The “Not-so-New” Madeira Free Zone Regime

Rui Camacho Palma and Raquel Galvão da Silva – Linklaters

Following the approval of the European Commission, Law 65-A/2007, of 26th November, authorised the Portuguese Government to enact what we may designate as the third Madeira Free Zone (MFZ) regime.

The new regime, in force until the end of 2020, applies to (i) entities licensed between 1st January 2007 and 31st December 2013, with effect as of 1st January 2007, and (ii) all other entities licensed to operate within the MFZ, with effect as off 1st January 2012, as both the first regime (for companies licensed until the end of 2000) and the second regime (for the small number of companies licensed since 1st January 2003) will expire on 31st December 2011.

Whereas the first regime was characterised, in broad terms, by a corporate tax exemption on profits arising from transactions with non-Portuguese resident entities, the new regime (very similar to the second) restricts the scope of eligible activities (i.e., financial intermediary, insurance and intra-group services are excluded), imposes more demanding conditions, replaces the exemption with reduced rates (3% from 2007 to 2009, 4% from 2010 to 2012 and 5% from 2013 to 2020) and caps the taxable income that may avail of such reduced rates, depending on the number of jobs maintained (except for holding companies).

Licensed entities are required to (i) maintain 1 to 5 jobs in their first six months of activity and invest a minimum of 75,000 Euro in the acquisition of fixed assets in the first two years, or, alternatively, (ii) create 6 or more jobs in the first six months. Although not set forth in the authorising law, the Government will introduce the requirement that licensed entities commence the activities within six months (for international services) or one year (for industrial activities or shipping registry) from the date of licensing.

Regarding the taxable profit that may benefit from the reduced rates, the ceilings vary in accordance with the number of jobs maintained in each year, ranging between a taxable profit of up to 2 million Euro - 1 to 2 jobs - and up to 150 million Euro - when more than 100 jobs are maintained.

Industrial activities may avail of a further credit of 50% of the corporate tax bill, if additional substance requirements are satisfied.

Finally, benefits arising to shareholders or counterparties of licensed entities, comprising exemptions from withholding tax and stamp duty, among others, in force since the first regime, will remain available.

As from 2012, the attractiveness of the Madeira Free Zone corporate tax regime will not be the same as today and when the new Value Added Tax (VAT) rules on business-to-consumer supplies of telecommunication and e-commerce services (VAT imposed at the rate of the customer's, rather than the supplier's, jurisdiction) enter into force, in 2015, they will level the playing field between Madeira and Luxembourg (with a 15% VAT rate) and the other EU Member States.

Notwithstanding the above, all over the world the “infamous” off-shore regimes are under the pressure of the OECD, the EU and the public opinion. On the other hand, whereas within the EU only “wholly artificial arrangements” may be challenged, according to the European Court of Justice, structures in third countries are increasingly prone to being challenged by the tax authorities, particularly when devoid of adequate levels of substance.

In this context, the new regime, backed by the EU authorities, although not so beneficial as the one which put Madeira on the map of international tax planning, may well be, from 2012 onwards, one of the most competitive in the world, attracting investment and generating tax revenue (e.g., on labour income and transactions that would never have arisen or taken place in Portugal in its absence). Let us hope we are able to defend it and promote it to our collective advantage in a globalised economy.