Spain’s new rules on controlled foreign companies could have a major impact on non-resident holding companies, and in particular those residing in a country outside the EU and EEA due to the controversial implementation ( and, in our opinion, incorrect) of the ATAD directive in Spain. The new wording could give rise to the application of the CFC rules to situations in which it is clear that there is no artificial relocation of income to a territory with low or no taxation, a potential double taxation on 5% of dividends and capital gains (1.25% effective tax in Spain triggered twice) obtained by foreign holding companies even in cases where the dividend allocated to the Spanish shareholder is distributed during the same period tax, or even the exclusion of foreign holding companies from the exemption from Spanish participation on capital gains.
Which is new?
Law 11/20211, which implements Council Directive (EU) 2016/1164 of 12 July 2016 (known as âATADâ)2 in Spain, introduced several changes to Spanish regulations3 Rules relating to foreign companies (“SEC”) with effect from 1 January 2021 which will have an impact not only on foreign operating subsidiaries or permanent establishments generating “passive income” but also on non-resident holding companies, and in particular holding companies resident in a country outside the European Union (âEUâ) and the European Economic Area (âEEAâ).
Until Law 11/2021, the Spanish CFC rules did not have a major impact on Spanish companies with a majority stake in foreign holding companies because the CFC regime expressly excluded dividends and capital gains obtained. by foreign holding companies from â¥5% ranking subsidiaries of the “passive income” imputation rule, if the foreign (first rank) holding company had (at the level of the group of companies) the “substance” corresponding (i.e. human and material resources) to manage participation.
However, the removal of this exception, as well as the reduction from 100% to 95% (i.e. implying an effective tax of 1.25% in Spain) of the Spanish participation exemption applicable on dividends and capital gains of non-Spanish subsidiaries, will imply that Spanish companies may be obliged to recognize, under CFC rules, an amount of 5% of dividends and gains obtained by foreign holding companies if such dividends or gains have been subject to tax at a rate lower than 75% of the Spanish corporation tax (“CIT”) (i.e. 1.25%)4.
In addition, the (in our opinion incorrect) implementation of the ATAD Directive in Spain has given rise to a number of technical doubts (see next section) regarding the interpretation and application of Spanish CFC rules. This could imply that, in addition to accounting for income obtained by foreign holding companies, the Spanish tax authorities may understand that:
- Spanish companies (including those applying the Spanish ETVE5 regime) may be subject to an additional 5% tax in Spain on dividends from foreign sources previously included in the tax base of the Spanish shareholder’s corporate tax (even if they are distributed during the same year as interim dividend); and
- The capital gain resulting from the sale of shares in a foreign holding company that has been subject to CFC rules during previous tax periods cannot (partially or totally) benefit from the Spanish participation exemption.
Main controversial aspects of Spain’s amended CFC rules
CFC rules are designed to prevent taxpayers from deferring the taxation of profits in low or no tax jurisdictions. Subject to a minimum tax calculation test, these rules have the effect of reallocating the income of a low-tax SEC subsidiary to its parent company, which becomes taxable in its country of tax residence.
We include below some of the main controversial issues arising from the changes introduced by Law 11/2011 in the Spanish CFC rules:
Do Spain’s CFC rules still apply to dividends and capital gains received by foreign holding companies that have been fully exempt in their jurisdiction of tax residence?
Spain’s CFC rules are triggered if the income received by foreign affiliates has not been taxed at least 75% of what it would have been taxed in Spain (i.e. the tax test minimum). Therefore, if such dividends or capital gains have been taxed at less than 1.25% (or fully exempt or not taxable due to the existence of a territorial tax regime) in that jurisdiction, the Spanish shareholders are in principle required to include in their tax base of corporate tax under the CFC rules an amount of 5% of the dividends or capital gains obtained by the foreign subsidiary, even if these dividends or capital gains n ‘have not yet been distributed to the Spanish shareholder.
However, subject to a detailed review of each scenario, there are situations where this inclusion may not be required, for example:
- Technically, the Spanish participation exemption has been interpreted as a total exemption which in certain cases must be reduced by a flat rate of 5% corresponding to the management costs relating to the operation in such a case are fixed at a flat rate. If the jurisdiction of the foreign holding company had a similar exemption (i.e. a total exemption reduced by a flat rate of â¥ 5% due to management fees), the Spanish CFC rules would not apply. would not apply;
- If the Spanish company does generate management fees (to be analyzed in more detail, what should be considered as âmanagement feesâ for this purpose) greater than 5% of the dividends / capital gains received during the of a given tax period, the Spanish CFC rules would not apply;
- If the foreign holding company is tax resident in the same jurisdiction as the second tier operating subsidiaries concerned, the literal wording of the Spanish CFC rules may lead to the conclusion that the dividends / gains obtained by the foreign holding company are affected by the rules. related to CFCs, but this conclusion would be totally contrary to the objective of the CFC rules because in these cases it is clear that there is no artificial relocation of income to a territory with a low tax rate or without taxation. We are awaiting further guidance from the Spanish Directorate General of Taxes to apply the CFC rules in such situations.
Will dividends / gains subject to the CFC in Spain be taxed again when such dividends are distributed in the current financial year or in subsequent years?
Following the literal wording of the Spanish corporate tax law, even if the dividends distributed by the foreign subsidiary have already been submitted to the Spanish corporate tax in the hands of the Spanish shareholder due to the application of the Spanish corporate tax rules. SEC, the distribution of said dividends by the foreign holding company to the Spanish shareholder would trigger an additional effective taxation of 1.25% in Spain (even if it were distributed in the same year as an interim dividend).
In our opinion, there are very good reasons to defend that any taxation applicable to dividends distributed when the income previously included in the taxable base is distributed to the shareholder would be contrary to the ATAD Directive, because:
- The ATAD Directive states that the income to be included under the CFC rules is “undistributed income”, and therefore the CFC rules should exclude the taxation of dividends distributed in the same year as dividends. temporary workers; and
- The ATAD Directive requires that the CFC rules ensure that there is no double taxation when the amounts of income previously included in the tax base are distributed to the shareholder, so that there should not be additional tax on dividends distributed in subsequent tax periods, as happened with the previous wording of the CFC rules.
Is the Spanish capital gains participation exemption threatened when the participation in a foreign holding company is sold?
The combined effects of the new Spanish rules on CFCs and the removal of the exception applicable to foreign holding companies may jeopardize the application of the Spanish participation exemption to capital gains resulting from the sale of shares in a foreign holding company. This is because the Spanish participation exemption is not applicable to capital gains derived from shares in CFC entities where 15% or more of its income is considered passive income for the purposes of CFCs.6.
The literal application of the exclusion established in the Spanish participation exemption for SEC entities does not correspond to the other provisions and requirements of the Spanish participation exemption, as it is designed to âexamineâ direct holding companies7 and focus on second-tier (or lower) operational subsidiaries to determine whether the conditions for applying the exemption are met.
Therefore, in our opinion, the Spanish legislator should include a safeguard clause in the exclusion of SECs from the participation exemption when the SEC entity is a foreign holding company. In the meantime, we expect the Spanish Directorate General of Taxes to confirm that foreign holding companies should be eligible for the Spanish participation exemption.
Spanish multinational groups investing abroad or foreign multinational groups investing through Spanish holding companies must analyze the changes introduced in Spanish CFC rules in order to properly assess the impact of these new tax measures on their corporate structure. company, and in particular if the investments are structured through foreign holdings.
1. Law 11/2021, of July 9, relating to measures to prevent and combat tax fraud.
2. Council Directive (EU) 2016/1164 of 12 July 2016 establishing rules against tax avoidance practices which directly affect the functioning of the internal market.
3. A foreign company is considered to be controlled for the purposes of the SEC if the Spanish taxpayer, alone or jointly with related parties, has a direct or indirect participation of at least 50% in the share capital, equity, results or the voting rights of the company. foreign entity.
4. We note that the withholding taxes incurred by the foreign holding company on these dividends will be calculated for this minimum tax.
5. Entidades de Tenencia de Valores Extranjeros.
6. If the foreign holding company does not receive passive income (or if it is less than 15% of its total income) during certain holding periods, the participation exemption is not applicable to the share of the capital gain which corresponds to the tax portion of the periods during which the 15% has been exceeded.
7. Unless they are located in a non-cooperative jurisdiction for Spanish tax purposes.