On 1 December 2022, the new so-called “Start-up Law” was passed by the Spanish Parliament. The Law aims to foster the start-up ecosystem in Spain establishing a specific regulatory framework that supports the creation and growth of start-ups. Additional information can be found here.
Amongst the new measures is one that follows a path open under the income tax rules applicable to tax residents of the Spanish provinces of Guipúzcoa, Vizcaya, Álava and Navarra: in these four provinces, and depending on the specific province of residence, carried interest income would be taxed as employment income (benefiting from a 50% allowance) or as a capital gain (taxed at low tax rates). Now, for the first time, the (federal) Spanish Personal Income Tax will provide guidance on the tax treatment of the so-called carried interest income for directors, employees and / or managers of specific closed-end alternative-investment funds (such as Spanish and EU venture capital (capital riesgo) entities or funds).
The bad news: As it was inferred from specific tax rulings issued by the Spanish tax authorities, carried interest income will be taxed as employment income, subject to marginal tax rates of, currently, up to 54%.
The good news: A 50% allowance may apply, subject to certain requirements, reducing the effective tax rate to a maximum rate as low of 22.5%!
Who qualifies? Any Spanish resident individual who is a director, employee and / or manager of specific closed-end alternative-investment funds (as listed in the “Start-up Law”), or of their management entities or other group entities, and which hold shares or other rights, including success fees, which grant special rights over the return of eligible closed-end alternative-investment entities.
Which are the eligible closed-end alternative investment entities?
- Spanish venture capital entities
- European venture capital funds
- European social entrepreneurship funds
- European Long-Term Investment Funds
- Other entities analogous to the above
Which other requirements must be met?
- The special economic rights of the carried interest holder must be conditional on the rest of the fund’s investors (of the entity or closed-end alternative investment fund) reaching a minimum guaranteed rate of return on the investments made by the closed-end alternative-investment entity – a rate of return that must be defined in the articles of association or regulations of the investment entity.
- The special shares or carried-interest rights must be kept by their holder for a minimum of five years, unless they are redeemed or become “ineffective” or are totally or partially forfeited as a consequence of a change in the managing entity or the holder dies before the end of that period. In these cases, the special shares or carried-interest rights must have been kept uninterruptedly up to the point when the relevant event occurred.
Great. May I then set up my carried interest vehicle in Jersey or the Cayman Islands?
No! The 50% tax allowance will not apply when the special economic rights derive directly or indirectly from an entity resident in a country or territory that is classified as a non-cooperative jurisdiction (i.e. a tax haven) for Spanish tax purposes, or in a country or territory with which Spain has not entered into a tax information exchange agreement.
What’s the verdict on the new rules?
There are some open questions, for instance, how do you determine which are those other entities “analogous” to venture capital entities, European social entrepreneurship funds or ELTIFs? Would a LP of the venture capital fund’s management entity, and which is not a director, employee or manager, be entitled to the 50% rebate? Which entity should withhold the tax on account of the Personal Income Tax of the carried-interest holder? Would the acquisition of the special shares or carried-interest rights generate any taxable income for the acquirer (director, employee and / or manager). It seems, it should not, right? What does minimum “guaranteed” return for the “real” investors mean? Is this even allowed, to guarantee a return? It may be the case that the legislator meant to make a reference to carried interest being payable once a minimum return has been paid to the investors, correct?
But the new rules are extremely good news, a tax framework which provides much needed legal certainty on the taxation of carried interest, at a very reasonable tax cost, as well.