• The issue of municipal surtax on the tax credit for international juridical double taxation of income

    By Rui Miguel Pereira Sampaio



    Economic double taxation, along with juridical double taxation, has a crucial importance into the modern global tax competitiveness and efficiency.

    With the global economy, States must take action to adopt their tax systems to the new reality, to fulfil the unbearable lightness of the tax, i.e., the absence of tax where it already exists.

    Double taxation reflects the overlap of tax in the same expression of wealth, especially in a multi-location situation which result from the taxation of income already taxed.

    If, on one hand, we found several double taxation manifestations that are admissible, on the other hand, there are those that are clear violations of the principle of contributive capacity and of justice.

    Although the principle of tax non-discrimination isn´t (usually) typified by law, it arises from the principle of equality, of (valid) economic justification, of neutrality, of efficiency and of competition, but most of all it arises from customary international law.

    The problem

    When the Resident State applies the credit method, to avoid juridical double taxation (or economic, in some circumstances), it retains the right to tax the total income of the taxpayer but allows it a deduction. States can apply this method regardless the existence of a Double Taxation Convention (DTC) with the Source State, as it occurs with Article 91 of the Portuguese Corporate Tax Code.

    This deduction could be full credit or ordinary credit. In the case of full credit, the Resident State allows the deduction of the tax due in the Source State on the income from that State. If the Resident State applies the ordinary credit, in no case it allows more than the portion of tax in the Source State attributable to the income from that State (maximum deduction).

    So the question is, when applying the ordinary credit method, does the limit includes the municipal surtax or not, if the income arises from States to whom the Resident State didn´t celebrate DTC´s?

    The answer to this question has different consequences. If we consider, as we do, that the Resident State must include the municipality surtax as well the corporate tax to the income from the Source State, then the portion of tax deductible will be higher.

    Let´s consider the following example:

    Total income: € 1.000.000

    Income from Resident State: € 200.000

    Income from Source State (v g. through a permanent establishment): € 800.000

    Tax rate Resident State: 25% (corporate tax) + 2% (municipality surtax)

    Tax rate Source State: 35%

    Tax due Resident State: € 270.000 (€ 1.000.000 x 27%)

    Tax due Source State: € 280.000 (€ 800.000 x 35%)

    Ordinary credit:

    1. i) Tax paid Source State: € 280.000

      Tax due in Resident State on the income from Source State (corporate tax plus municipality surtax) = € 800.000 x 27% (25% + 2%) = € 210.600

      Deduction (lower of the two) = € 210.600

    2. ii) Tax paid Source State: € 280.000

      Tax due in Resident State on the income from Source State (corporate tax without municipality surtax) = € 800.000 x 25% = € 200.000

      Deduction (lower of the two) = € 200.000

    As we can see, if we consider that the municipality surtax is included in the ordinary credit method (together with the corporate tax) the amount to deduct can be higher.

    The municipality surtax and it´s interpretation

    Accordingly to the Portuguese municipality surtax regime, this tax is only due if the income is subject to corporate tax. Thus, there is close connection between the municipality surtax and the corporate tax.

    So, the best interpretation, according to the teleological interpretation and the accessorium sequitur principle, is to consider that when the ordinary credit method asserts the corporate tax it also asserts the municipality surtax.

    The ordinary credit method, as provided in the Portuguese regime, is applicable to all incomes regardless the existence of a DTC. Therefore, there is no teleological reason to exclude the full application of the ordinary credit method, which includes the municipality surtax, towards the income from the Source State to whom there isn´t any DTC.

    The principle of neutrality also says that the decision to invest must be not be undermined by narrow interpretation of the law and of the mechanisms to apply the avoidance of the double taxation.

    Furthermore, in the presence of a legal mechanism to avoid double taxation, to maintain the taxation of the municipality surtax and refrain the corporate tax would be contradictory. In fact, the municipality surtax grants the municipalities financial resources of their own for the economic activities performed only in their geographical division. Hence, it is unreasonable to tax an income obtain outside their division, since no closeness link exists between the municipality and the income obtain in the Source State. Different situation whereas the Resident State taxes the resident income worldwide.

    The Organization for Economic Co-operation and Development Commentaries on the Articles of the Model Tax Convention on Income and on Capital

    Despite the Organization for Economic Co-operation and Development (OECD) Commentaries on the Articles of the Model Tax Convention on Income and on Capital don´t constitute legally binding rules, practice and respect has granted them a moral force to serve as an instrument to solve double taxation conflicts, namely to help in the interpretation of the DTC rules.1

    In this regard, even in the absence of a DTC, the Resident State should apply the OECD Commentaries on the Articles of the Model Tax Convention on Income and on Capital to help in the interpretation and application of his domestic rules.

    The legal framework of the Resident State, in this case Portugal, was shaped by the OECD Commentaries on the Articles of the Model Tax Convention on Income and on Capital. Thus, the State feels compelled to go to the source of such rules to help in their interpretation and application.

    The OECD Commentaries on the Article 2º of the Model Tax Convention on Income and on Capital says that “It is immaterial on behalf of which authorities such taxes are imposed: it may be the State itself or its political subdivisions or local authorities (constituent States, regions, provinces, déparements, cantons, districts, arrondissements, Kreise, municipalities or group of municipalities, etc.)”.

    On other words, according to the OECD Commentaries on the Article 2º of the Model Tax Convention on Income and on Capital, the definition of taxes includes state taxes and municipal taxes, as well the main taxes and accessory taxes.

    In this regard, it should be noted that the Portuguese legislature included the municipality surtax in all the DTC´s that has concluded, so that in the interpretation of the teleological elements, no justification can be withdrawn for not including the municipality surtax in the application of the ordinary method towards the income arising from States to whom no DTC was celebrated.

    And Portugal didn´t make any observation or reservation in the OECD Commentaries on the Article 2º of the Model Tax Convention on Income and on Capital, so, in a way, peacefully accepted the understanding that the taxes referred in the Model Convention, which served as model to the DTC´s celebrated by Portugal, included state taxes and municipal taxes.

    Thus, the joint analysis of the grammatical element of the Article 91 (1) (b) of the Portuguese Corporate Tax Code, of its teleological element - elimination of international double taxation -, of the coherence of the unity of the legal system - all the DTCs concluded by Portugal include the municipal surtax - and the aid of the OECD Commentaries on the Article 2º of the Model Tax Convention on Income and on Capital suggests that Article 91 (1) should be interpreted with the sense and scope that the ordinary credit method includes the states taxes but also the municipalities taxes, despite the income was obtained abroad in States to whom the Resident State didn’t celebrated a DTC.

    The principle of nondiscrimination in international taxation and fair tax treatment in the International Trade and Investment Agreements

    The principle of nondiscrimination in international taxation plays a key role in international trade, with grounds for equality, justice, international cooperation, fiscal neutrality and economic equity.

    Although not explicitly enshrined in a legal rule, the principle of nondiscrimination in international taxation enjoys a diffuse protection in the area of income taxation. The present paper does not allow us to go further in this matter, but we wish only to emphasize that in our view this principle does not result only from the (sovereign) will of the States in the agreements that it celebrates.

    In general terms, the principles of nondiscrimination in international taxation and fair tax treatment are intended to prevent, in the context of international situations, that a State arbitrarily privileges a taxable person located in a given country to the detriment of other located in a different country, which are in an identical situation (the last expression implies multiple interpretations).

    If the territories where the income was obtained are full members of the World Trade Organization (hereinafter WTO) and signatories to the General Agreement on Tariffs and Trade and the Marrakesh Agreement, we will also have to apply the provisions of those agreements aimed at eliminating discriminatory treatment.2

    Tax discrimination prohibited by the WTO does not have to be observed vis-à-vis domestic economic agents, but it can be applied in relation to economic agents from other countries.

    As well as it does not have to be limited to indirect and customs taxes, but may include direct taxes (in this sense, Argentina case - Bovines Hides DS155, and the case United States - Tax Treatment for Foreign Sales Corporations DS108).

    The WTO Agreement also includes investment and trade-related services and measures (Trade Related Investment Measures3), and not just trade in goods.

    Regarding the issue of confrontation of the WTO Agreement and the DTC´s concluded by Portugal, we fully agree with Pedro Infante Mota and Ricardo Henriques da Palma Borges:

    However, it results from the WTO Agreements that they may supersede DTCs as far as trade matters are concerned (notably Art XIV lit (e) GATS and the SCM Agreement). Moreover, it stems from the pacta sunt servanda principle of Art 27 VCLT that two DTC partners that are also Members of the WTO, upon entering such organization, have to accept its trade discipline”.4

    In other words, considering that the WTO Agreement and the DTCs concluded and ratified have the same legal value (international treaties), we cannot discriminate negatively against a member country of the WTO, of which it is also a member, for another WTO member with which it has concluded a DTC.

    In this regard, as the conclusions of the Congress of the 2008 International Fiscal Association in Brussels, dedicated to the issue of non-discrimination at the crossroads of international taxation:

    International double taxation has long been recognized as an impediment to international trade and investment. This arises most obviously in the country where the investment is made (the source country) and the country where the investor resides (the residence country)”.5

    Concerning the direct effect of the rules and principles of the WTO Agreement, that is to say, the invocation of its norms by individuals, most legal systems joined the monist theory with primacy of International Law, according to which International Law, including Conventional Law, is internally effective.

    In addition, the courts can use the WTO Agreement to interpret domestic rules, in accordance with the principle of indirect effect and the theory of conformity interpretation (or Charming Betsy Doctrine).

    According to the Charming Betsy Doctrine on the interpretation of Domestic Law in the light of International Law, no rule of domestic law should be interpreted as contrary to international law, which places the State in violation of International Law, unless there is an internal rule expressly provides otherwise (which does not exist in Portuguese case).

    With regard to international decisions on discriminatory tax treatment in the context of international trade treaties, see the decision of the International Center for Settlement of Investments Disputes of 16 December 2002 in the case of Marvin Feldman v. Mexico v. ARB (AF) v. 99/1, and July 1, 2004, of the London Court of International Arbitration in Occidental Exploration and Production Company v. Ecuador No. UN 3467.

    The normative scope of the principle of nondiscrimination is reflected in several provisions of the Portuguese legal system, including constitutional through Article 13 of the Portuguese Constitution, or European by Articles 18ss. (Nondiscrimination), Articles 49ss (Freedom of establishment) and (State aid), all of the Treaty on the Functioning of the European Union (TFEU).

    Bear in mind that we don´t advocate the complete and unlimited elimination of the fiscal sovereignty of the rights to tax. We are only saying that in case of doubts as to the interpretation and application of a rule, it is necessary to consider the rules expressly adopted in this matter and the fair and balanced application of the international treaties concluded.

    For instance, in the particular case of the Agreements on the Promotion and Reciprocal Protection of Investments. Under the terms of these Agreements, investments made by investors of any Contracting Party in the territory of the other Contracting Party and their income shall be treated fairly and equitably and no less favorable than that granted by the latter Contracting.

    The limit laid down in that agreement refers only to the granting of preferential treatment or privilege (positive discrimination) and not to the granting of less favorable treatment (negative discrimination), as in the present case. Another international agreement to prohibit tax discrimination, with the resulting obligations, as explained above.

    In this regard, the Portuguese Arbitral Court, in case n.º 340/2017-T, concluded that the obligations assumed by Portugal under the WTO and the Agreement on the Promotion and Reciprocal Protection of Investments concluded with Angola, which are aimed at eliminating restrictions on free international investment competition, will be more satisfied if, in the tax area, "differences between residents investing abroad are avoided, depending on the country where investments happen".

    That arbitration decision continues: “ (…) even if it can be understood that such international commitments do not directly bind the tax legislator, the interpreter cannot fail to keep them in the name of the unity of the legal system as a whole." For "the interpretation that ensures the coherence of the legal system is certainly the one that corresponds to the most correct legal solution that is supposed to have been accepted by the legislator (Article 9 (3) of the Portuguese Civil Code)."

    And finally, we cannot fail to call the collation the precious principle of justice and contributive capacity.

    The principle of justice and contributive capacity

    If, for example, the income obtained in the country where the permanent establishment is located (Source State) is taxed therein and that same income will be incorporated into the accounting results of the parent company where it will be taxed again in the territory of its headquarters (Resident State), on the basis of the worldwide income principle, we face a violation of the principle of justice and contributive capacity.

    As we have seen above, by disregarding the municipal surtax from the calculation of the ordinary credit method, the tax credit for double taxation is lower.

    Therefore, the income obtained, for example, by the permanent establishments in the Source States will be double taxed, inasmuch as by reducing the tax credit, with the exclusion of the municipal surtax in these cases, the difference between the tax paid abroad and the tax that such income would be subject in the Resident State is increased.

    Taxation according to the principle of contributive capacity means the existence and maintenance of an effective connection between the tax benefit and the economic assumption selected for tax purposes, requiring a minimum of logical and economic connection between the economic strength or potentiality of the taxpayer and the coactive subtraction of that wealth.

    However, any restriction to the elimination or mitigation of international double taxation entails the taxation of an economic force greater than that shown.

    In the path of Klaus Tipke, the demand for fiscal justice cannot be based on another criteria, but that of the taxable capacity, since it is also the ultimate objective of taxation - taxing the wealth where it exists - and that is where taxpayers feel the sacrifice - waiving the satisfaction of private needs that implies the payment of taxes.

    Such a principle is not at all insignificant and must in fact constitute such a "demand for fiscal justice", especially in times when revenue collection, masquerading as a vehicle for combating fraud and tax evasion, seems to be the ultimate goal of constituted power, without any importance given to the value of justice, of fiscal justice.


    Thus, we can conclude that the international legal double taxation credit system, as enshrined in Article 91 (1) b) of the Portuguese Corporate Tax Code, provides that the calculation of the Corporate Tax fraction comprises the value of the Corporate Tax plus the municipal surtax, regardless of whether the income obtained abroad is covered or not by DTC's.

    In the absence of a DTC between Portugal as a State of Residence and the Source States, the Model Convention should be applied in the interpretation and application of (1) of the Portuguese Corporate Tax Code, considering the soft law nature of the Model Convention.

    The interpretation and application of Article 91 (1) of the Portuguese Corporate Tax Code cannot result in negative discrimination between countries with which Portugal has concluded DTCs and with which Portugal has not entered into DTCs, all of which are WTO members because it would be in clear violation of the international principles of non-tax discrimination.

    The interpretation and application of Article 91 (1) of the Portuguese Corporate Tax Code cannot result in non-compliance with the principle of fairness and contributive capacity, a corollary of the principle of equality, with the double payment of tax (the tax paid abroad and the tax paid in Portugal, with the undue reduction of the tax credit for international legal double taxation).

    1. Michael Lang, Introduction to the Law of Double Taxation Conventions, IBFD, Linde, 2010, pp. 43 to 45, Miguel Angel Collado Yurrita e Gemma Patón García, “Las fuentes del Derecho Tributario Internacional”, Manual de Fiscalidad Internacional, Instituto de Estudios Fiscales, Manuales de la Escuela de la Hacienda Pública, 3º edição, 2007, Volume 1, organization by Teodoro Cordón Ezquerro, p. 153.
    2. As pointed out by André Gonçalves Pereira and Fausto de Quadros: “The general principles guiding the GATT [current WTO] are as follows:
      1. Principle of free trade;
      2. Principle of nondiscrimination or equal treatment between the Contracting State:
        1. Granting most-favored nation treatment (Article I);
        2. The national treatment clause on taxation and national regulation (Article III, paragraph 2);
        3. The elimination of quantitative restrictions (Article XI)”

      Manual de Direito Internacional Público, Almedina, 3º edition, 1997, pp. 561 to 562.

    3. The WTO Agreement doesn´t apply only to goods but also to services, including intellectual property, as a result of the Uruguay Round.
    4. “National Report Portugal”, WTO and Direct Taxation, EUCOTAX Series on European Taxation Series n.º 10, Kluwer Law International, 2005, coordination of Michael Lang, Judith Herdin and Inês Iofbauer, pp. 566 to 567.
    5. Cahiers de Droit Fiscal International IFA 2008 Brussels Congress, Volume 93a, p. 74.
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  • The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.

Rui Miguel Pereira Sampaio

Rui Sampaio, is based in Porto, Portugal. He is a member of the Portuguese Bar Association and a Specialist Lawyer in Tax, title awarded by the Portuguese Bar Association. Master of Laws and Professor of International Taxation at the Polytechnic Institute of Cávado and the Ave, Portugal. Participates and investigates on matters related with international tax law and tax policy.

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