Spain: Changes to the Spanish participation exemption regime
Luis Manuel Viñuales
Having overcome – or, at least, that's what Spaniards hope – the toughest economic crisis in recent Spanish history, the government has started working on a major tax reform, centred predominantly on corporate and personal income taxes. The reform is expected to come into force on January 1 2015 and, therefore, the preliminary Bills are likely to undergo changes during its passage through parliament. One of the main aspects of the corporate income tax reform which has already been published and which is unlikely to undergo much change during the legislative process is the Spanish participation exemption regime, aimed at avoiding instances of international double taxation under existing law.
Until now, Spanish resident entities enjoyed a tax exemption on dividend income and capital gains derived from qualifying participations in non-resident entities. The main requirements to be met were i) a minimum 5% shareholding during one year, ii) an active-income test, and iii) a subject-to-tax test, which was deemed to be met if the non-resident entity was resident in a country with which Spain has concluded a tax treaty. Not surprisingly, the European Commission questioned the compatibility of the participation exemption regime with EU law, as the rules for avoiding domestic double taxation were very different from the exemption regime described above.
Thus, the Spanish Administration has decided to, in some manner, extend the regime to dividends and capital gains derived from Spanish resident entities, while at the same time introducing some significant changes with respect to the existing participation exemption.
One of the main changes is the elimination of the tax treaty safe-harbour for meeting the subject-to-tax test and the introduction of a minimum 10% nominal tax requirement for the non-resident affiliate. This change would make it advisable to review existing structures in which the non-resident affiliate is resident in a tax treaty country but enjoys tax holidays or is subject to a territorial tax regime, as it is unclear whether the participation exemption would apply in those cases under the new rules being proposed. A similar review should be made of structures of Spanish companies with branches in those jurisdictions, as the subject-to-tax requirement for the foreign permanent establishment's income to be tax exempt in Spain is the same (that is, a nominal 10% tax would be required).
A second change to be noted is that the 5% shareholding would not be required if the acquisition cost of the holding reaches a €50 million ($67 million) threshold. This change is relevant for foreign-securities holding entities for which the participation exemption regime applied if the cost of the holding reached a much lower threshold: €6 million. As of today, the preliminary Bill does not include a transitional regime or a grandfather clause applicable to existing structures.
Although, in principle, the active-income test is not included as such in the preliminary Bill, the participation exemption will not apply where the corporate purpose of the non-resident entity is the management of securities (or holdings in other entities) or of real estate assets. This restriction, which could have relevant adverse implications in various cases (for example, chain of holding companies or companies leasing real estate without their own employees), is likely to be replaced during the passage through parliament by a general restriction on the application of the exemption in respect of non-resident entities that do not carry out an economic activity as defined in the preliminary Bill. This amendment, if approved, would extend the participation exemption to holding companies, provided that they have the necessary human and material resources to carry out the activity, and to real estate companies, if those resources are available at any other group entity.
Lastly, as a clear influence of the OECD BEPS action plan, the preliminary Bill provides that dividends which result in a tax deductible expense at the distributing entity would not be tax exempt in Spain.
In short, the proposed changes should be closely monitored in the following months while they are being discussed in parliament, and a thorough review of structures that rely on the Spanish participation exemption regime is essential to ensure that they continue to comply with the new requirements.
Luis Manuel Viñuales (email@example.com), Madrid
Tel: +34 91 514 52 00