Portugal’s corporate tax system is a significant barrier to investment and economic growth. According to the International Tax Competitiveness Index 2023, Portugal ranks second to last due to its high top corporate tax rate of 31.5 percent and the complexity introduced by its top-up taxes and corporate incentives. This puts Portugal’s corporate tax rate 8 percentage points above the OECD average of 23.6 percent. If Colombia’s recent plan to reduce its corporate income tax rate from 35 to 30 percent is adopted, Portugal would have the highest corporate rate in the OECD.
Portugal’s system of progressive top-up taxes and various incentives cause considerable structural problems and distortions. The municipal top-up tax of up to 1.5 percent and the general top-up tax employ a progressive structure with three different rates on taxable income, before the deduction of any carried forward losses. This progressive structure discourages productivity-enhancing mergers and acquisitions, as combining the merging companies’ income shifts them into higher tax brackets.
Portugal’s top-up taxes make up to 10.5 percentage points of the corporate tax rate unavailable for loss offsets, in addition to the restriction of loss carryforwards to 65 percent of taxable income. This disproportionately deters investment projects with long time horizons and variable income profiles. For example, pharmaceutical companies typically undergo lengthy periods of research and development investment before reaping the financial rewards from their products. Restrictions on firms’ ability to carry forward losses lead to these investments being taxed at higher rates.
Portugal’s non-neutral tax incentives such as its patent box and R&D tax credits also distort economic decision-making. The patent box regime gives an 85 percent tax exemption to income derived from the use of various forms of intellectual property. Its R&D tax credits apply an implicit subsidy rate of 35 percent to qualifying expenses, a reduction in tax liability that is independent of the marginal tax rate. Preferential tax treatment creates incentives to engage in tax planning by assigning income to intangible assets and focus on tax-advantaged expenses rather than those with the highest payoff.
In summary, Portugal’s corporate tax system has considerable structural weaknesses that make it internationally uncompetitive for investment. Policymakers should consolidate its progressive and distortive corporate income tax schedule into a single corporate rate more closely aligned with the OECD average, allow companies to carry forward a larger share of their past losses against the entire corporate tax base, and discard preferential tax incentives in favor of better cost recovery for all types of investment. If policymakers are willing to pursue bold reform, Portugal has the opportunity to achieve sustainable economic growth by emulating the simpler, more neutral, distribution-based system that excludes retained and reinvested profits from taxation.
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