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Spain: Complexities of participation exemption and the CFC rules

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Law 11/2020 introduced an important change to the participation exemption rules

Gonzalo Gallardo of Garrigues explains why it would be advisable for taxpayers in Spain to re-examine their investment structures abroad.

The State Budget Law for 2021 (Law 11/2020) introduced an important change to the participation exemption rules provided in the Spanish corporate income tax legislation, and the Law 11/2021, on measures to prevent tax fraud, among others, amended the controlled foreign companies (CFC) rules in relation to corporate income tax (and individual income tax). These two changes take effect for fiscal years commenced on or after January 1 2021 and they are related to each other.

Spain is implementing participation exemption rules which affect dividends and capital gains coming from investees. Two types of requirements need to be met if the direct or indirect investee is a non-resident entity: relating to ‘participation’ (namely an ownership interest, at least 5% of the capital or equity must be held, directly or indirectly, for at least a year uninterruptedly); and to ‘taxation’ (it must be subject to and not exempt from a tax similar to Spanish corporate income tax at a nominal rate of at least 10% or it must be resident in a country with which Spain has signed a tax treaty with an exchange of information provision). 

The Spanish CFC rules consist, basically, of making a Spanish company be taxed in Spain on incomes (described in the Corporate Income Tax Law – and referred to below as ‘flowable’ income) obtained abroad by a foreign subsidiary. 

Broadly speaking, this occurs where (i) the Spanish company has at least a 50% interest (individually or jointly with another related individual or entity) in the equity, earnings or voting rights of a non-resident entity; (ii) the amount paid by that non-resident entity on those amounts of income in respect of a similar tax to Spanish corporate income tax is lower than 75% of the tax that would be charged in Spain; and (iii) all ‘flowable’ amounts of income obtained by the non-resident entity are together equal to or higher than 15% of its aggregate income. 

In one change, Law 11/2020 has reduced the exemption allowed for dividends and capital gains obtained by corporate income taxpayers, whereby any taxpayer receiving those amounts of income will have to include in their tax base 5% of the amount obtained. In another, Law 11/2021 has deleted the provision expressly stating that those dividends and capital gains were not treated as income qualifying for the CFC rules (they were not ‘flowable’ income).

It seems from this that, as a general rule, Spanish companies will have to include in their corporate income tax bases 5% of the dividends and capital gains obtained by their foreign subsidiaries (at least 50% owned) which are holding companies (at least 15% of that subsidiary’s aggregate income comes from dividends and capital gains from investees) where those amounts of income benefit from a full exemption from tax in their country of residence (lower therefore than 75% since in Spain, in principle, 1.25% would be charged – the result of multiplying the 5% in the tax base by 25%). 

That remark might be questionable, however, in that, because the 5% included in the tax base is in respect of “management costs related to the investments giving rise to those amounts of income”, it could be considered that the treatment applicable to dividends and capital gains in Spain, technically continues to be a full exemption and therefore similar to that for a foreign holding company. As mentioned in the preamble to Law 11/2020, Council Directive 2011/96/EU allows the member states to treat management costs as deductible, with a 5% limit in relation to the investment in the subsidiary. 

Therefore, in this full exemption scenario, it is not a case of those amounts of income being given ‘privileged’ treatment in the subsidiary’s country of residence or being ‘low taxed’, as would be expected from the essence of the CFC rules, it is instead a case of the tax cost in Spain on those dividends or capital gains being raised indirectly through the attribution of imputed non-deductible costs.

Law 11/2020 has imposed that ‘partial’ tax liability on 5% in all dividend distributions, even if they are in a chain in the same group in Spain, including in a consolidated tax group. Nevertheless, the CFC rules state that “a same amount of income may only be attributed once, regardless of the form and the entity in or at which it is disclosed”, and there is no provision allowing an exception in the case of these dividends or capital gains. 

Therefore, what we would have is that under the provisions in the law, only the dividends received by one of the entities in the chain could be attributed under the CFC rules. However, if it has been made clear in the law, because Law 11/2020 has stated as much, that despite the dividend or capital gain obtained by the non-resident having been attributed, and 5% of the attributed income being included in the tax base of the Spanish parent company, when the parent company receives this income in the form of a dividend, it will again have to include 5% of the received dividend in its tax base. 

It could be thought that this second taxation of the dividend is not consistent with the concept of a CFC, because the attribution is considered to take place to cancel the tax effect of ‘shifting’ those amounts of income abroad, and that income is treated for tax purposes as part of the taxable income of the company from which it was ‘shifted’, so any later distribution of that income should be irrelevant (i.e. not exist) for these purposes.

Lastly, it should not be forgotten that this is income obtained abroad by foreign companies. Because they expressly state as much, these rules do not apply where the entity is resident in another EU country or is part of the European Economic Area, provided that they carry on ‘economic activities’. This last element, involving whether or not the management of the shares conducted by a holding company is an ‘economic activity’, which may give rise to different interpretations, should be construed in light of how it is treated under EU law. 

They also contain a particular scenario, on which Spanish domestic law does not set out a specific limit, involving cases where foreign holding companies reside in countries with which Spain has signed tax treaties. Those treaties contain rules restricting the contracting states’ ability to tax certain types of income not obtained in their country, so applying the CFC rules to dividends and capital gains obtained by those companies should be analysed from the standpoint of those rules, which are in a category above the domestic legislation itself. 

The comments made above should be seen as a brief introduction to the new scenario created by these recent changes to the legislation and which already applies to Spanish groups with presence abroad or foreign groups with presence in Spain. The complexity of these rules and the implications that may arise might make it advisable to re-examine investment structures abroad.


Gonzalo Gallardo

Partner, Garrigues



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