The Portuguese state budget – a swap for tax revenues?

How the Portuguese
derivatives market will
react to the new
amendments introduced by
the 2008 State Budget Law (Law 67-
A/2007, of December 31) – the 'Budget
law' – is an issue that we believe will
keep banks, Portuguese swap
counterparties and lawyers busy for some

Pedro Cardigos e Inñs
Festas de ABBC, opinan
sobre el impacto de las
relacionadas con
operaciones del
mercado de derivados
que han sido
introducidas por el
nuevo presupuesto
Hasta ahora, una
entidad financiera (EF)
portuguesa que
acordara una operación
swap con una entidad
no financiera tení­a la
obligación de realizar la
retención fiscal sobre
las ganancias derivadas
de la parte contratante
mencionada. No
obstante, existí­a una
estructura alternativa
que utilizaba una EF no
residente, en la que no
era necesario imponer
dicha retención.
A consecuencia de las
enmiendas esta
posibilidad ya no es
factible. Los autores se
preguntan si el
resultado impactará
sobre las EFs lusas que
operan en el ámbito del
hedging internacional.

The Budget law has introduced
substantial amendments to the taxation of
currency swaps, interest rate and
currency swaps, and foreign exchange
swaps ('swap transactions'), by
assimilating the gains deriving from them
to interest income. Prior to this statutory
change, these gains were simply deemed
income on capital.

Previously, a Portuguese financial
institution ('FI') entering into swap
transactions with Portuguese
counterparties (which were not a FI)
would be required to withhold tax on
gains payable to such party. The typical
alternative structure was to enter into
such swap transactions with a nonresident
FI, in which case gains payable
to such a counterparty by a Portuguese
resident would not be subject to
withholding tax in Portugal by virtue of
the application of any of the Double
Taxation Agreements ('DTAs') to which
Portugal is a party.

By statutorily changing the swap
transaction gains characterisation, the
Portuguese State's purpose is to increase
tax revenues by having these gains
subject to withholding tax in Portugal.
This is done by maintaining the existing
withholding situations, but also
extending it to cases where the relevant
beneficiary is not only a non-resident FI
but also a resident in countries with
which Portugal has entered into a DTA.

In fact, as of January 1, 2008, gains by
a non-resident FI deriving from a swap
transaction entered into with a
Portuguese entity are now subject to
withholding tax at the applicable rate of
20%, whenever the debtor is subject to
corporate income tax (and/or must
maintain an organised accounting

Moreover, in cases where a DTA
applies and depending on the definition
of 'interest', a swap transaction gain,
being locally assimilated to income
interest, will no longer be exempt but
merely subject to a reduced withholding
tax rate (varying between 10% and 15%).

Although at reduced rates, it is likely that
a relevant tax event will be triggered by
the Portuguese affected party in their
derivative contractual documentation,
since the consequent gross-up obligations
will tend to implode the economics of the
affected swap transactions.

The Portuguese State's revenue aims
for this tax change are however likely –
as usual – to bounce as a result of the
alternatives the Portuguese financial
legal market has already identified to
circumvent it.

Nonetheless the ultimate question to
be asked is: will these new alternative
structures leave Portuguese institutional
counterparties of swap transactions in a
better (or at least a similar) position
compared to where they were before the
change in the law?

The question is likely to be answered
pessimistically, which raises concerns
over the 'light hearted' manner in which
the changes were introduced, since they
miss completely the target of increasing
tax revenue, while affecting the capacity
of Portuguese institutional companies to
operate on an equal level in the
international hedging arena.

Pedro Cardigos is a banking and finance
partner at ABBC – Sociedade de Advogados –
and Inñs Festas is an associate and member
of his team. They can be contacted at and