A 22 December 2020 ruling from the Spanish Supreme Court (the Ruling) has confirmed that taxing non-Spanish resident pension funds on dividends paid by Spanish-resident companies is contrary to the free movement of capital within the EU.

Spanish Non-Resident Income Tax Law (NRIT Law) provides for an exemption at source for dividends paid by Spanish companies to pension funds established within the European Union (EU) or the European Economic Area (EEA).

At the time the dividends examined by the Ruling were paid and taxed, NRIT Law did not provide for an exemption on the, then standard, 18% dividend withholding tax on dividends paid to pension funds based in the EU/EEA or elsewhere. However, Spanish pension funds were subject to a Corporate Income Tax (CIT) rate of 0%, which implied that non-Spanish resident pension funds were discriminated vis-à-vis Spanish pension funds.

Functioning of the withholding tax

NRIT Law provides for a withholding tax on dividends that is not strictly a payment on account. Indeed, a refund of the excess is simply not feasible since by virtue of law the amount charged as withholding always matches the final tax payable. As a result, pension funds not established within Spanish territory or the EU or EEA may be discouraged from investing in companies resident in Spain.

The parties’ allegations

The Ruling was issued after the Spanish Tax Administration denied a Canadian pension fund its request for a refund of the withholding tax. According to the Canadian pension fund, the difference in tax treatment between Spanish and Canadian pension funds was exclusively based on tax residence, which made it contrary to the free movement of capital established in Article 63 of the Treaty on the Functioning of the European Union (TFEU).

For its part, the Spanish Tax Administration stated that the Canadian pension fund could not be treated equally to a Spanish pension fund, since it was not equivalent to Spanish pension funds. Additionally, it would not be entitled to the tax relief granted by NRIT Law to EU or EEA-based funds since access to information regarding Canadian funds is not identical to access to information among EU / EEA Member States.

The ruling

The Spanish Supreme Court recalled that a difference in tax treatment between Spanish and non-Spanish resident pension funds is not contrary to the free movement of capital within the EU if (i) it is not exclusively based on tax residence, and (ii) the domestic legislation provides for a mechanism that enables the equal treatment of pension funds with equivalent circumstances.

According to the Ruling, the Spanish Tax Administration could have determined by means of the exchange of information clause (EOI clause) contained in the Tax Treaty in force between Spain and Canada whether the Canadian pension fund complied with the requirements set for Spanish and EU or EEA-based pension funds to be exempt from tax on dividends paid by Spanish companies.

However, Spanish domestic law did not establish a mechanism by which non-Spanish resident pension funds could evidence if they were, for these purposes, subject to the same or similar circumstances as Spanish-resident pension funds, which implied that non-Spanish resident pension funds were simply not able to obtain tax relief on dividends paid by Spanish companies.

As a result, the difference in tax treatment for dividends paid to pension funds was contrary to the EU principle of free movement of capital since it proved to be based exclusively on the tax residence of the Canadian pension fund.

Practical issues 

A very similar ruling was issued by the Spanish Supreme Court on 13 November 2019 regarding dividends distributed by Spanish companies to non-Spanish resident investment funds. While Spanish resident investment funds are taxed at a 1% CIT rate, equivalent non-Spanish investment funds were taxed under the former NRIT Law at a 18% rate, except where the relevant tax treaty established a lower tax rate.

Note that, prior to 2011, EU and EEA investment and pension funds were excluded from the tax exemption. It was not until the Court of Justice of the European Union held that this difference in tax treatment was discriminatory that NRIT Law was modified.

Now NRIT Law should be amended to grant non-Spanish resident investment and pension funds the exemption from withholding tax if they meet the same requirements as are set for entities resident in Spain. Meanwhile, non-Spanish resident pension funds could request a tax refund from the Spanish Tax Administration.