In more detail
How does the tax neutrality regime work in Spain?
The Special Regime for Mergers, Spin-offs, Asset Contributions, and Share Swaps (FEAC Regime) allows the deferral of taxation on latent capital gains in restructuring operations, provided that valid economic reasons exist and the reorganization is not a tax driven decision. This regime is essential to facilitate corporate restructurings without immediate tax burdens. In this regard, this special tax regime was implemented so that taxation is neither a stopper nor an incentive to proceed with restructurings. The FEAC Regime applies automatically and only needs to be notified to the Spanish Tax Authorities when a restructuring transaction is carried out. The existence of valid economic reasons does not need to be proven before applying the FEAC Regime, but this requirement can be revised in case of tax audit and it is an essential aspect of the restructurings.
What is the new interpretation from the TEAC in order to apply the FEAC Regime?
The TEAC resolutions focus on non-monetary contributions of shares from an operating company, where undistributed profits (reserves) were accumulated, by an individual (the shareholder) to a holding company (normally, the family business) applying the FEAC Regime. In the cases analysed by the TEAC, it was observed that there were no clear valid economic reasons to carry out these transactions. The primary presumption is that the main objective behind these restructurings is to obtain tax advantages. Specifically, the distribution of dividends from the operating entity to the holding entity, or the future sale of shares of the operating entity, would qualify for the participation exemption regime. This regime allows for significant tax benefits, as both capital gains and dividends distributed would be 95% exempt from taxation in the holding entity. Therefore, the application of the participation exemption regime results in a substantially lower effective tax rate. Under this regime, all capital gains and dividends are taxed at an effective rate of 1.25%. This is in stark contrast to the maximum tax rate of 28% that would apply if the sale or distribution of dividends were made directly by the individual shareholder, rather than through the holding entity.
When it comes to the facts surrounding these cases, the holding companies incurred into extraordinary expenses for the benefit of their sole shareholder and made investments into financial products for the benefit of their sole shareholder. Additionally, these holding companies did not engage in any different business activities where they could reinvest the dividends received from the operating companies.
Given these circumstances, the TEAC has determined that the FEAC Regime is not applicable. Instead of regularizing the deemed capital gain on the contribution of shares to the holding company in the fiscal year of the contribution, the TEAC calculates this capital gain and attributes it to the shareholder as the tax benefit from the contribution materializes. For example, when the operating company distributes reserves generated prior to the contribution as exempt dividends to the holding company, this amount is taxed at the shareholder’s level as part of the capital gain on the contribution. If the tax benefit arises from the sale of shares, the capital gain is taxed in the fiscal year of the sale, always limited to the amount of the tax benefit obtained under the Spanish participation exemption regime.
Following these new resolutions, the Spanish Tax Authorities have adopted a very restrictive interpretation. They have initiated tax audits to scrutinize these non-monetary contributions and aim to tax the deferred capital gain based on the tax advantages obtained post-contribution, thereby overriding the application of the Spanish participation exemption regime.
What do these new resolutions from the TEAC imply?
The novelty of these resolutions lies in their allowance for the Spanish Tax Authorities to regularize the capital gain obtained from the contribution based on the tax advantages derived from these operations (dividend distributions or sales) indefinitely. This approach disregards the Spanish statute of limitations of four years, meaning that operations can be reviewed indefinitely, regardless of whether they are statute-barred due to the focus is the year when the tax advantage is obtained instead of the year of the share´s contribution. This creates significant legal uncertainty for taxpayers.
In addition, the Spanish Tax Authorities have adopted a very strict and aggressive approach of these new resolutions. They are even regularizing non-monetary contributions where valid economic reasons were double-checked through a Binding Ruling with the Spanish Directorate of Taxes and which have no connection to the background of the TEAC resolutions. This includes situations where the holding companies had a different business purpose than the operating company and no expenses or investments were made in favour of the sole shareholder.
Strategic considerations
This new interpretation from the TEAC of restructuring transactions and the application of the FEAC Regime has important implications:
- Review of structures: It is crucial to review current structures and be conservative with dividend distributions post non-monetary contributions of the shares until this aggressive interpretation from the Spanish Tax Authorities on the TEAC's resolutions is assessed by Spanish Courts.
- Economic justification: Ensure that all restructuring operations have a solid economic justification to apply the FEAC Regime and keep sufficient documentary support to build the arguments in case of a potential tax audit. It is crucial to ensure that these transactions are backed by valid economic reasons to withstand scrutiny from tax authorities.
- Litigation: We are taking numerous cases to court to appeal against the disproportionate interpretation of the Spanish Tax Authorities, which undermines the FEAC Regime.
- European legislation: There is even a complaint filed by the Spanish Association of Tax Advisors (AEDAF) at European level, arguing that Spanish legislation contravenes the European Directive because of the broad concept of tax fraud or tax abuse in the context of this special regime, making it difficult for taxpayers to apply the FEAC Regime and creating legal uncertainty. To conclude, The TEAC resolutions underscore the need for careful planning and justification of nonmonetary contributions of shares within family businesses. As such, we must be prepared to build a solid defence on the FEAC Regime application and adapt to an increasingly complex and scrutinized tax environment in the context of Spanish tax audits and subsequent litigation.
