5 November 2014 EY Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: http://www.ey.com/gl/en/ Services/Tax/International- Tax/Tax-alert-library#date Spain proposes to strengthen CFC rules Executive summary The Bill amending the Spanish Corporate Income Tax (CIT) Law, which is expected to be enacted before year-end, and which if passed will apply as from 1 January 2015, contains a strengthening of the current rules governing Controlled Foreign Companies (CFC). The proposed regime, which, as stated in the preamble of the Bill, is in line with the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) project has two main purposes: (i) to avoid the transfer of profits outside Spain merely for tax reasons; and (ii) to set limits on the scope of the new rules governing the Spanish participation exemption regime on dividends and capital gains. 1 Detailed discussion Current CIT Law Article 107 of the Spanish CIT Law currently in force sets forth that a Spanish parent company must include certain categories of passive income obtained by its nonresident subsidiary in its Spanish CIT base. Accordingly, such income is subject to tax in Spain when the following conditions exist: 50% or more of the capital stock, equity, results or voting rights of the non-spanish resident subsidiary is owned by the Spanish company (on a stand-alone basis or taking into account the percentage owned by related entities or individuals). The tax (identical or analogous to Spanish CIT) paid abroad by the non-spanish resident entity on the passive income is under 75% of the tax which would have been payable in Spain on such income had it been obtained in Spain (i.e., 22.5%). Article 107 of the Spanish CIT Law contains a rebuttable presumption, pursuant to which tax haven resident subsidiaries which do not draw-up consolidated annual accounts with their Spanish shareholder are deemed to pay a tax abroad on the passive income that is below this threshold.
The categories of passive income that must be allocated to a Spanish parent company when the above circumstances exist are the following: Income derived from the holding of real estate, excluding: (i) income obtained in the context of a business activity (that is, where there are human and material resources in the company carrying out this activity), or (ii) income obtained from the lease of this type of property to foreign (non-spanish resident) group companies. Dividends, excluding dividends derived from: (i) shares held pursuant to mandatory legal requirements, (ii) shares held in the context of a licensed brokerage activity or (iii) from shares when there is a minimum 5% shareholding, the shareholder has the appropriate human and material resources to manage the participation in the affiliate (s) and at least 85% of the affiliate (s) s revenue is derived from the performance of business activities. Interest income, excluding interest: (i) derived from receivables generated within the commercial supply of goods and services, (ii) obtained by a licensed financial entity or (iii) derived from intra- group financing, provided that at least 85% of the borrower s revenue is derived from the performance of business activities. Financial, insurance and other service activities, to the extent such services are provided to related Spanish companies and these give rise to a tax deductible expense in Spain, excluding the following cases: (i) when income obtained by the foreign company from non-related parties exceeds 50% of total income or (ii) when income is directly related with an export activity. Capital gains derived from the transfer of the assets and rights described in the previous points. Although the Spanish parent company is generally allowed to credit the tax actually paid by the nonresident subsidiary on the income which must be included in its Spanish CIT base, taxes paid in tax havens cannot be credited. CFC rules do not apply to subsidiaries resident in the EU provided that the taxpayer is able to prove that the incorporation and operations of the subsidiary responds to valid business reasons and that the subsidiary carries out an economic activity. CFC rules under the draft CIT Bill The draft CIT Bill introduces relevant amendments to the CFC regime, which could be, broadly, summarized as follows. The conditions for a subsidiary to qualify as a CFC are, as is currently the case, a 50% ownership and a low level of taxation. As the CIT rate is expected to be reduced from the current 30% to 28% for FY 2015 and to 25% for FY 2016 onwards there may be certain CFC entities that will no longer fall under the low taxation condition (i.e., the minimum taxation would decrease from the current 22.5% to 21%/18.75%). Where a subsidiary meets the substance requirements mentioned above, all income obtained by the subsidiary must be included in the Spanish parent company s CIT base, unless it can be proved that (i) such activities are carried on with the human and material resources of another non-spanish resident entity belonging to the same group (as defined under article 42 of the Spanish Commercial Code); or (ii) the subsidiary s incorporation and operation are grounded on valid business reasons. Where the subsidiary has resources for the carrying on of business activities, only the following categories of income qualify as passive and therefore need to be included in the Spanish parent s CIT base: Income derived from the holding of real estate, excluding: (i) income obtained in the context of a business activity (that is, where there are human and material resources in the company carrying out this activity), and (ii) income obtained from the lease of this type of property to foreign (non-spanish resident) group companies that allocate such real estate to a business activity. 2
Dividends or other income from shares, excluding such income where there is a minimum 5% shareholding for a minimum one year period, the entity holding the shares has appropriate human and material resources to manage its affiliate (s) and the majority of the assets of the entity from which the dividend of other income derives is assigned to a business activity. Income derived from the holding of an interest in an entity (e.g., dividends) and interest income excluding income derived from: (i) the compliance with mandatory legal requirements resulting from a business activity; (ii) contractual obligations resulting from a business activity; (iii) a licensed brokerage activity; (iv) assets held by financial or insurance entities within their business activity; (v) interest paid by a company belonging to the same group (as defined under article 42 of the Spanish Code of Commerce) that derives at least 85% of its income from the carrying on of business activities. Income derived from capitalization and insurance transactions in which the beneficial owner is the CFC itself. Income derived from intellectual and industrial property, technical assistance, movable property, image rights, leasing and subleasing of a business or a mine when it is not related to a business activity. Capital gains derived from the transfer of the above assets or rights. Income from derivative financial instruments except those used to cover a specific risk derived from a business activity. Financial, insurance and other service activities is CFC income under the same conditions as currently applicable, but the exclusion under which service income related to export activities would not be attributed to the Spanish parent is suppressed. The draft bill continues to set forth an exception for EU subsidiaries, pursuant to which CFC rules do not apply to subsidiaries resident in the EU provided that the taxpayer is able to prove that the incorporation and operations of the subsidiary responds to valid business reasons and that the subsidiary carries out an economic activity. The participation exemption regime under the draft bill and the CFC rules The draft bill provides that the Spanish participation exemption regime does not apply to capital gains derived from the direct or indirect transfer of non-spanish resident subsidiaries, where at least 15% of the income of such subsidiaries is subject to the above CFC legislation. It is important to note that the participation exemption regime allows a partial exemption for capital gains derived from subholding entities which in turn hold subsidiaries that are compliant and non-compliant with the relevant requirements. Moreover, should the relevant requirements not be met in one or several years of the holding period of the subsidiary, the participation exemption will be partially available to the capital gain derived from the subsidiary. Impact The new rules may have a significant impact on structures already in place, particularly, for groups which have CFCs deriving income that does not fall under the current rules but that would potentially fall under the scope of the new rules. Special attention should be paid to: CFCs lacking any type of substance, understood as appropriate human and material means devoted to the subsidiary s activity, either in the CFC or in other entities belonging to the same group CFCs deriving income from intellectual and industrial property, technical assistance, movable property, image rights, leasing and sub-leasing of a business or a mine IP CFCs deriving service income related to exporting activities, when the services are rendered to Spanish related companies and give rise to a deductible expense in Spain Structures involving any of the above entities should be reviewed in light of the new proposed rules. 3
In addition, although the new proposed rules continue not to apply to EU subsidiaries (in the terms explained above), EU structures should also be reviewed, bearing in mind the BEPS environment and the aggressive position that the Spanish tax authorities are currently adopting with respect to the valid business reasons for international structures. Finally, the amendments on the CFC rules would also have impact on the application of the Spanish participation exemption regime with respect to capital gains derived from the transfer of non-spanish resident subsidiaries since the draft bill makes the application of the participation exemption to capital gains arising from the transfer of shares in certain foreign subsidiaries dependent on compliance with (amended) CFC rules. Endnote 1. For background, see EY, Spain proposes amendments to the Spanish ETVE and participation exemption regimes, dated 12 September 2014. For additional information with respect to this Alert, please contact the following: Ernst & Young Abogados, Madrid Laura Ezquerra +34 91 572 7570 laura.ezquerramartin@es.ey.com Ernst & Young LLP, Spanish Tax Desk, New York José Antonio Bustos +1 212 773 8954 joseantonio.bustos@ey.com Cristina de la Haba +1 212 773 8692 cristina.delahabagordo@ey.com 4
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