Japan and Spain have signed a new tax treaty in connection with income taxes and to prevent tax evasion and avoidance (the “Treaty”). The Treaty introduces major changes to the former treaty, which dated back to 1974, and will result in elimination or reduction of taxation at source.
The new Treaty includes the OECD and G-20’s recommendations from Project BEPS and is in line with the 2017 OECD Model Tax Convention and the new international standards deriving from the so-called Multilateral Instrument. It introduces anti-abuse rules and establishes a favourable legal framework to promote direct investment and commercial and economic transactions between both countries, in particular for multinational groups.
It is worth noting that the Treaty’s scope is limited to income taxes and, unlike other tax treaties, it does not cover wealth taxation.
The Treaty significantly reduces or shelters the taxation of dividends, interest and royalties at source:
- Dividends: 5% withholding unless the beneficial owner of the dividend (i) is a company that has directly or indirectly held at least 10% of the voting rights in the payer of the dividend for 12 months; or (ii) is a “well-known pension fund”. In the latter case, the dividends will not be subject to withholding tax at source. Moreover, the Treaty establishes a reduced rate 10% withholding for cases of hybrid asymmetries (i.e. dividends are deemed as deductible for the company paying them out).
- Interest: not subject to withholding tax. However, a 10% withholding rate applies to interest calculated with reference to revenue, sales, income, benefits or other property income generated by the debtor or a related person (e.g. profit-participating loans).
- Royalties: not subject to withholding tax.
However, these benefits do not apply (i) if the company receiving the payment is excluded because the limitation-on-benefits clause applies, or (ii) the payments are not received by their “beneficial owner”.
Moreover, the Treaty updates the taxation of capital gains derived indirectly from the transfer of real estate: any capital gains obtained by a resident of a signatory State after transferring shares or other interests in a company, partnership or trust can be taxed in the other signatory State if, at any time within the 365 days preceding the transfer, over 50% of the value of the interests derives directly or indirectly from real estate located in that other signatory State. Capital gains derived from transfers of rights that directly or indirectly entitle their owner to use the real estate may also be taxed at source.
Conversely, the Treaty includes a specific provision for individuals who face the so-called exit tax on unrealised gains following a change of residence. In these cases, the other signatory State will carry out the corresponding adjustment over the capital gains obtained when the properties are transferred to avoid double taxation, if needed.
The Treaty includes a new provision under which income obtained by a passive investor resident in Spain as a result of a Tokumei Kumiai (a sort of silent or anonymous partnership) can be taxed without limitation under Japanese regulations, if the income comes from Japan and is deductible when the taxpayer’s taxable income in Japan is calculated.
Also worth noting, because it is unique in relation to other treaties Spain has signed, the Treaty introduces a limitation-on-benefits clause (known as the LOB clause) under which specific benefits of the Treaty are limited to persons that meet the criteria set out in the LOB clause.
In this regard, multinational groups must be especially careful with holding entities, entities that carry out management and financing activities for the group (including cash pooling), and entities that manage investments or hold or manage intangible assets, as these economic activities are not exempt from the application of the LOB clause unless they meet the requirements to be considered a qualified person.
The Treaty also includes a general anti-abuse clause (the Principal Purpose Test or PPT rule) and two specific anti-abuse clauses, one against three-way transactions with permanent establishments and another for cases of taxation on a remittance basis.
Finally, although the Treaty is expected to enter into force on 1 May 2021, most of its major changes (in particular, the reduced rates or exemptions on withholding taxes at source) will be effective as from 1 January 2022.