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Spanish tax legislation found to infringe the free movement of capital

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Jorge Moreira Peláez of Garrigues reports on the National Appellate Court ruling that tax legislation failed to safeguard the free movement of capital for non-resident legal entities.

In judgments led by Garrigues and delivered on March 31, May 5 and May 10 2023 (appeals No. 736/2019, 758/2019 and 701/2019), the National Appellate Court has held that Article 24.6 of Legislative Royal Decree 5/2004 of March 5 2004, approving the revised Non-resident Income Tax Law, infringed the free movement of capital recognised in Article 63 of the Treaty on the Functioning of the European Union, when it retained the wording prior to its reform by Law 26/2014 of November 27 2014.

Paragraph 6 was originally added to Article 24 of the Non-resident Income Tax Law by Law 2/2010 of March 1 2010, to, as its title expressly mentioned, “adapt it to EU legislation”.

Specifically, this adaptation consisted of allowing any non-resident individuals and legal entities operating in Spain without a permanent establishment to deduct certain expenses from income obtained in Spain; in particular, the same expenses which were deductible for resident individuals under the Spanish personal income tax rules.

As a result of their assimilation to individuals, the reform was insufficient to safeguard the free movement of capital from the standpoint of non-resident legal entities.

The National Appellate Court’s ruling

Now, the National Appellate Court, in line with Garrigues’ submissions and conversely to earlier pronouncements by the tax authorities and by the Central Economic-Administrative Tribunal, has confirmed the insufficiency of the above reform.

The court has declared that the initial wording of Article 24.6 of the Non-resident Income Tax Law – which prevented, among other non-resident income taxpayers, foreign insurers from deducting the same expenses as could be deducted by Spanish insurers to calculate their tax burden in respect of taxable income derived in Spain – was contrary to EU primary legislation.

In this sense, the National Appellate Court has completely endorsed Garrigues’ argument that, in spite of Law 26/2014 not yet being in force in the period to which the claim related, foreign insurers were entitled to deduct from the income they received – in the case at issue, dividends paid by Spanish companies – the profit-sharing technical provision recognised to allocate a share in this Spanish-source financial income to their life assurance policyholders and beneficiaries. This practice is characteristic of such types of insurance-savings products that are popular in some European countries.

Moreover, the National Appellate Court also rejected the Spanish tax authorities’ position, which, irrespective of the applicable legislation, denied the existence of a direct link between income derived in Spain and the expenses in respect of such technical reserves recorded by foreign insurers in their countries of residence. And it did so in the same way, and with the same legal reasoning, as it previously adopted in a judgment dated October 28 2016 (appeal No. 13/2013) to uphold the same ability to deduct expenses based on the same EU principle, then with respect to provisions recorded for unit-linked insurance policies.

The outcome of this is that the National Appellate Court has ruled that the Spanish tax administration must reimburse any undue tax payment to the claimant insurer, plus late-payment interest for the period running from when this excessive tax burden was withheld by the payer from the gross amount of that income.

A note of caution

Despite the victories obtained at the National Appellate Court, which will foreseeably be confirmed in the appeals Garrigues has filed on behalf of other clients, this firm’s experience in this type of dispute makes it fear that the Spanish tax authorities will be reluctant to accept without question any refunds of tax overpayments that foreign insurers start requesting on the back of this case law. In this respect, the provision of correct and complete proof will continue to be a determining factor to prevent tax authorities from denying refunds, or make it difficult for them to do so, based on failure to evidence the entitlement to the right.

Moreover, these pronouncements are not a guarantee that the tax authorities will follow this case law to solve other tax discrimination situations, which continue to arise against non-resident insurers and pension funds (it would, for example, be the case for all undertakings resident outside the EU, since Law 26/2014 only benefits EU residents).

Nevertheless, it is to be hoped that the National Appellate Court or other courts of justice deciding on these cases will continue to consider to be correct the arguments Garrigues will submit to defend its clients’ rights and interests.

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