With the exception of the financial sector, senior executive compensation is not subject to special rules or regulations under Portuguese law.
There is, therefore, a high degree of flexibility for parties to arrange the remuneration schemes that better suit the interests of both companies and employees.
The way companies choose to structure and implement these remuneration schemes is influenced by a multiplicity of factors, namely by:
- the tax and social security regime, seeking the least costly solutions for both employer and employee;
- the labour rules, which in Portugal are particularly restrictive, trying to adopt forms of remuneration that enable some degree of flexibility and the possibility of altering its value and structure; and
- management reasons granting benefits designed to encourage productivity and increase loyalty and length of service.
These benefits may be subject to a company's performance results (performance-related margin and bonus system, equity participation or stock options) or related to an employee's performance (either individual or group performance evaluation), or both, or can be deferred benefits for the purpose of discouraging a change of job to a competing company (pension schemes, among other things).
i Income tax for employees
The State Budget Law for 2019 has not brought about any relevant change regarding Portuguese income taxation.
Tax-residency is the key concept of the Portuguese income taxation rules. An individual is deemed to be resident in Portugal if he or she spends over 183 days in the Portuguese territory or if he or she has his or her main abode in this country. Therefore, strictly under domestic rules, if an individual's primary place of residence is in Portugal, that person will be considered a Portuguese resident even if he or she spends most of the year abroad.
Individuals that are classified as residents in Portugal for tax purposes are subject to Portuguese personal income tax on their worldwide income, that is, irrespectively of where their income is generated. On the other hand, non-residents are subject to tax only on the income that is deemed to be obtained in Portugal. The tax is levied on specific categories of income defined as Category A through to Category H. In general, active income (including employment compensation) is taxable at progressive rates of up to 48 per cent (on income in excess of €80,000) whereas passive income (dividends, capital gains and interest) is taxable at a fixed rate of 28 per cent. An additional progressive surcharge is applicable at the following rates: 2.5 per cent on taxable income exceeding €80,000 and up to €250,000, and 5 per cent on taxable income exceeding €250,000.
Income earned by non-resident individuals is generally subject to withholding tax at a rate of 25 per cent. The payer is responsible for withholding the applicable tax.
Compensation for employment work (salary) is included in Category A of taxable income. Fringe benefits and all other forms of compensation related to the employment relation are also generally subject to tax under Category A.
The attribution (for free or at a discounted value) of shares by an employer to an employee is taxable as employment income, and there is no taxation until the shares are effectively acquired, either by a transfer for no consideration (or a discounted value) or by exercising the option to acquire shares at the strike price. In both cases, the difference between the consideration paid by the employee and the fair market value of the shares on the date of acquisition is characterised as employment income and is subject to tax according to the rules described above.
Any gains realised on a subsequent transfer of those securities or any dividends received are subject to withholding tax in Portugal at a rate of 28 per cent. This rate is final for both resident and non-resident individuals.
All deferred payments, according to the Portuguese tax rules, should only be taxed upon effective attribution, that is, only in the year they are paid or made available to an employee.
Pension fund contributions made by employers are immediately taxable as employment income where such contributions are individualised and constitute acquired rights of an employee. By contrast, contributions made by employers that are not individualised or do not constitute acquired rights of an employee are not taxable at the moment of the contribution, but rather at the moment the funds are paid to the beneficiary. In these cases, if the funds are paid by the pension fund before the retirement age, the income is also classed as employment income.
Finally, it is also important to consider a special tax regime for individuals that become residents in Portugal under the non-habitual residents tax regime (NHR). This regime was designed to attract foreign individuals to Portugal, and under this regime individuals will benefit from preferential rates as well as full exemptions in certain categories of income, as further explained below.
ii Social taxes for employees
In Portugal, there are no different rules concerning social taxes applicable to residents and non-residents.
Regular salary (excluding extraordinary bonuses) for work that is materially executed in Portugal is subject to social security contributions at a rate of 23.75 per cent for employers and 11 per cent for employees.
A new law was approved in July 2019 that foresees an additional contribution for companies with a percentage of fixed-term employment contracts that is higher than the average registered in the same sector of activity. The additional contribution can be up to 2 per cent depending on the percentage of fixed-term contracts. The entry into effect of this statute is subject to further regulation, which is not yet been approved.
Employers with no establishment in Portugal who hire employees to work within the Portuguese territory must register before the Portuguese Social Security and enter into a mandate contract appointing an employee as the company representative for social security purposes. Social contributions shall be paid by both parties at the ordinary rates.
iii Tax deductibility for employers
Remuneration paid to employees is generally deductible by employers without exception, and to this effect there is no difference on the basis of the level or qualifications of an employee. However, certain incurred expenses, such as extraordinary bonuses paid to members of boards, incurred or supported by entities subject to corporate income tax, are subject to a penalty taxation at the level of the company. The most noticeable example is the case of bonuses, which are subject to such penalty tax at a rate of 35 per cent.
The form in which remuneration is paid does not affect the amount or the timing of the deductibility.
iv Other special rules
No special rules apply to the taxation of compensation paid to employees in the context of an event of change of control.
The amounts received by employees for the termination of an employment contract are exempt up to the average of their regular salary subject to taxation of the past 12 months multiplied by the years of work. This exemption does not apply for termination payments to directors and board members.
On the other hand, for social security purposes, no liability to contributions arises in respect of the compensation for the termination of an employment contract, except in some cases of termination by agreement.
III TAX PLANNING AND OTHER CONSIDERATIONS
Individuals that transfer their tax residency to Portugal may apply for the NHR tax regime, which allows for rate reductions or exemptions on certain categories of income, as further explained below.
The NHR regime is applicable for a period of 10 consecutive years from the year of registration as a resident on Portuguese territory. Taxpayers that cease to be residents in any of those years may still apply the regime in any subsequent year that they return to Portugal, but always within the original 10-year period.
Under the NHR rules, foreign-sourced employment income (including salary) is exempt from tax in Portugal to the extent it was effectively taxed in the source country (i.e., either in the country where the employment is effectively exercised or where the employer is resident for tax purposes).
If this income is not taxed abroad, then the foreign source compensation income is taxable under the same rules that apply for domestic-sourced income.
In turn, domestic source employment compensation income is generally taxable at progressive rates (of up to 48 per cent on income in excess of €80,000) unless it relates to employment in a high-value-added activity, which consists of activities that are specifically listed, in which case the income is taxable at a fixed rate of 20 per cent.
In any case, if an employer is a non-resident entity without a branch or any other form of permanent establishment in Portugal, this income, even if taxable, will not be subject to withholding tax in this country.
IV EMployment Law
i General remarks
Portuguese employment law is applicable to all employees regardless of their qualifications or position in their employer's organisation. Hence, executives and senior executives' employment contracts are subject to the same worker protection rules and regulations as other employees, although there are some exceptions, most of them related to working time limitations. One important exception is the possibility of hiring senior executives, whose jobs presume a special trustworthiness, under the regime of service commission. This type of employment contract may be used for the admission of new personnel or applicable to pre-existing employees. The general rules on termination are not applicable here (see subsection iii).
The Portuguese Labour Code (LC) has several rules about remuneration that should be taken into consideration when designing compensation and benefits schemes. The most relevant is the prohibition to reduce pay, even with an employee's consent, except where expressly provided for by law (such as the adoption of exceptional measures for companies in economic difficulties) or by collective agreement. However, this prohibition does not affect the grant of variable payments or bonuses related to an employee's or company's performance provided certain conditions are observed. It is also possible to remove pay supplements directly dependent on the terms and conditions under which work is rendered provided there is a clear connection between the payment and the work conditions that justify that payment.
In the majority of cases, remuneration is agreed on a monthly basis, but for senior executives it is becoming more frequent to establish an annual amount. Since the LC establishes that all employees are entitled to holiday and Christmas allowances, when remuneration is agreed on an annual basis it should be clear that this amount already includes the above-mentioned allowances.
Long-term incentive plans (such as the grant of bonuses related to a company's performance or stock options) are not regulated by employment law. They can be subjected to specific conditions to avoid the benefits emerging from these plans having a retributive nature, and are therefore subject to the guarantee provisions regarding retribution.
ii Restrictive and non-solicitation covenants
As a general rule, an employee's right and freedom to work render null and void any restrictive covenants during employment or even after an employment's termination. There are, however, exceptions, and exclusivity clauses and non-compete agreements are allowed provided the four following requirements are simultaneously met:
- the covenant is put down in writing, under the employment contract or under the termination agreement. It can also be included in any other document, such as share acquisition agreements, which are subject to the same rules if the selling shareholder is an employee;
- the performance of a competing activity is likely to cause harm to the employer;
- the non-compete clause may be applicable for a maximum of two years after termination of the contract or up to three years if the activity performed entails a special relationship of trust or access to sensitive information; and
- the employee is granted compensation for the period in which his or her activity is restricted.
There is no legal rule establishing the amount that should be paid to an employee for the period of a non-compete clause. Although the amount of compensation varies with the particular circumstances of each case, the Supreme Court has already decided in one case that compensation equivalent to 30 per cent of the annual remuneration was acceptable, and in another case that 20 per cent was not sufficient.
In the event of an unlawful dismissal or termination on justified grounds by an employee based on an employer's illegal conduct, compensation shall at least correspond to the amount of the monthly basic salary paid to the employee at the time of his or her termination. Otherwise, a non-compete clause cannot be invoked. An employer can, nonetheless, subtract from the compensation income eventually earned by an employee following the termination of a contract.
If an employee fails to comply with a non-competition clause, his or her employer may request him or her to reimburse the compensation paid as well as seek compensation in excess of that amount if the damage suffered by the employer is higher.
Non-solicitation covenants of customers or clients are only allowed if they result from a non-competition covenant that fulfils the above-mentioned requirements.
Finally, any agreement settled between employers not to hire each other's employees will be null and void.
iii Termination of employment
Termination of open-ended employment contracts cannot be carried out by an employer outside a just cause scenario. This concept includes both disciplinary dismissals and dismissals based on objective grounds, as expressly provided for under the Portuguese LC.
The LC foresees the following types of dismissal: dismissal based on the unlawful conduct of an employee (or disciplinary dismissal); redundancies or dismissals resulting from the elimination of jobs (collective dismissals and individual redundancy); and dismissal for failure to adapt (which is not used in practice).
A dismissal may only occur after following a complex procedure that takes several weeks to be completed. If the proper procedure is not observed, the dismissal is considered unlawful even if there were reasons to terminate a employment contract.
In cases of disciplinary dismissal, an employer does not have to pay compensation for the termination of the employment contract or provide for a notice period, although the dismissal procedure must always be completed.
In the case of redundancies (collective dismissal or individual redundancy), the final decision has to be issued observing a prior notice period of 15, 30, 60 or 75 days, depending on an employee's seniority. In the event of a collective dismissal or individual redundancy, employees are entitled to compensation. The rules about compensation were updated in 2011, 2012 and 2013. For contracts that entered into force after 1 October 2013, the compensation corresponds to 12 days of basic pay and seniority allowances for each year of employment, capped at 12 times the basic monthly salary or 240 times the minimum wage (currently €144,000).
Ordinary employment contracts are not allowed to establish different rules on termination (whether more or less favourable to employees). Therefore, it is not possible to agree in advance (in the original employment contract or in another complementary agreement) on the value of the compensation to be paid in cases of termination (golden parachute clauses). This, however, does not make it invalid for parties to enter into a termination agreement and to agree on the compensation amount under that agreement.
Dismissed employees may file a claim before a labour court to challenge the termination of their labour contracts.
If the court decides that there was any illegal procedure or lack of reasons or formalities for a dismissal, employees may choose between being reinstated in the company or receive compensation ranging between 15 and 45 days of base remuneration plus a seniority bonus for each year or fraction of year of seniority, with a minimum of three months of base remuneration plus seniority bonus.
In both situations, employees shall be entitled to the salaries that they would have received if the dismissal had not taken place, and to an eventual compensation for damage suffered.
If an employer is a company that has nine employees or less, or if the employees dismissed are directors or managers, the employer can oppose reinstatement. This is provided that the employer can show that the employee's return would seriously interfere with and prejudice the company's ordinary activities. The court must assess the employer's arguments. In this particular case, the employee will be entitled to a compensatory award equivalent to between 30 and 60 days of basic pay and seniority payments for each full year or fraction of a year's service, subject to a minimum of six months of base remuneration plus seniority bonus.
The general rules on termination are not applicable to executives who have been hired through the special regime of employment contract in commission. In this case, termination by an employer does not need to be justified; nor is it necessary to follow a specific procedure. Both parties may terminate the employment relationship at will, by giving a prior notice of 30 days or 60 days to the other party, depending on whether the contract has lasted up to two years or for more than two years. Termination at an employer's initiative gives an employee the right to compensation corresponding to 12 days of basic pay and seniority allowances for each year of employment. The notice period and the compensation amount may be increased under the employment contract in commission (this not being possible under ordinary employment contracts).
The reasons that may lead to a unilateral termination of a contract by an employee with just cause may be related to unlawful behaviour by his or her employer (constructive termination) or to objective reasons (such as the lawful modification of the employment conditions). If it becomes immediately impossible to continue an employment relationship in ways to be considered as just cause, an employee may terminate it immediately, without prior notice. When termination is based on an employer's unlawful behaviour, an employee is entitled to compensation to be determined between 15 and 45 days of base pay and seniority pay for each year worked, depending on the amount of compensation and the extent of the employer's unlawful conduct, and may not be less than three months of base pay and seniority pay. The same applies in cases of termination due to objective reasons, when employees are also entitled to receive compensation (equal to that foreseen for collective dismissals).
A change of control as such is not a valid cause for termination either for employers or for employees. An employment contract remains in force with the same terms and conditions previously agreed. Even for senior executives that may have had a special relationship with the previous owner a change of control is not a cause for termination, since the employer remains the same – the company - despite any changes in its ownership structure.
Under Portuguese law (which broadly speaking is a transposition of the regulations contained in the EU Directive 2001/23/EC of 12 March), the transfer of an undertaking does not constitute cause for termination by an employer. Employment contracts will be automatically transferred to the transferee under the exact terms and conditions in force at the moment the transfer occurs. However, employees' right to oppose the transfer of their employment contracts to the transferee is expressly included in Portuguese employment law. Employees are entitled to oppose the transfer of their employment contract whenever such transfer may cause them serious loss, namely by the transferee's evident insolvency or difficult financial situation, or if the employees do not trust the transferee's policies regarding the organisation of work. The above-mentioned grounds are so broad and subjective that it can be questioned whether employees are truly obligated to justify their opposition. In the alternative, employees are entitled to terminate their employment contracts, with this termination being considered a unilateral termination with just cause. Employees will therefore be entitled to monetary compensation calculated in accordance with the rules applicable to a collective dismissal.
V SECURITIES LAW
According to Portuguese securities law, a share plan has regulatory implications solely if it can be qualified as a public offer.
An offer is deemed to be public in the following circumstances:
- if the offer of securities is addressed, wholly or partially, to unidentified recipients;
- if the offer is addressed to all the shareholders of a public company;
- if the offer is, wholly or partially, preceded or accompanied by a prospectus or a solicitation for investment from unidentified addressees, or by other promotional material; and
- if the offer is addressed to at least 100 persons who are non-qualified investors resident or established in Portugal.
The application of these criteria to share plans is not always straightforward, the key question lying on the qualification of a plan as an offer of securities. For example, phantom stock purchase plans in principle should not be qualified as an offer of securities, as they do not involve the effective acquisition of securities.
If the share purchase plan involves a public offer, a filing will be required with the Portuguese Securities Market Commission (CMVM) and a prospectus must be approved. Acceptances of an offer have to be transmitted through an authorised financial intermediary.
An important exemption to the prospectus requirement is granted for public offers of securities to existing or former directors or employees by their employer that has securities already admitted to trading on a regulated market or by an affiliated undertaking, provided that a document is made available containing information on the number and nature of the securities and the reasons for and details of the offer.
Otherwise, registration with the CMVM is not required in connection with the offering of securities to current or former members of the management or workers' bodies by their respective employer, a company in a controlling or group relationship with the latter or a company subject to common ownership, provided that the issuer has its statutory or effective place of business in the European Union and a document providing information on the number and nature of the securities as well as the reasons and characteristics of the offer is available.
Directors of an issuer of securities admitted to trading on a regulated market (or of a controlling company), as well as related persons, shall notify the CMVM within five working days of all transactions carried out on their own account, on account of third parties or on their behalf involving shares of said issuer or related financial instruments, where the value of such transactions reaches €5,000.
In addition to the general rules of information on inside information, issuers and persons acting on their behalf or account have to draw up insider lists (e.g., lists of persons with access to privileged information), with the law providing for a set of specific duties associated with this obligation:
- to include in the list, inter alia, a person's identity, the reasons for his or her inclusion and the date of his or her inclusion;
- to keep the list strictly up to date;
- to inform the relevant person of his or her inclusion in the list, and the legal consequences in the case of disclosure or misuse of inside information;
- to keep the list for a period of five years; and
- to immediately forward the updated list to the CMVM whenever it so requests.
Disclosure of information on remuneration of members of corporate bodies of public companies is subject to statutory law and regulations approved by the CMVM, requiring disclosure of remuneration policies approved on an annual basis to be included in the respective accounts and the corporate governance annual report if applicable.
Disclosure should cover individual and aggregate remuneration of directors and members of the audit body – referring to the components giving rise to the variable remuneration – as well as the parts of the remuneration already paid and those payable in the future.
Public companies shall be entitled to adopt a corporate governance code different from the regulations approved by the CMVM, provided, however, that the same applies equivalent disclosure rules and principles.
Disclosure requirements embody the principle of comply or explain pursuant to which justification should be provided in relation to each of the requirements not complied with by the relevant company.
Currently, there is a statutory principle of say on pay by shareholders, who are called to review the statement of the remuneration policy of members of the corporate bodies.
VII CORPORATE GOVERNANCE
As a general statutory rule, approval of the remuneration of members of the corporate bodies of a company is entrusted to the general meeting or to a corporate remuneration committee designated for the purpose (and enjoying of independence from the management bodies).
Certain adjustments to this principle may exist depending on the corporate governance structure adopted (for instance, in dual public companies inspired by the German model, competence is transferred from the general meeting to the supervisory board).
The Companies Code allows the remuneration of executive directors to partially consist of a percentage (the maximum amount of which needs to be set out in the articles of association) of a company's profits, whereas the remuneration of directors with supervisory functions (i.e., members of the audit committee) must mandatorily consist only of a fixed sum (this solution is often recommended for all non-executive directors).
Public companies are subject to enhanced corporate governance requirements on the approval of the remuneration of members of corporate bodies, in particular directors and executives. The latter remuneration should be structured in a way to allow it to be aligned with the interests of stakeholders and based on performance evaluation, and not to incentivise excessive risk assumption.
In this context, there are various recommendations in relation to performance evaluation criteria, such as the growth of a company and the value obtained for its shareholders, the adoption of a variable remuneration component payable on a deferred basis and remuneration caps. Clawback and recoupment provisions may be considered, particularly in the context of executive directors' agreements, although no express requirement exists regarding the matter (but without prejudice, in any event, to the statutory provisions on directors liability in relation to a company).
VIII Specialised regulatory regimes
Portugal has implemented the EU regulations and the European Banking Authority orientations on remuneration in the financial sector, which cover the remuneration of members of boards and also staff members whose professional activities have material impact on institutions' risk profiles. In these cases, it is necessary to implement specific remuneration policies that must follow certain guidelines and are subject to some restrictions, in particular regarding variable remuneration (see the EU Overview chapter).
There are also specific rules on the remuneration of directors and management board members of companies owned or controlled by the government, although executives under employment contracts are not covered by those rules.
Special measures that, during the financial crisis period (running from 2011 to 2015), imposed a salary reduction and a freeze on the career progression of civil servants and employees of companies owned or controlled by the state were eliminated in 2017 and 2018.
IX developments and conclusions
The tax regime and its constraints are likely to continue their influential role on how remuneration schemes are designed, particularly with regard to executives. Considering the high tax burden in Portugal, any change in income taxes for both individuals and companies will certainly influence how remuneration schemes are organised. However, as a new government will be formed by the end of the year, following the National Assembly elections in October 2019, any relevant reforms should only take place in 2020.
1 Bernardo Abreu Mota, Martim Morgado, Pedro Furtado Martins are partners and Ricardo Cunha Leal is a trainee at Campos Ferreira, Sá Carneiro & Associados – Sociedade de Advogados.