Leveraged dividends: recent tax ruling

A recent tax ruling, issued by the Spanish Tax Authorities, has accepted the deductibility of interest accrued on a loan, which was granted by a syndicate of banks to a Spanish resident borrower with the purpose of financing the distribution of a dividend to its foreign shareholder, under the provisions of the new Corporate Income Tax (CIT) Law which entered into force on 1 January 2015.

In the last few years, leveraged dividends have been in the spotlight because there has been no guidance about the deductibility of interest for CIT purposes, and the Supreme Court has recently disallowed the deductibility of interest accrued on a private equity recapitalisation transaction (Dorna case), arguing that interest benefited the shareholders (and not the Spanish borrower) because they were accrued for the purpose of distributing "earnings". The Supreme Court did not characterise the distribution as an ordinary dividend distribution due to the absence of accumulated reserves at the level of the borrower, but as a recharacterised distribution of earnings - utilidades.

The Spanish Tax Authorities have accepted that the only CIT rule that limits the deductibility of the interest accrued in the context of a leveraged dividend distribution is the 30 per cent EBITDA limitation (article 16 of the CIT Law), and this implicitly implies that interest should not be disallowed under article 15.a) of the CIT Law which disallows expenses benefitting the shareholder. This was the Supreme Court's interpretation within the context of a very complex recap transaction under a CIT Law which is not in force anymore.

This new tax ruling gives some clarity about the deductibility of interest in leveraged distributions, although a detailed case-by-case factual analysis of each potential leveraged distribution will be necessary to conclude about the applicability of this new ruling to other potential transactions. Thus, this new ruling cannot be definitely invoked for any private equity recapitalisation transaction without proper further analysis.

The main practical consequence of this tax ruling is that it could be invoked in other cases with identical or very similar background to the case at hand. Thus, if you were considering to execute a leveraged distribution of these characteristics, this new tax ruling could provide you with some guidance on what the position of the tax authorities regarding leveraged dividend distributions could be, once the analysis of the specific facts and circumstances has been already made. If the potential transaction shared sufficient similarities with the case at hand, the new ruling could provide enough comfort to proceed with the transaction without requesting an ad-hoc ruling, although this last option would be the only one which would eliminate any risk.