entity and were demonstrably not taxed in the hands of the beneficiary.
This limitation may be particularly relevant to occupational pensions funded wholly or partly by an employer.
The importance of the Double Taxation Agreement
Once the nature of the pension has been established, the agreement between Portugal and the country of origin must be reviewed.
The agreement will determine whether the income may be taxed:
- only in Portugal;
- only in the country of origin;
- or in both countries, with a mechanism to eliminate or reduce double taxation.
Tax already paid abroad does not, by itself, remove the obligation to report the pension in Portugal.
Where applicable, foreign tax may be taken into account through the international double-taxation credit, subject to the limits established by Portuguese law and the relevant agreement.
What documentation may be required?
The beneficiary should seek to obtain:
- the pension contract or scheme rules;
- the identity and nature of the paying entity;
- information concerning contributions made by the beneficiary and the employer;
- clarification of the previous tax treatment of the contributions;
- confirmation from the paying entity as to whether the capital and income components can be separated;
- annual statements showing the amounts paid;
- evidence of tax paid abroad;
- documents establishing whether the pension is a social security, government service, occupational or private pension.
For the application of paragraph 2 of Article 54, the documentation does not necessarily have to quantify the capital component. It should, however, support the nature of the payment, the origin of the contributions and the inability to obtain a breakdown between capital and income.
Reporting the pension in Portugal
Portuguese tax residents must report foreign pensions in their annual Portuguese Personal Income Tax return, Modelo 3, using Annex J for foreign-source income.
The return should include the relevant information concerning the pension and any tax paid abroad. The correct reporting will depend on the classification of the payment and the application of the Portuguese tax rules and the relevant international agreement.
Redemptions of pension funds, life insurance policies or other financial products that are not treated as pension payments are outside the scope of this article, as different tax rules may apply.
In summary
The taxation of a foreign pension should not be determined solely by the commercial name of the product or by its treatment in the country of origin.
It is necessary to consider:
- the type of pension;
- the paying entity;
- the origin of the contributions;
- the previous tax treatment of those contributions;
- the payment method;
- whether the beneficiary invested capital in the arrangement;
- whether that capital can be separated from the income generated;
- the relevant Double Taxation Agreement;
- and the beneficiary’s individual Portuguese tax position.
Where it is not possible to separate the repayment of capital from the income generated, Article 54 may allow 85% of the total annuity to be deducted, provided that all applicable statutory conditions are met.
JS Advisers can assist with reviewing the pension documentation, determining the appropriate treatment under Portuguese tax law and the relevant Double Taxation Agreement, and ensuring that the related Portuguese reporting obligations are correctly fulfilled.
Legal references: Articles 11, 15, 54 and 81 of the Portuguese Personal Income Tax Code.
This article is provided for general information purposes only and does not replace an individual tax analysis of the pension, its contractual terms, the contributions made and the applicable Double Taxation Agreement.