In our post published last November, we mentioned several tax measures included in two key draft bills which could affect foreign investors and individuals with economic ties to Spain. Both laws have been approved by Congress (i.e. the 2021 General State Budget Bill and the Law on Measures to Prevent and Combat Tax Evasion) and most of the changes are already in force. As anticipated, the reform generally increases taxation and complexity around compliance.
In addition to the measures included in the draft bills, the following two key changes were introduced in the course of the parliamentary process. First, the application of the 1% corporate income tax (CIT) rate to the Spanish “SICAV”, which has traditionally been an attractive vehicle for high net worth individuals and families in Spain to make investments, is now only applicable to those SICAVs in which each of the 100 required shareholders hold a minimum investment of EUR 2,500. Secondly, following EU case law, the right of non-Spanish tax resident individuals to apply the most favourable regional legislation on Inheritance and Gifts Tax has been recognised, putting an end to the historic discrimination described in our post published last March.
The combined effect of some of the approved measures includes certain consequences that may not be apparent at first glance. The limitation of the Spanish participation exemption regime, together with the extension of the ‘controlled foreign company’ (CFC) regime to foreign holding companies, might result in specific international structures becoming inefficient from a Spanish tax standpoint.
According to the Spanish CFC regime, income obtained by a non-resident entity can be attributed to its Spanish shareholders (both entities and individuals) provided that they have a majority stake, and the non-resident entity is taxed less than 75% of the corporate income tax that would have been paid in Spain. These requirements remain unchanged. However, the CFC regime had traditionally excluded the attribution to the Spanish shareholder of dividends and capital gains obtained by the foreign entity from subsidiaries in which it held at least 5% (and had sufficient human and material means to administer its interests in such subsidiaries), leaving foreign holding companies outside the scope of the CFC rule. This exclusion has now been removed.
This amendment by itself would have no major consequences if it was not accompanied by the changes made to the Spanish participation exemption regime (i.e. article 21 of the CIT Law). Historically, this regime provided a full exemption for dividends and capital gains obtained by Spanish resident entities. However, pursuant to the 2021 General State Budget Bill, the Spanish participation exemption is now limited to 95% of the amount of the dividends and capital gains (instead of a full exemption). As a result, the dividends or capital gains obtained by the foreign entity, which may be fully exempt in the jurisdiction of tax residence (under the corresponding double taxation relief), would be subject to 1.25% effective CIT taxation had the company been a Spanish resident entity. In many cases, this will result in the foreign entity being taxed less than 75% of what would have applied under Spanish legislation, thus triggering the application of the CFC rules.
This interpretation of the amendments, which is in accordance with the literal wording of the law, makes it highly advisable to carefully review all international investment structures involving a Spanish holding entity and foreign sub-holding entities, as they might no longer be tax efficient.
In particular, this may affect foreign-based multinational corporations which have fully or partly invested through a Spanish ETVE. In the meantime, we hope that the Spanish General Tax Directorate helps to clarify the effects of this new legislation and provide legal certainty to international investors.