UK resident lenders and UK branches of EU/EEA lenders were eligible, until the end of the transition period on December 31 2020, for the exemption applicable to interest income. The exemption was granted by the Spanish domestic legislation to EU/EEA resident lenders as long as they were acting through branches located in the EU/EEA.
Moreover, the Spain–UK tax treaty did not (and does not) allow the ‘source state’ to tax interest paid by a resident in the other contracting state (the taxing power is attributed entirely to the state of residence of the recipient of the interest).
This means that, even in the current post-Brexit scenario (there are no agreements concerning direct taxation between the EU and the UK), UK resident financial institutions that have Spanish debtors in their loan portfolios, should not be affected, not simply as a result of the customary gross-up clauses, but also due to the tax treaty itself.
Consequently, they will not incur any tax/withholdings on the interest payments made by Spanish resident borrowers, and those institutions will normally retain their status of ‘qualifying lender’ according to the standard definition of this term present in most of the loan agreements currently in the market.
However, EU financial institutions operating in the UK through a branch will not be able to apply the Spanish domestic exemption or the treaty 0% withholding tax (WHT) to the interest they collect from Spanish borrowers, mainly because they do not have their own legal personality separate from that of their head office and they will not have access to the treaty of the jurisdiction where the branch is located but the one of its head office.
As a result, the main consequences of Brexit for this type of structures could be as follows:
The domestic exemption will no longer be applicable, due to the law allowing the exemption only for payments made to entities resident in the EU/EEA, or to permanent establishments located in the EU/EEA of a resident in the EU/EEA. Therefore, branches not located in the EU/EEA (even if they belong to entities resident in the EU) or EU/EEA branches of non-EU/EEA resident entities will not be able to claim the exemption; and
To determine the taxing power for the income obtained, branches have to apply the tax treaty with the jurisdiction in which the head office is resident. So, obviously, if the tax treaty for the head office is that with the UK or another similar treaty providing that Spain cannot tax the payment of interest, Brexit will not create an adverse effect, unlike what will happen if the tax treaty grants taxing power (even if it is limited to a reduced WHT rate) to Spain.
The same conclusion was pointed out by the Directorate General for Taxes (DGT) in a binding ruling dated September 26 2019, in which it concluded that interest derived from a loan granted to a Spanish entity by a UK branch of an Irish financial institution should (after Brexit) be taxed in Spain (subject to the limits determined in the Ireland–Spain tax treaty, 10% in this case). This ruling was issued in 2019 when the exemption under Article 14.1.c) of the Nonresident Income Tax Law was available for UK branches, since the UK was still a EU member state, but the ruling already anticipated the tax consequences for the structure derived from Brexit (2021 onwards).
Although it would be possible to analyse whether the Spanish DGT’s interpretation might breach any principles of EU law (e.g. freedom of capital movement) and/or the UK treaty non-discrimination clause, if an entity finds itself in a scenario like that described, it will be necessary to review the specific clauses in the facility agreements to check the exact provisions in this respect and examine on a case-by-case basis all the existing available legal alternatives for reducing this impact.
Ramón Tejada
Partner, Garrigues
José Ignacio Ripoll
Principal associate, Garrigues
E: jose.ignacio.ripoll@garrigues.com
