A Subsidiary's Old Profits Cannot Count Twice: Portugal Closes a Route to a Bigger Corporate Tax Deduction
A binding ruling says dividends from profits a parent company had already booked do not add to the equity increase behind the ICE deduction, unless the payout was approved before the parent closed its accounts.
A company cannot count dividends from a subsidiary towards Portugal's corporate capitalisation incentive if it had already booked the subsidiary's profits in earlier years, the Tax and Customs Authority (AT) has ruled. The binding ruling, published on the Portal das Finanças and reported by ECO on Tuesday, closes off a way some groups had hoped to enlarge a valuable deduction from corporate income tax (IRC).
What the incentive does
The Incentive for the Capitalisation of Companies (Incentivo à Capitalização das Empresas, ICE), set out in article 43.º-D of the Tax Benefits Statute, is meant to encourage businesses to strengthen their own capital instead of relying only on debt. It is not a grant. A company that increases its equity can deduct an amount from its taxable profit before IRC is worked out.
The deduction is calculated by applying the average 12-month Euribor for the tax year, plus a spread of two percentage points, to the net increase in eligible equity. The increase is measured over the current year and the six previous tax periods. ECO gives an example: with one million euros of eligible net equity increases and a rate of, say, 5 percent, a company could deduct 50,000 euros from its taxable profit.
There is an annual ceiling: the deduction cannot exceed the higher of four million euros or 30 percent of EBITDA. In certain cases, the part above the EBITDA limit can be carried forward for five years.
The case the tax office examined
The company that asked for the ruling was a parent that uses the equity method to account for a subsidiary. Under that method, the subsidiary's profits raise the value of the parent's investment in the year they are made, and flow into the parent's accounting profit and equity at that point. Later, the subsidiary paid out dividends from those profits, and the parent placed the money in retained earnings or free reserves. It asked whether that step counted as a new net increase in equity for the ICE.
The answer was no. Among the equity increases the regime accepts is the allocation of "accounting profits available for distribution" to retained earnings, reserves or capital. The AT said the starting point is accounting profit, not taxable profit, and it must be profit that can actually be distributed. Amounts booked under the equity method that were still unrealised when the parent's results were allocated are "not available for distribution".
When the dividend arrives in a later year, the value of the investment falls and cash rises, but the parent's accounting profit for that year is unaffected. Moving the money into retained earnings "is not an allocation of accounting profits, but merely a transfer between equity headings," the AT concluded. "Not every change in equity is relevant," it noted.
The exception
The tax office did accept one situation. If the subsidiary's shareholders have already approved a distribution of that year's profits to the parent by the time the parent approves its own accounts and its proposal for allocating results, those profits are treated as realised for the parent. The share of the subsidiary's profit that was booked under the equity method, and whose distribution has been validly approved, can then count as "profit available for distribution" for the ICE.
Why it matters
For groups with subsidiaries, the timing of shareholder meetings now matters. A subsidiary that approves its dividend before the parent closes its accounts can bring those profits into the ICE; one that decides later cannot. Binding rulings apply to the taxpayer that requested them, but the AT publishes them so that other companies and their accountants know how it reads the law.
