Withholding taxes on net income – complying with EU and Spanish law

According to the Spanish non-resident income tax law (NRIT Law), the tax base for non-residents who obtain income in Spain without a permanent establishment is, in general, the gross amount of such income.

In the case of taxpayers who are resident in the EU (without a permanent establishment), however, a special rule was introduced in 2010. According to this rule, when determining the tax base, expenses can be deducted, if there is a direct relation between the expenses and the income obtained in Spain and a direct and inseparable economic link to the activity performed in this territory (a special rule introduced into the NRIT Law to bring it into line with EU law).

However, the rules on withholding taxes on income paid to non-residents expressly forbids the deduction of such expenses when calculating the withholding tax base.

This difference in treatment between the final amount of non-resident income tax and the tax withheld often results in taxpayers paying an amount of tax which exceeds the sum ultimately due. Also, it should be remembered that non-residents are not obligated to file a tax return if tax has been withheld, which is consistent with the fact that withholding and taxation rates are equivalent. This should simplify the formal obligations for non-residents, yet, due either to the non-resident's lack of awareness of their rights as an EU resident, or to the inconvenience of having to file a self-assessment for taxes refundable, it may lead to the excess tax withheld becoming a definitive cost.

The National Appellate Court (NAC) has analysed this issue and has recently handed down three judgments (the most recent dated February 13, 2023). It concludes, clearly and categorically, that the fact that expenses cannot be deducted when calculating the withholding tax base is out of step with EU law.

In these judgments, the court analysed the tax treatment of payments for the licensing of software. After concluding that these payments are royalties and not business profits, the court considered whether the withholding rate on such royalties should be applied to the gross amount of the royalties or applied following the deduction of expenses directly related to the activity. The court ruled in favour of the latter option.

The NAC’s reasoning is of considerable interest, among other reasons, because it deviates from the position adopted by the Supreme Court in the past: namely in its judgment of February 9 2016. The NAC took into account later rulings of the CJEU, such as its judgment of July 13 2016 in the Brisal case, stating that: “unfavourable tax treatment contrary to a fundamental freedom cannot be regarded as compatible with EU law because of the potential existence of other advantages”.

Furthermore, the NAC highlights that the European Commission, in its package of infringement decisions of October 2021, included its decision to initiate infringement proceedings against Spain. In the proceedings, the Commission asked that Spain adapt its rules on withholding taxes at source on royalties received by non-residents. And on this basis, the NAC concludes that, given the primacy and direct application of EU law, when calculating the tax base for withholdings and prepayments on royalties paid to non-residents (resident in the EU), expenses directly linked to their activity should be deductible.

This is undoubtedly good news and, although it will more than likely lead to much debate on which expenses should be admissible for these purposes, it paves the way for claims seeking refunds in this respect.