Spanish Tax Authorities deny withholding tax exemption on Spanishsourced. on lack of business purpose at EU parent entity level.

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1 17 October 2016 Global Tax Alert Spanish Tax Authorities deny withholding tax exemption on Spanishsourced dividends based on lack of business purpose at EU parent entity level EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Executive summary The Spanish Tax Authorities (STA) recently published a binding tax ruling 1 containing their interpretation of the requirements imposed to qualify for the withholding tax (WHT) exemption as provided under the European Union (EU) Parent-Subsidiary Directive (PSD) 2 (as transposed by Spain into its domestic tax law) on dividends distributed by Spanish companies to shareholders resident in other EU Member States. The Spanish WHT exemption provision includes an anti-abuse rule which requires that, when the majority of the voting rights of the EU parent entity are directly or indirectly held by individuals or entities that are not tax resident within the EU, the incorporation and operation of the EU shareholder must be grounded on sound economic purposes and business reasons. This anti-abuse rule was implemented in the last Spanish major tax reform (effective 1 January 2015) and this binding ruling is the first one addressing the new wording of the law. Among other factors being considered, the STA understands that, where a Spanish company which has been operating as a holding company for a long period of time with a suitable organization of human and material resources to manage its shareholding in other lower level entities, there would not be business reasons for having another holding company on top in Luxembourg performing those same functions.

2 2 Global Tax Alert Therefore, in absence of supporting business reasons for adding another layer within the corporate structure in another EU Member State, the STA concluded that the dividends distributed from the Spanish subsidiary to the Luxembourg Parent would not qualify for the WHT exemption. Detailed discussion Background A Spanish holding company (SpainCo) was incorporated in 2001 and participates in several Spanish and foreign subsidiaries engaged in different operating business activities. SpainCo is set up with a suitable organization of human and material resources to manage such shareholdings. In January 2011, a Swiss tax resident individual (Ultimate shareholder) inherited the shares in SpainCo. At that time, Ultimate shareholder already held stock in a number of entities, including a Luxembourg holding company (LuxCo 1), incorporated in November 2010, which also held and managed stock in another entity in Luxembourg (LuxCo 2). In December 2012, Ultimate shareholder effectuated a stockfor-stock exchange by contributing the shares in SpainCo to LuxCo 1. In addition, LuxCo 1 became a member of the board of directors of SpainCo and received remuneration for those services. Currently, LuxCo 1 also holds shares in a company in Singapore (SingCo). Ultimate shareholder moved its tax residency to Singapore in 2015 and would like to concentrate its new investments in that region going forward. LuxCo 1 claims to have sufficient human and material resources to manage its participations in SpainCo, LuxCo 2 and SingCo (i.e., board of directors made up of seven members with sound experience in international investments, one employee taking care of administrative tasks and bookkeeping, and one office at its disposal in Luxembourg properly equipped with computers and other resources, among others). Spanish WHT exemption rule SpainCo is willing to make a dividend distribution to LuxCo 1. As a general rule, dividends distributed by a Spanish company to a nonresident shareholder are subject to Spanish WHT at a 19% flat tax rate over the dividend gross amount. However, the dividend distribution may qualify for a domestic WHT exemption (in line with the PSD) on dividends distributed to a parent company resident within the EU, provided that certain requirements are met. These requisite conditions are summarized as follows: Both parent and subsidiary must be subject to and not exempt from one of the corporate income taxes mentioned in Article 2.c of the PSD The profit is not distributed out of the proceeds obtained upon the liquidation of the Spanish subsidiary Both companies must have one of the legal forms included in the Appendix of the PSD Parent has held a minimum stake of 5% in the Spanish subsidiary (or acquisition cost exceeds 20 million) for, at least, one year All of the above requirements for the application of the WHT exemption would be met in the instant case. This notwithstanding, the Spanish tax law also contains an anti-abuse provision whereby if the majority of the voting rights of the EU parent entity are directly or indirectly held by individuals or entities that are not tax resident in an EU country, the applicability of the exemption is subject to the condition that the incorporation and operations of the EU entity is grounded on sound economic purposes and business reasons. After analyzing the functions carried out by LuxCo 1, the STA came to the conclusion that the incorporation and operation of this company was not grounded on sound economic purposes and business reasons because the holding activities performed by LuxCo 1 were essentially the same as those carried out by SpainCo. Moreover, SpainCo would have been carrying on such holding and management activities long before LuxCo 1 (i.e., since 2001) and, therefore, it is presumed that SpainCo would have had even more experience than LuxCo 1 in performing such functions. Furthermore, SpainCo is endowed with the proper organization of human and material resources to carry out the abovementioned holding activities and so far has proved to manage its participation in a significant number of operating companies in a professional and efficient fashion. Accordingly, the STA considered that the interposition of another layer in the structure (i.e., LuxCo 1) solely duplicates the resources that are necessary to operate the overall holding activity but without achieving cost savings, economy of scale,

3 Global Tax Alert 3 risk of ring-fencing or any other type of economic benefit, other than attainment of a tax advantage (i.e., benefitting from the WTH exemption on dividends distributed to another EU-resident company, as opposed to the WHT that would have been otherwise imposed in Spain on dividends distributed to an individual tax resident outside the EU, where the domestic WTH exemption would not be available). In light of the above, the STA concluded that the double-tier holding structure is mainly tax driven and therefore denied the WHT exemption on the dividends distributed from SpainCo to LuxCo 1. Impact The STA continue to adopt a very strict stance when interpreting the business purpose that is required to qualify for the domestic WHT exemption (harmonized with the PSD) on Spanish-source dividend distributions, in line with the trend followed by prior binding tax rulings and case-law in Spain. For this reason, foreign investors in Spain should carefully analyze on a case-by-case basis the level of substance that their corporate structures have in terms of business purpose before repatriating funds out of their Spanish subsidiaries. Endnotes 1. The ruling was issued on 22 June Directive 2011/96/EU, of 30 June Other companies tax resident within the European Economic Area (EEA), such as Iceland and Norway, may benefit from this WHT exemption as well subject to certain requirements.

4 4 Global Tax Alert For additional information with respect to this Alert, please contact the following: Ernst & Young Abogados, Madrid Alfonso Puyol Ernst & Young LLP, Spanish Tax Desk, New York José Antonio Bustos Manuel Paz

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