Regulations enacting the special regime for individuals who become Spanish tax residents came into force in June 2005. The regime had been put in place from January 1 2004, but was pending implementation through the corresponding regulations. Full development of the regime is of great importance for multinational groups that transfer employees to Spain under tax equalization arrangements since it could have a substantial impact on their profit & loss accounts.
Individuals who become Spanish tax residents can elect to be subject to personal income tax or to non-residents´ income tax if some requirements are met. The election also implies taxation as a non-resident for net-worth tax purposes.
The procedure to make the election was to be set by the Ministry of Finance. This has been established through Royal Decree 687/2005 and Ministerial Order 1731/2005, which apply from January 1 2004. The royal decree goes far beyond the establishment of a procedure and develops substantial aspects of the regime.
The requirements to make the election are as follows:
The individual cannot have been a tax resident of Spain in the 10 years before their transfer to Spain.
Transfer to Spain must be the consequence of a working contract. The individual may enter into a working contract with a Spanish employer, be appointed director thereof or be transferred by a foreign employer through an expatriation letter.
Work must be effectively performed in Spain. Work may be partially performed outside Spain if the salary for work abroad does not exceed 15% of the total salary of the year. If the working contract provides that the individual performs functions in another group company, this threshold goes up to 30%.
Work must be done for a Spanish resident company or for a permanent establishment of a non-resident company.
The salary income cannot be exempt from non-residents´ income tax.
The election applies in the year in which the individuals become tax residents and for the following five years. The impact of it is far-reaching. Residents are taxed on their worldwide income and net worth at progressive rates that go up to 45% and to 2.5%, respectively. Capital gains may be taxed at a flat 15%. Non-residents are taxed only on Spanish-source income and net worth. Tax rates on income are flat, that is, 15% (interest and dividends), 25% (general) and 35% (capital gains). Net-worth tax rates are the same as those of residents.
The election must be made in the six months after the commencement of activities in Spain and can be subsequently waived. Individuals that became tax residents in 2004 or 2005 before publication of the royal decree could have made the election up to August 11 2005. Once the election is made, waiver or non-compliance with all requirements precludes a new election.
Certificates attesting to tax residence within the meaning of a tax treaty are only issued to these individuals if reciprocity with the other state exists.
This regime can create substantial tax savings, but does not always result in a more favourable treatment. Non-residents´ taxation is more onerous in some areas, such as capital gains (the EU Commission has recently started a procedure against Spain for this). A case-by-case analysis is necessary to ascertain when election and, eventually, waiver, are advisable.
José Ignacio García Muniozguren (jose.ignacio.garcia@garrigues.com), Madrid
