The European Commission's decision on the aid scheme granted to companies of the Madeira Free Zone —Regime III, which finds that the aid was granted unlawfully due to noncompliance with the conditions underlying the tax benefits in question—has been made public, thereby obligating the Portuguese government to recover the amounts unduly granted and the resulting interest. The Portuguese government has initiated the procedure to notify the aid deemed to have been improperly granted and subject to repayment.

Tax Benefits of the Madeira Free Zone and the European Commission’s Decision 

The Madeira Free Zone was established by the Decree-Law No. 500/80 of October 20, with the aim of promoting the economic and social development of the Autonomous Region of Madeira by offering various tax incentives to companies that set up operations there.

Over the years, four tax regimes applicable to entities authorized to operate in the Madeira Free Zone have been established, with Regimes III and IV currently in effect. Under both regimes, the thresholds for taxable income—to which the reduced rate applies—are determined based on the number of jobs that eligible entities maintain each year.

Requirements 

Two of the requirements that entities holding a license in the Madeira Free Zone must meet in order to qualify for the tax benefits provided by law—and thus benefit from a reduced tax rate—are: 

• job creation, 
• that the profits eligible for the tax reduction be related to activities actually and physically carried out in Madeira.

It should be noted that the number of jobs created or retained each year is the key factor in determining the maximum limits on the tax base to which the reduced rate applies.

Maximum Limits

Income earned by entities authorized to operate in the Madeira Free Zone may be subject to corporate income tax at a reduced rate, which has been set at 5 % for the years 2013 through 2027.

However, the benefit is limited by the application of caps on the taxable income to which a reduced rate applies, based on the number of jobs that the beneficiary entities maintain each year, under the following conditions:

• 2.73 million euros for the creation or retention of one to two jobs; ;

• 3.55 million euros for the creation or retention of three to five jobs; ;

• 21.87 million euros to create or retain 6 to 30 jobs; ;

• 54.68 million euros for the creation or retention of 51 to 100 jobs; and

• 205.50 million euros through the creation and retention of more than 100 jobs.

The European Commission's investigation 

Given the conditions governing access to tax benefits, and in order to monitor them, the European Commission conducted an investigation in which it concluded:

That the number of jobs taken into account by Portugal in calculating the amount of aid under the scheme included jobs created outside the Madeira Free Zone and even outside theEU; that part-time work hours were included in full-time work hours; and that members of the board of directors were counted as employees in more than one company benefiting from the scheme. 

In this context, and following the European Commission’s decision of December 4, 2020—which was not published until May 2022— the Portuguese government—through its customs and tax authority—must notify all companies that may have unduly benefited from said state aid.

Thus, if notified to that effect, legal entities that are unable to prove that their taxable income or the jobs created are linked to activities actually carried out in the region, that is, if they have not actually contributed to the region’s development, may, in theory, be required to repay the amounts corresponding to the tax benefit granted.

Some developments 

The Portuguese Tax and Customs Authority (Autoridade Tributária e Aduaneira) has begun the process of complying with the European Commission’s decision by notifying the entities identified as having received this state aid, allegedly in an improper or illegal manner.

As a first step, these taxpayers may (and should) exercise their legal right to be heard and, naturally, challenge the figures used to adjust their taxable income as a result of the European Commission’s decision, after having determined that they meet the necessary conditions for receiving the benefits in question.

Subsequently, if the claim is found to be unfounded, corporate income tax assessment notices may be issued, which may also be contested.

It should be noted that the amounts in question will consist of the adjustment to the IRC (principal) and the respective interest calculated from the date the aid was made available until the date of its actual recovery.

It should also be noted that, although the Portuguese government (through the tax and customs authority) is complying with the European Commission’s decision, it has appealed that decision before the Court of Justice of the European Communities.

The European Union, arguing in essence that:

• The MFZ scheme is part of the overall structure of the Portuguese tax system, and these measures should be considered general measures rather than state aid measures; ;
• The program is not selective, because the measure does not favor certain companies or the production of certain goods; ;
• If the MFTZ program involved aid, it should be considered existing aid; ;
• "Conducting business in Madeira" should mean only that the business is conducted in Madeira through a registered office and a management and decision-making center, without the need for human capital; ;
• There can be no geographical limitation on the activities, and this cannot mean that they must be limited to the territory of Madeira, as this restrictive interpretation is not consistent with the Union’s established case law on the center of main interests; ;
• EU law does not provide for a uniform definition of «employment contract,» «employment relationship,» «worker,» or, consequently, “position.”.