The Spanish Supreme Court sets some limits to the Tax Authorities in the review of the taxation of income received by foreign investors
17 July 2023
17 July 2023
The Spanish Supreme Court has recently issued several judgments in which it has established criteria that sets limits to the Spanish Tax Authorities when taxing certain Spanish-source income received by foreign investors. In recent years, there has been an increasing level of litigation due to the trend of the Spanish Tax Authorities to tax income (particularly interest and dividends) received by foreign investors established in the European Union ("EU") or in countries with a Double Taxation Agreement ("Tax Treaty") with Spain, in particular on the basis that the recipient is not the beneficial owner of the income, in application of an (in our opinion) excessively broad interpretation of the case law of the European Court of Justice.
These recent judgments contribute to generate a higher level of legal certainty in the structuring of investments in Spain through holding companies, by confirming certain elements that the Spanish Tax Administration must take into consideration when reviewing such structures. In particular, the Supreme Court considers that:
The Supreme Court confirms that the Tax Administration cannot assume the existence of an abuse merely because, at the top of a chain of holders, there is an entity not entitled to the exemption, thus passing on to the taxpayer the burden of proving the existence of valid economic reasons in the structure. On the contrary, the Supreme Court, in light of the European Court of Justice's Case Law as regards the burden of proof of abuse, confirms that it is for the Tax Administration to prove the existence of abuse in order to be able to deny the application of the exemption in the distribution of dividends to a EU resident entity.
For the Supreme Court, a holding company is considered to be the beneficial owner and, consequently, the dividends received will be exempt in Spain if it:
i. is a permanent investment vehicle
(a) whose investment activity commenced before the investment concerned was made;
(b) has made material investments in different jurisdictions; and
(c) was not incorporated expressly to make such investment (but holds several investments and the controverted investment's weight is not predominant);
ii. obtains significant income other than that reviewed by the Spanish Tax Authorities;
iii. does not redistribute the majority of income it receives, but manages the income received with a view to reinvest and optimise the use of cash; and
iv. acts autonomously, through a Board of Directors that takes and implements all decisions relating to the management of resources and the repatriation of funds.
The Supreme Court considers that circumstances such as the ones above entail that the company receiving the dividends cannot be considered as an instrumental entity, as it carries out the genuine economic activity of the execution and management of its investments. The Supreme Court also considers that the existence of a single decision-making unit and a total sole control held by the non-EU resident parent company of the group is not an element which can on its own impact such conclusion.
The Supreme Court considers that foreign tax residence certificates issued for the purposes of a Tax Treaty do not constitute a mere indicator of the tax residence of the recipient of the income, but have the value of full evidence, so that the Tax Administration and the national courts must presume their validity and cannot reject their content or judge the circumstances in which they have been issued. If there is a tax residence conflict (i.e. if the two States consider the taxpayer to be resident in their territory), it must be resolved by applying the "tie-breaker" rules provided for in the applicable Tax Treaty and not unilaterally.
The above Supreme Court's position, in addition to establishing certain guidelines for the Tax Authorities when reviewing the application of the above exemptions, confirms the need to have the necessary substance and business rationale in the incorporation and operation of investment platforms resident in EU Member States in order to benefit from the exemption on dividends and interest received from Spanish sources. In practice, this means that holding companies, among other issues:
1. are continuous investment platforms, carrying out a variety of investments over time and, if possible, in multiple jurisdictions;
2. have the necessary structure of material and human resources to carry out their investment activity;
3. are managed by an experienced and qualified management body that is effectively involved in the decision making process of strategic business matters (with documentary evidence of such involvement);
4. "recycle", at least partially, the cash distributed by its subsidiaries in the execution of new investments so that the cash is not automatically repatriated in its entirety to the ultimate investor; and
5. obtain annual certificates of tax residence in their respective jurisdiction for the purposes of the Tax Treaty with Spain.
The existence of circumstances such as the above should, on the basis of the Supreme Court's position, help to reduce the risk of denial of exemptions on the Spanish source dividends or interest that the holding company receives. Notwithstanding this, it will be for the Spanish Tax Authorities to assess, on a case-by-case basis, the factual elements present to determine whether the holding company can benefit from such tax benefits.
If you would like advice on the structuring of investment platforms or tax disputes in light of this case please contact us.