March 2005 was a productive month in tax terms. While the Spanish minister of finance made public the main guidelines for the tax reform announced by the Socialist Party, it was also known that an administrative tribunal ruled on the meaning of the anti-abuse provision relating to dividend distributions to EU parent companies.
With respect to tax reform, the announcement has not been considered as the complete overhaul of the tax system which certain tax experts expected.
In the first place, the reform will be limited, for the time being, to the personal income tax, and will take place as from 2007, instead of 2006 as was originally predicted. Although not much detail has been provided, some guidelines will be followed:
long-term capital gains will be taxed at 18% (now 15%), but with a de minimis exemption;
the tax scale will be comprised of only 3 or 4 brackets (now 5) and the top marginal rate (now 45%) will be reduced; and
some tax credits and allowances (acquisition of permanent home and contributions to pension funds for example) will be readjusted in order to make them more accessible to low-income earners.
The government's intention is to introduce the reform into parliament by the last quarter of 2005, so that it is debated widely during 2006.
As for the Corporate Income Tax, its reform is still under study and there is no fixed date for completion yet. No details have been anticipated either.
Dividend distributions to EU parent companies
The Tribunal Económico-Administrativo Central (the Central Economic-Administrative Tribunal) has issued an important ruling on dividend distributions to EU parent companies.
Since 1992 Spain has made use of the possibility to introduce an anti-abuse provision in the implementation of the Parent-Subsidiary Directive, in order to avoid Directive shopping. Thus, the exemption applicable to dividend distributions is not available where the majority of the voting rights of the EU parent are held, directly or indirectly, by non-EU residents. However, there are three safe harbours:
the EU parent is in fact conducting a business directly linked to the Spanish subsidiary's business;
the EU parent's purpose is the management of the Spanish subsidiary through an adequate structure of human and material means; or
evidence can be given that the EU parent was incorporated for sound economic reasons and not only to benefit from withholding tax exemption.
Although these safe harbours have not been paid much attention in the past, it was an accepted issue that a holding company with substance enough could always qualify either under first or second points above. This conception has been shaken by a new ruling.
In the case at hand, a Spanish company was a wholly-owned subsidiary of a Dutch company, which carried on R&D activities for all its subsidiaries. This Dutch company was in turn a wholly-owned subsidiary of another Dutch company, whose only shareholder was a US Company.
The tribunal ruled that the withholding tax exemption did not apply since:
the activities of the Dutch parent were not sufficiently related to the activities of the Spanish subsidiary; and
the Spanish subsidiary had expenses related to computing, accounting and other management activities.
The third safe harbour was not even addressed by the tribunal.
This decision seems to adopt a too narrow approach towards parent-subsidiary relations. In the first place, the law does not require a certain degree of relationship between the activities of the two companies, but just a relationship. Secondly, the fact that the Spanish company carried out part of its own management does not mean that the Dutch company did not manage its investment in the Spanish company with its own means. And, lastly, the "sound economic reasons" safe harbour deserved better attention from the tribunal.
José Palacios (jose.palacios@garrigues.com) and Álvaro de la Cueva (alvaro.de.la.cueva@garrigues.com) Madrid
