Portugal Golden Visa and the PFIC statement demystification

The Portuguese golden visa has long been one of the most popular residency by investment programs in the world, attracting investors from all corners of the globe through its simplified program, captivating investments, and the massive benefits it offers.

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The golden visa offers investors a route to obtain EU residence in Portugal through investing in one of various investment routes, the most popular in the past few years being mutual investment funds, which require a total outlay of 500,000 euros held for five years. While investment funds offer golden visa applicants a simple, profitable, and easy-to-liquidate way to obtain Portuguese residents, some investors need to take some matters into consideration before choosing a fund, namely those hailing from the US.

While most of its applicants came from the Eastern Hemisphere, an increasing number of applications are now flocking in from the USA as more Americans look to secure a robust "Plan B" to leverage against global instability. The number of US investors applying for the golden visa has skyrocketed in the past two years, with the first four months of 2022 registering almost 75% of all the American applications in 2021. Similarly, the number of applications lodged through investment funds has increased, but this brings an important issue with it for Americans: how to handle investments that fall under the US's Passive Foreign Investment Company (PFIC) tax regulations. 

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What is a PFIC?

PFICs are foreign companies or entities if they derive at least 75% of their income through passive means, or if 50% of their assets are passive income-producing assets. 

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Generally, foreign fund investments, such as mutual funds, bond funds, equity funds, and private equity funds, are examples of PFICs. Those investing in Portuguese private equity funds as part of the Golden Visa process fall under this category.

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For purposes of income tax in the US, persons who invest in PFICs must report their direct or indirect (including through an entity or trust vehicle) investment in PFICs on an annual basis as part of their US income tax filing obligation using Form 8621, and report whether they:

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• Receive certain direct or indirect distributions from a PFIC;
• Recognize a gain on a direct or indirect disposition of PFIC stock;
• Are reporting information with respect to a QEF or section 1296 mark-to-market election;
• Are making an election reportable in Part II of the form.

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It is crucial to note that US citizens must affirmatively choose to be taxed through the more favorable Qualifying Elective Fund (QEF) Regime, or be subjected to the less favorable (and seemingly punitive) default Excess Distribution Regime (ED). 

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Common mistakes concerning PFICs

When a US investor makes a direct or indirect investment into a PFIC, they are susceptible to costly mistakes if they do not consider all the important matters concerning their tax obligations. Here are some of the biggest mistakes to be wary of when investing in a PFIC:

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Not reporting their PFIC on an annual basis

The IRS requires US citizens who have direct or indirect interests in PFICs to report such as part of their annual US income tax filing, failure to do so could catch the attention of the IRS and could result in costly penalties or fees. 

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Not making a QEF election from the start

There is a massive difference between the ED and QEF regimes when it comes to taxes levied on PFIC income. A QEF election must be affirmatively made in the first year. If not timely made, the default ED regime will apply.

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The ED regime is designed to dispose of any deferral benefit, and prevents the conversion of ordinary income into preferentially taxed capital gains; essentially, it does this by subjecting all earnings to ordinary income tax rates (no possibility of obtaining a lower long-term capital gain rate), and then requiring the use of the highest marginal individual income tax rate for each related year. The rules are very complex and punitive.

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Further, once distributions are eventually received, if they exceed a certain threshold as compared to receipts from previous years, they are deemed to have been received by the US taxpayer since the beginning of their investment. Accordingly, the distribution is allocated in a pro-rata fashion to each year of their holding period, and interest is then assessed on the unpaid deemed taxable income from each such year. When you then add up the tax for each year of the holding period, plus interest associated with not having paid such tax, you end up with a very high amount due, especially if you also failed to make your annual Form 8621 filing and receive the associated penalties.

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On the other hand, the QEF regime is much simpler, allows the conversion of ordinary income into preferentially taxed capital gains where applicable, and provides similar tax rules to domestic taxation, albeit there is an annual requirement to include and pay tax on one’s pro rata share of the PFICs ordinary and capital income, even if no distributions are actually made.

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Importantly, it is vital for investors to elect the QEF at the start of their holding period, as switching from ED to QEF later is a complex and costly matter. 

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Choosing the wrong partner

This may be one of the biggest and most common mistakes many make when investing in a PFIC.

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A good partner, especially within the realm of the Portuguese golden visa, can greatly alleviate the complexity of PFIC taxation. Choosing the wrong partner can make the process more complex, costly, and irreversible.

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The most important part of choosing the right fund manager is making sure they understand the US tax system and how PFIC taxes work, as they can make the entire process spanning years much easier. They will also understand the financial ramifications and accommodate the needs of a US investor much better. 

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Another vital factor is the documentation, as it is imperative that US investors obtain a PFIC Annual Information Statement for their 8621 form, or information necessary to complete such form, in order to qualify for the QEF regime. Those who cannot obtain this information cannot elect the QEF regime and must settle for the ED framework. Investors should ensure the fund managers can provide them with this information prior to committing.

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A robust fund manager can also connect investors to tax experts who are well-versed in PFICs and other US international reporting obligations that may be associated with such investments. 

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Understanding the US investor

At Optylon Krea, we have extensive experience dealing with US investors within the scope of the Portuguese golden visa. We cater to their every need in a knowledgeable, efficient manner, transforming their golden visa venture into an enjoyable journey void of any obstacles or complexities. 

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To know more about obtaining Portuguese residence through investing in a Portuguese mutual investment fund while simultaneously making a profit and controlling your tax obligations, contact us to book a free, comprehensive consultation with one of our experts. 

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