Taxation: business vs rental income

In this series, we examine implementation issues surrounding the new Holiday Let Licensing legislation

1. Taxation: business vs rental income

2. Lawyers and contracts

3. “Simplex and property problems

4. Rental agent v property manager

As you have previously read (short term letting in 2008 – new legislation), how you set up your contracts defines the nature of your activity and how your income will be treated for tax purposes.  

This is one of many reasons why clear contracts are essential to a successful and trouble-free operation.  Equally important are the implications inherent in each solution.  Let us examine the characteristics of each and the subsequent pros and cons to help you determine which is right for you.

Category F - Rental Income

Renting out self-catering accommodations under Category F is a ‘simple’ solution and should be relatively straightforward from a tax point of view:

Obligations:  

No prior tax registration

is required.

Accounting and tax reporting are relatively simple and inexpensive.

Advantages:

Low accounting charges.

Portugal offers non-residents an attractive flat tax rate (15 per cent).

Any taxes as well as expenses for Fiscal Representation and Property Management normally serve as tax credits or tax deductions in the home jurisdiction.

No special operating licence is required

that might impact the Habitation Licence of

your property.

Drawbacks:

Mortgage interest is not deductible in most cases.

Expenses for services such as regular maid

service, food packs and owner inspections are

not allowable.

No depreciation allowance.

Limited deductions.

Category B - Business Income

If you organise as a business, you face a more ‘complicated’ solution with many tax advantages yet more requirements, implying greater complexity but greater potential long-term savings.

Standard Accounting (Non-Residents: mandatory; Residents: optional)

Obligations:

Tax registration as a sole trader.

When income exceeds 10,000 euros, VAT must be charged.

Charted Accountant required.

Advantages:

Mortgage interest is deductible.

Many business expenses become allowable.

Depreciation further lowers tax liability.

Losses can be carried forward and eventually reduce Capital Gains liability.

Renunciation of VAT exemption could substantially lower the final purchase price of new construction.

Drawbacks:

More complex and with higher professional fees.

Being commercial, property registration may need to be changed.

May not be attractive to all future buyers.

Simplified Regime (only available to Residents)

Obligations:

Tax registration as a sole trader.

When income exceeds 10,000 euros, VAT must be charged.

Potential Advantages:

Simplicity and low cost.

No Charted Accountant required (lower overhead).

Favourable tax treatment (tax based on only 20 per cent of invoicing).

Drawbacks:

Non-Residents ineligible.

No allowances.

Mortgage interest not deductable.

Depreciation not allowable.

Being commercial, property registration may need to be changed

Lawyers and contracts

In this series, we examine implementation issues surrounding the new Holiday Let Licensing legislation

1. Taxation: business vs rental income

2. Lawyers and contracts

3. “Simplex and property problems

4. Rental agent v property manager

WHEN PURCHASING property in Portugal and its subsequent rental, it is advisable to seek the services of a reputable lawyer or solicitor to help you make the right decisions regarding issues such as property purchase, as well as related deeds and contracts.

Contracts

Rental agreements and related contracts are essential to assure:

Control - a written agreement customised to your needs means that you are the one who defines what you are doing.  In the event of an inspection, inspectors will have their own agenda that is unlikely to coincide with your best interest.

Clarity - When you put an agreement in writing, you have taken an important step to avoiding misunderstandings. Whether it be your expectations of a payment schedule, rules regarding property usage, or clarifying which legal statutes regulate your activity ­­- a contract is key to meeting your objectives.

There are at least three types of contracts that you may need:

1) Contract between Owner and Renter - At many levels, it is important to spell out expectations, rules and requirements during the renter’s stay in your property.  Everyone’s rights need to be protected and a written contract is a prerequisite to a satisfactory arrangement for all concerned.

2) Contract between Owner and Property Manager - It should be obvious by now that short term rental activities offer both reward and risk. This is especially true for property managers who often assume certain tasks related to rentals. If property managers fail to clarify their role, they leave themselves open to accusations of operating an unauthorised and unlicensed business subject to substantial fines.

3) Disclaimer - In your advertising, you will want a Disclaimer to fully clarify your offering. Reaching out to potential renters also means exposing yourself to prying eyes. Detailing the operational statutes is a common practice in Civil Code Countries and can help to nip problems in the bud.

Proper contracts are an essential preventative step to assure that your rental activity is transparent and being conducted on a fully compliant basis. This one-off measure can prove invaluable when confronted with adversity.

Property purchase

The Legal Representative should ensure that your purchase is as trouble-free as possible. A lawyer will provide legal guarantees that the purchase of your property is free from any debts or charges, and that all fees including electricity, water and community fees are paid up to the day of completion.

When you instruct a lawyer to handle the purchase, the following important aspects should be covered:

The title of the property is checked;

The person selling the property actually owns it;

Whether there are any charges on the property;

All construction has been properly authorised and licensed;

The terms and conditions stipulated by the seller are checked for fairness;

A report of the findings is then compiled for you to consider, before proceeding with the signing of Promissory Contracts.

After the signing of the deed, your lawyer will then arrange:

The transfer of the title into your name;

For any fees and taxes to be paid;

For the title to be registered in the local Land Registry in your name.

Simplex’ and property problems

ONE OF the obvious corollaries to a compliant letting activity is having planning permission in order for any property improvements and refurbishments.  

Even today, getting a proper factura from your builder can be like pulling teeth.  In the past, different levels of planning permission often proved to be slow, expensive and complicated.

For these and other reasons, over the years, many homeowners just went ahead with a project and skipped the bureaucracy. To make matters worse, when property was eventually sold, the purchasers’ lawyer often took a ‘shortcut’ and skipped the time-consuming due diligence to assure everything was in proper order.

In other words, it is not at all uncommon for buyers to discover later unregistered and unapproved additions, garages, swimming pools, etc, on the premises.  

It is safe to assume there will be negative consequences if a problematic property is let under the new regime, due to mandatory minimum standards of comfort and safety required for registration.  In other words, if the swimming pool is illegal, it is unlikely to make the grade!

‘Simplex’

It is no secret that the Portuguese tax system has been cluttered with petty rules that needlessly complicate procedures, often making compliance a nightmare of complex do’s and don’ts that often defy rational explanation. What may come as a surprise is that something is finally being done to improve the situation.  Since 2006, the government has been introducing hundreds of different measures in a programme called ‘Simplex’.  As the name indicates, the purpose of the new rules is to simplify or eliminate needless red tape relating to different forms of governance.

The following is a partial list of some of the many areas that have benefited from this program:

Energy Safety

Business Formation

Communications

Tourism

Trademarks

Licensing

Education

Registries

These and other measures intend to simplify and rationalise the system for citizens, business and institutions alike. While neither perfect nor complete, they do act as an important first step in making compliance straight forward and user friendly.

Property improvements

Under new legislation that came into effect in March 2008, many ‘minor’ changes to property no longer require any reporting or permissions.  More substantial ‘secondary’ improvements, such as swimming pools and garages, need only be reported to the local authorities and supervised by an architect or civil engineer.  In other words, these qualified professionals can now take responsibility for the project with only perfunctory reporting to the Câmara.

Needless to say, these new procedures can open the door to solving the knotty problems associated with unauthorised improvements from the past as well.  

Even if it were not your intention to let to holidaymakers, working with a qualified architect or civil engineer to sort out any unapproved construction issues regarding your property should prove to be the sensible thing to do.

Rental agent v property manager

THE GROWTH of self-catering apartments and villas has proven a boon to the activity of property management throughout Portugal.  

Despite some ups and downs, a combination of ingredients makes this business highly promising in the foreseeable future.

In addition to traditional factors such as climate and political stability, new components like ever increasing demographic mobility within the EU and the advent of low-cost air travel throughout Europe, promise to make residential tourism a year-round phenomena rather than a one-off high season event.

However, confusion generated around the holiday let licensing issue has led a number of agents to move their business operations outside of Portugal. Even so, the properties themselves cannot be moved and potentially remain vulnerable to attack if not prepared.  Smaller operators often cannot afford to take refuge abroad.

How can property managers protect themselves against the pitfalls of Decree Law nº 39/2008?

In addition to the ‘three C’s’ for individual property owners - Comprehension, Clarity & Compliance - there are additional ways that property managers can better organise themselves to defend against potential problems associated with tourist developments:

a) Separating services

It should be obvious that property management is one activity, being a rental agent is quite another. The latter requires a real estate operator’s licence issued by INCI (formerly IMOPPI). Although not incompatible, the two activities should best be kept separate. In the initial registration of one’s business, the Economic Activity Classification (CAE) would better be described as ‘Property Management for Others’ rather than providing ‘Furnished Accommodations for Tourists’.

b) Internet advertising

It is essential to be seen as a service provider, merely acting as outsourcing agent on behalf of the owner. Any advertising should make explicitly clear that the rentals are contracted directly between owner and renters.  

The owner may also outsource certain services such as marketing, rental administration, etc.  Nevertheless, the purpose and applicable legislation must be clearly stated. In a set of agreed Terms and Conditions for any lets, it is essential to be explicit regarding which legislation should apply. On Internet listings, you should have a Legal Disclaimer in Portuguese as well as in English to clarify the intended statutory purpose of the listings.

c) Outsourcing client accounts

Many property managers run internal client accounts where they collect money from the owners for expenses as well as credit income from rentals. This in-house arrangement can work when the business is small but often becomes stained as volumes grows and eventually can easily spin out of control. More importantly, the practice blurs the essential distinction between property manager and owner by mixing accounts and moneys together.

If, on the other hand, separate bank accounts were to be used by each owner with the property manager intervening to make and receive payments on behalf of the owner, the line of demarcation would always remain clear.  An owner’s funds go directly in and out of the owner’s bank account; property managers would reckon separately and be paid accordingly for services rendered.  This ‘outsourced’ banking arrangement can usually be set up without charge to either property manager or owner.

d) Villa management compliance

Not only do owners have to be compliant with Fiscal Representation requirements and filing of annual income tax returns, property managers have their own compliance obligations to be met. The initial business registration mentioned above in a) is only the first of a number of necessary steps when operating a business in Portugal. If your business is to be a true success, playing by the rules is essential in the long run.

If you act solely as property manager or merely as an agent for the owner in administering holiday lets, being on solid, defensible ground is all-important when facing a potential challenge from inspectors. As is always the case, clarity, compliance and common sense will provide an excellent foundation for any on-going, successful business.