Spain

SPAIN

The Spanish Tax System

SYNOPSIS: There is a common misconception in the UK and Ireland that foreign residents need pay little or no tax in Spain and that the authorities are quite relaxed about collecting taxes. In reality, whilst prudent decisions can save investors and/or fiscal resident's significant sums, nothing could be further from the truth. In reality, the Spanish rigidly enforce their taxes; require permanent residents and foreign companies to acquire tax identification numbers, tax residents on their worldwide income and assets, have punitive inheritance and gift taxes; property acquisition taxes as high as 9.5% plus taxes that UK and Irish nationals would not be used to such as the annual wealth tax. Nevertheless, as will be shown, despite the quagmire of potential tax exposure a well advised person can protect his/her hard earned money/assets relatively efficiently but only if executed through tried, trusted and needless to say scrupulously legal methods.

HISTORICAL SYNOPSIS : Contemporary Spain can trace its history back to 1469 when the kingdoms of Aragon and Castile united through the marriage of Fernando de Aragon and Isabel de Castillo. By 1492 these united kingdoms managed to usurp the Moors from the kingdom of Granada securing virtually all of the Iberian Peninsula. In the same year, the Americas were discovered by Christopher Columbus resulting in the establishment of one of the World's most important empires stretching at one point from California in the north to Chile in the south, not to mention various European and Africa interests. The defining event in modern Spanish history was the 1936 Civil War. It resulted in the death of some one million people and the leadership of General Francisco Franco, the fascist self-proclaimed President of the Spanish Republic 11936 to 1975). Notwithstanding Franco's close relationships with both Hitler and Mussolini, Spain was strictly neutral during the Second World War (1939 to 1945) although his inward-looking and extremely dictatorial regime undoubtedly held Spain back both economically and socially. In fact, up to and until the 1960's Spain was officially classified as a developing country by the United Nations. After Franco's death in 1975 the Spanish monarchy was reinstated with the anointment of Juan Carlos as King of Spain. Despite the fact the young aristocrat was personally groomed by Franco for this position, he soon showed himself to be a unifying force in what was still a potentially very unstable country. However, the greatest force for development was Spain's entry to the European Union in 1986, which resulted in unprecedented economic growth and investment with Spain once more being counted amongst the world's greatest economic powers. Nevertheless, on a per capita basis Spain is only just ahead of Portugal, Greece and the 10 new accession states, which joined the EU in 2004. The country also has doggedly high unemployment and relatively low wages; but on the positive side has a far better health system and lower crime rates than either the United Kingdom or the Republic of Ireland.

COUNTRY FACTS

Location: Spain occupies most of the Iberian Peninsula (along with Portugal) from the Bay of Biscay and the Pyrenees in the north to the straits of Gibraltar in the south. It also takes in the Canary Islands in the Atlantic, the Balearic Islands in the Mediterranean and Ceuta and Melilla in North Africa. Mainland Spain is mostly plateaux with forestry in the north and open arid land in the south. The country covers an area of 505,957 square kilometres, which makes it the second largest country in the EU after France. The coastline alone is over 4,964 square kilometres.

Climate: Highly variable from region to region. The Mediterranean coasts generally have hot, dry summers and mild sometimes rainy winters. The central plateau has very hot summers and cold winters whilst the north Atlantic coast has weather not that dissimilar to Southern England or Ireland. The Canaries are sub-tropical whilst the Balearic Islands have cool wet winters and warm, dry summers.

Population: 45,116,894

Development: The per capita gross domestic product of Spain in 2007 was
US$27,422 per person. This ranks Spain as the 33rd wealthiest country in the World. For comparison this compares to the UK with a per capita GDP of US$27,700perperson (The 24th wealthiest country) or Ireland with a per capita GDP of US$38,812 per person (The 4th wealthiest country).

Capital city: The capital city of Spain is Madrid. It has a population of approximately 4,000,000 and is the 3rd largest city in the EU after London and Paris. World famous for its museums, architecture and nightlife. Other cities of note include Barcelona, Valencia, Seville and Granada.

Currency: The Euro is used in Spain together, at the time of writing, with Ireland, France, Portugal, The Netherlands, Belgium, Luxembourg, Germany, Austria, Italy, Greece, Sweden Slovenia and Finland. The new accession states, apart from Slovenia above, plus the UK and Denmark currently use their own currencies.

Education level: According to the OECD the current literacy rate in Spain is 98% compared to a 99% level in the UK and Ireland.

Language: Spanish is the official language of Spain but Catalan (Catalonia, the Balearics and Valencia), Euskera/Vasco (The Basque Region) and Gallego (Galicia) are both widely spoken and jointly official in their respective regions. Catalan is closely related to Spanish and Italian, Gallego is part of the Celtic Family of Languages whilst entomologists consider Euskera/Vasco separate from the Indo-European family of languages but with Brethonic (Welsh, Cornish and Breton), rather than Gallic (Irish and Scottish) Celtic undertones.

Trade Bloc' membership: Spain has been a full member of the European Union since 1986 and is also a member of the Organisation for Economic Co-operation and Development (OECD)

 

Setting up a Business in Spain

Many people invest in Spain not simply to retire or acquire a holiday home but to actively engage in business. The most common investments, not surprisingly, revolve around supplying services to other expatriates or holidaymakers. The favoured businesses include setting-up and running small guesthouses or hotels, apartment and villa rentals, property management plus a whole panacea of services aimed at the expatriate market including building, plumbing, translation etc. As in any country, it is vital that considerable thought is given not only to what business services can be provided but how investments should be made - As has already been inferred in respect to purchasing a Spanish property, the main window of opportunity to correctly structure ones affairs exists before becoming fiscally resident in Spain. On a general level, it cannot be stressed too much that the Spanish way of going things is often very different to the British or Irish norms and that such differences should be identified BEFORE investing. It is also a very good idea to ensure that you have sufficient savings to cover yourself for at least the first 6 months of your business venture. Further, as in the UK it is highly advisable to try and separate business from personal assets ideally by using a limited liability company or branch. However, what cannot be over stressed enough is that thorough research should be carried out before proceeding with any business investment - In far too many cases the 'dream' of living in a sunny climate seems to mitigate all logic, DO NOT LET THIS HAPPEN TO YOU!

 

MAJOR LEGAL ENTITIES

As already discussed in respect to purchasing property there are two major limited liability entities in Spain; the sociedad anonima (SA) and the sociedad de responsibilidad limitada (SL). The former is equivalent to a UK or Irish public limited company or PLC whilst the latter is equivalent to a private limited company limited by shares or Ltd. Unlike the British Isles far fewer small businesses use a limited liability entity primarily for reasons of cost - the average cost to set up a SL is between €1,500.00 and €2,500.00, with the minimum capitalisation level being €3,000.00 plus 1% duty - but it is still recommended for all but the smallest enterprises. Apart from the two Spanish SA and SL companies, there is also the possibility of setting up a branch of a UK company, which has the considerable benefit of being far cheaper than setting up a SL whilst being governed by UK company law, rules, procedures and accountancy practices - The more familiarity that exists when moving to Spain the better. The general corporate tax rate is 35% (see Law 43/1995) but small to medium sized enterprises are taxed at the lower 30% rate, capital gains are taxed at only 15%. In addition, it should be noted that the Canary Islands are treated as a Special Economic Zone (Zona Especial Canaria) and offers distinct Holding Company benefits (There is no Stamp Duty) together with a TVA rate of only 5%. Further, companies setting up in the Canaries and that carry out their activities within the Canaries are subject to a progressive corporate tax rate starting at 1% and then rising to 5% over a 5 year period. Canary Island companies cannot avail of these lower rates if really trading outside of the Canaries or simply repatriating funds to the Islands. Apart from Stamp Duty the cost of registering companies in the Canary Islands is analogous to the Spanish Mainland.

PARTNERSHIPS

Partnerships in Spain may be either general (compania colectiva) or limited (compania en comandita). It should be noted that in both cases below the partnerships are fiscally transparent save for non-resident partners who will be taxed according to the appropriate double taxation treaty provisions.

Compania Colectiva (CC): Most British companies and annual submissions are now formed electronically at Companies House in Cardiff or Edinburgh. SCF Legal & Corporate Management Services Limited is an authorized electronic company formation agent for Great Britain and a member of the Fe Phrainn Scheme in the Republic of Ireland

Compania en Comandita (CEC): This is the Spanish equivalent to the American limited partnership with both general and limited liability partners. The words "compania en comandita" must always follow the names of the partners concerned. There must always be at least one general partner who contributes to the capital and engages in the management of the partnership and one limited partner who simply contributes to the capital. General partners are jointly and severally liable for partnership debts and liabilities. Limited partners are only liable - as a shareholder would be in a limited liability company - in respect to the amount they have contributed. Where one is a limited partner and one has confidence in the general partner or partners this vehicle is fine.

 

Spanish Legal System

Civil Law

The Spanish legal system is based on the Code Napoleon and as such is primarily codified and relatively inflexible. Unlike common law countries such as the UK and Ireland, where judges have the ability to create law through precedents and/or actively interpret statutes (Acts of Parliament), their Spanish counterparts must slavishly adhere to the Civil Code -This having both positive and negative consequences. In particular, it should be noted that Spain has no equivalent of the laws of equity, which specifically allow judges considerable flexibility to develop case law without the need to consider a codified instrument provided such case law doesn't directly conflict with an existing statute. Another key distinguishing fact between Spain and common law jurisdictions is that it has no tradition of trusts, a creation of the laws of equity, and further it is not a signatory to the Hague Convention on Trusts in 1984. This means that their use in tax planning is more limited than in other jurisdictions and should only be used after having received expert tax planning advice.

Civil Law and Companies:

In 1978 Spain introduced its modern Constitution, which has given the Spanish juridical system a much-needed stability. In particular, all constitutional matters are under the final remit of the Constitutional Court which is important to investors in Spain since many tax planning methods used to mitigate Spanish tax exposure are often dependent on using EU Directives and Regulations, Double Taxation Treaty provisions and indigenous constitutional rights. In fact, as will become clearer in later chapters, a significant number of UK and Irish investors/ residents of Spain depend on the use of branches of foreign companies registered in Spain, offshore companies owning shares in local SLs (Sociedades de Responsabilidad Limitada) and specific provisions within the tax treaties between Spain and the United Kingdom and Republic of Ireland. In fact, without the certainty of the Spanish Constitutional Court, tax advisors could not save clients nearly as much money, particularly in respect to capital gains, inheritance and wealth taxes. It should be noted that if one is depending on an international treaty provision, it is essential that it has been officially listed in the Official Gazette since it is only then that the provision takes precedence over domestic laws. The only exception to this is when a tax planner is relying on EU Directives/Regulations since these are automatically enforceable at a European level through the European Court of Justice. An interesting side note is that whilst virtually all European countries recognise the primacy of international treaties over domestic laws this is not necessarily the case in the United Kingdom as there is neither a written constitution nor Constitutional Court.

 

The Spanish Tax System

TAXABLE BASE AND THE UK/IRISH DOUBLE TAXATION TREATIES

	FISCAL RESIDENT	NON-FISCAL RESIDENT
Income Tax	Worldwide 'Income'	Spanish 'Income' only
CGT	Main Home + resident = 0 2nd homes = 15%	Directly owned = 35% Spanish co. / branch = 15% Offshore company = 0%
Wealth Tax	Worldwide with deductions	Spanish assets no deductions unless owned by a company or branch
Heirship/Inheritance Taxes	Worldwide subject to Tax Treaties	Spanish assets only if directly owned

Fiscal Residence : If an individual is in Spain for over 183 Days in any Fiscal Year (This correlates with the Calendar Year in Spain) he or she will be automatically deemed resident in Spain for tax purposes. There can also be an automatic inference of tax residence on the basis that family members live in Spain (i.e. that children are in school), that one has the intention to permanently reside in Spain or, if a business has been established in Spain that it is the centre of economic interest. Of course, in the case of the tax residence automatically being ascribed despite not having been in Spain for a period greater than 183 days it is possible to rebut the inference/presumption especially if protection is being sought under the UK or Irish Tax Treaties. For example, within the Tax Treaty signed between the UK and Spain on the 21st of November 1975 there are a number of Tie Breaker' clauses used to determine fiscal residence. Thus, where local rules infer tax liability in both countries then the fiscal residence will be deemed to exist in the country where there is a permanent home, if there is a permanent home available in both countries then fiscal residence will be deemed to exist in the country which can be shown to be the centre of vital economic interests. If even the last test is unclear then fiscal residence will be ascribed to the country of which one is a national.

Fiscal Identification Numbers : A Foreigners Identification Number or NIE (Numero de Identificacion de Extranjerosl or, or in some areas a Fiscal Identification Number or NIF (Numero de Identificacion Fiscal), is required by all individuals fiscally resident in Spain. In addition, such identification numbers are also required where non-fiscally resident foreigners directly own property in Spain. Where companies own the Spanish properties of non-fiscally resident individuals it is not necessary to obtain a personal identification number. However, the companies themselves will have their own identification number/code known as a CIF (Codigo de Identificacion Fiscal) or Financial Identification Code.

Income Tax : Individuals deemed to be fiscally resident in Spain are taxed on their worldwide income, individuals not fiscally resident in Spain will - subject to applicable double taxation treaties - be only subject to income tax on their Spanish income such as income derived from property rental. * It should be noted that Spanish income taxes are not incremental but employ what is know as a tiered "Claw Back" system which means that once one has reached a new threshold one will be subject to that rate on all income.

* Spanish law requires that tenants must withhold 25% of any rent paid to a landlord as a credit against any future tax obligations by the landlord. However, when asked, the tenant is required to show proof that such withheld sums have in fact been paid to the Spanish fiscal authorities.

 

INCOME TAX RATES 2004 (SUBJECT TO "CLAW BACK" PROVISIONS)

	€0 - €4K	€4 - €13.8K	€13.8 - €25.8K	€25.8 - €45K	OVER €45K
Income Tax Rate	9.06%	15.84%	18.68%	24.71%	29.16%
Communal Tax Rate	5.94%	8.16%	9.32%	12.29%	15.84%
Total	15%	24%	28%	37%	45%

It should be noted that whilst non-residents are fully subject to the annual wealth tax on their Spanish assets (as outlined below) fiscally resident individuals are allowed deductions against income tax liabilities to the extent that combined income and wealth tax exposure cannot be greater than 60% of the total tax liability within any fiscal year. The corollary to this is that where wealth tax exposure exists the sum actually paid cannot fall below 20% of what would have had to have been paid if was not for income or other tax concessions.

 

ANNUAL WEALTH TAX RATES - 2004 (IN EURO)
0	167,129.00	0.2%
167,129.00	334,253.00	0.3%
334,253.00	668,500.00	0.5%
668,500.00	1,377,000.00	0.9%
1,377,000.00	2,673,999.00	1.3%
2,673,999.00	5,347,998.00	1.7%
5,347,998.00	10,695,996	2.1%
Over 10,695,996		2.5%

Inheritance and Gift Taxes (Impuestos sobre Sucesiones y Donaciones)

These apply, unlike in many countries, even in the case of a deceased husband passing on his wealth to his wife. The recipient pays the tax. Further, the standard rates of tax are subject to a Multiplier varying from 1.00 to 2.40 depending on the Class of the Recipient. For example the lowest rates apply to spouses and children followed by relatives, followed by others. In Spain there is no equivalent to a common law partner so such a partner would be subject to the very maximum Multiplier. There is a standard individual deduction, at the time of writing, of €15,956.87, which means that virtually every Spanish resident person is ostensibly subject to these taxes. The standard rates after taking account of the individual deduction vary from 7.65% to 34% however after the application of the Multiplier the rates can go as high as 81.6%. Thus, if a person gifted their house worth €1,000,000.00 to a spouse the tax payable would be €340,000.00; if on the other hand the gift were to a non-related third party the tax would be €810,600.00! Main Residence Tax Base Reductions -Where a spouse, child or relative over 65 who previously lived with the deceased for at least 2 years immediately prior to his/her death and continue to live in the said property for at least 10 years from the date of death the taxable base on the Main Residence will be reduced by 95% up to a maximum reduction of up to €122,606.47 for each inheritor. It should be noted that there is a very similar deduction for the transfer of a family business.

Spanish Anti-avoidance Provisions & Starting Up A Business

The key point to note is that Spain has developed a range of tax anti-avoidance provisions every bit as sophisticated as those employed in the United Kingdom and Republic of Ireland (see Article 25 of the Spanish General Tax Code). This means that whilst it is perfectly acceptable to use double taxation treaty provisions and EU directives and regulations to mitigate or legitimately transfer profits in or outside of Spain, it is certainly not acceptable or legal to insert in artificial fax haven companies (see Law 31/19901 or to siphon off surplus funds. Nevertheless, as will be shown the dynamics of many business activities carried out in Spain do present significant tax mitigation possibilities.
Transactions should be at "Arms Length": The thrust behind this principle is that intra-company transactions should only be deemed to be valid where the terms of such transactions are considered to be at market rates. Thus, creating artificially high interest rate levels between related companies la related company is deemed to be one where there is a direct or indirect common beneficial ownership of over 25% between the pertinent firms) would not be deemed acceptable.

Controlled Foreign Companies (CFC's):  Spanish CFC legislation is covered by Articles 2 and 10 of Law 42/1994. Basically it means that where a Spanish company owns or controls 50%, or more, of a foreign company and such foreign company is located in a jurisdiction where -subject to specific tax treaty provisions - the overall effective tax rate is less than 75% of the Spanish tax rate (i.e. in the case of corporate tax this would mean 75% of the 35% Spanish rate or 26.25%) then any passive income or capital gains must be imputed even if not distributed within the taxable base. Obviously, the point here is that reference is made only to passive income and such legislation does not apply to bona fide transactions carried out as part of genuine day-to-day business where there is a sound economic reason.

Example of legally avoiding exposure to unnecessary Spanish tax exposure: If one had bought a number of Spanish villas, or a hotel, in Spain specifically with the intention of attracting visitors from the United Kingdom or Ireland then it would be perfectly legitimate to establish a UK or Irish marketing company to exploit the British Isles market. Notwithstanding the significantly lower taxes in these countries (a universal 12.5% corporate tax applies in Ireland and a small company tax rate of 19% applies in the UK), the veracity of the business logic - i.e. the location of the customer base, EU membership and the existence of suitable double taxation treaties - would mean that such structures would be perfectly valid. Of course, the above is predicated on the assumption that there would be a genuine UK/Irish presence

Diagram 3: This shows how an Irish limited liability company could be set up to act as the booking/travel agency division of a company based in Spain owning a number of Spanish villas purchased for summer rental. It should be noted, that if the villas are not actually owned then of course CFC would not apply. For this structure to work there must be real management and control in Ireland and the fees charged must be roughly in-keeping with the industry norm

 

COUNTRY OF RESIDENCE	DIVIDEND WITHHOLDING TAXES	INTEREST WITHHOLDING TAXES	ROYALITY WITHHOLDING TAXES
Argentina	10% to 15%	12.5% to 14%	3%.5% and 10%
Australia	15%	10%	10%
Austria	10% to 15%	5%	5%
Belgium	15%	15%	5%
Brazil	15%	10% to 15%	10% to 15%
Bulgaria	5% to 15%	NA	NA
Canada	15%	15%	10%
China	10%	10%	10%
Czech Republic	5% to 15%	0% to 10%	5%
Denmark	10% to 15%	10%	6%
Ecuador	15%	5% to 10%	5% to 10%
Finland	10% to 15%	10%	5%
France	10% to 15%	10%	6%
Germany	10% to 15%	10%	5%
Hungary	5% t0 15%	NA	NA
India	15%	12%	4% to 8%
Ireland (Republic)	0% to 15%	NA	5%, 8% or 10%
Italy	15%	12%	4% to 8%
Japan	10% to 15%	10%	10%
Korea (South)	10% to 15%	0% to 10%	10%
Luxembourg	5% to 15%	10%	10%
Mexico	15%	0%, 10% or 15%	10%
Morocco	10% to 15%	10%	5% to 10%
The Netherlands	10% to 15%	10%	5% to 10%
Norway	10% to 15%	10%	5%
The Philippines	10% to 15%	10% to 15%	10%, 15% or 20%
Poland	10% to 15%	0% to 12%	10%
Portugal	10% to 15%	15%	5%
Romania	10% to 15%	10%	10%
Russia	18%	NA	5%
Sweden	10% to 15%	15%	10%
Switzerland	10% to 15%	10%	5%
United Kingdom	10% to 15%	12%	10%
United States of America	10% to 15%	10%	5%, 8% or 10%

Notes on the Spanish Double Taxation Treaty

1. Where no tax treaty exists then the withholding tax rate is a ubiquitous 25%
2. Variable rates may exist depending on the nature of the services/goods.
3. EU Member States Conditional Exemption from Withholding Taxes relating to
   Dividends: EU Parent/Subsidiary Directive 90/435 states that no withholding faxes shall be
   paid in respect to dividend distributions where:

• At least 25% of the equity of the subsidiary firm is owned by the parent.
• The subsidiary company is fully taxable in its country of domicile. It should be noted that
  this definition would include territories approved by the EU to fully or partly exempt local
  companies from corporate tax. Territories with such beneficial status would include Madeira
  and theoretically Gibraltar.
• The 25%> or higher equity stake has been held by the parent company for at least 2 years.