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ATAD Implementation: Impact in Spain with a Focus on Holding Entities

ATAD Implementation: Impact in Spain with a Focus on Holding Entities

Find here the full transcript for the keynote speech at #TLTaxCon19 on ATAD implementation and its impact in Spain with a focus on holding entities. It was delivered by Brígida Galbete, a Senior Tax Associate with Cuatrecasas in Barcelona. 

Brígida Galbete: My name is Brígida Galbete and I'm a senior tax associate at Cuatrecasas, I’m a colleague of Jaume. Jaume already introduced Cuatrecasas, it’s one of the biggest law firms here in Spain and I would say that our tax practice is one of the strongest. And I've been practicing tax for the last 15 years.

So we were kindly invited by Mateo and his team to speak about the current developments in Spanish taxation. And I'm afraid that we have not had many of those developments in the last year. And the reason being mainly the political situation; as you may be aware, we had general elections in December 2018. As a result of those elections, it was not possible to form a government, so we have a caretaker government currently. And we will have new elections next November and the caretaker government made a few proposals for amendments to our tax system. Some of those proposals were remarkable in the field of corporate income tax. But we will have to wait until the formation of the new government to see those changes implemented, probably in 2020. So maybe we will have some topics for the next conference on these points.

But just to give you a brief idea of what those proposals are that we will probably see implemented next year. One of the biggest changes may relate to the participation exemption. In Spain, as in many other European countries, we have an exemption on dividends and capital gains deriving from qualifying shareholdings in operating entities. And, currently, this exemption is a full exemption, 100%, but there is a proposal to reduce this to 25%. This is in line with what is currently in place in other European countries such as France or Italy, as far as I know, and we'll see if this is going to be implemented. Apparently, this will be and how this will affect holding companies, if it will have any effect on holding companies.

I have to say that there is another remarkable development that has recently taken place. But this is not related to any actions made by the Spanish government, which is the entry into force of the new protocol to the tax treaty between the US and Spain. This protocol was negotiated between 2010 to 2013 and it was ratified by Spain in 2014, but it was blocked in the US until very recently, until I think a couple of months ago. So, we have this new protocol in place but, as I mentioned, this is not related to any actions carried out by the Spanish government, which had already ratified the protocol in 2014. And this is good news. The new tax treaty is good news because it foresees major changes. But one of the most important ones is that the withholding tax on dividends will be reduced from 10% to 0% if there is a qualifying shareholding of 80% or to 5% if there is a whole qualifying shareholding of 10%, which is a big change.

So, I'm going to focus this presentation on other proposals that have not been implemented yet, but will be soon implemented, which is in relation to the laws developing or implementing the Anti-Tax Avoidance Directive (ATAD), in particularly directive ATAD I. As you may know, this directive is in place since 2016. It was later on a mandate in July 2017 to develop a little bit further about hybrid mismatches, and in Spain, there was a bill for the implementation of this directive in our regulations that is still on hold. But, as you may know, most of the provisions in this directive are supposed to be implemented by all European Member States by the first of January 2019, so they should be already enforced. So, we expect that as soon as we have a new government this will be one of the first amendments to be included in our legislation.

So, I'm going to focus particularly on the impact of ATAD implementation on Spanish holding companies. So, we all know what is a holding company. But, basically, this is an entity, which has the main purpose of managing shares. And it's important to remark this is the management of the shares and not the management of the subsidiaries themselves, and this is very specific and it has been repeatedly stated by our tax authorities in several tax rulings. And this holding regime is really attractive because it has access to the mechanisms for the avoidance of double taxation such as the participation exemption. It has access as well to the tax treaty networks, and this is why jurisdictions that want to promote the holding regimes such as Netherlands or Spain itself are working hard in enlarging the net of tax treaties. In Spain, I think that we have more than 100 tax treaties in place. But actually in Spain it’s quite easy to obtain a certificate of tax residence for a company, it's just normal application and the tax authorities will not ask many questions when a holding company is requesting one of these certificates. And it also has access to the European regulations, to the parent subsidiary directives, to the interest and royalty directives, but also to all the outcomes from the European Court of Justice.

But particularly the Spanish holding regime is very attractive from the perspective of the shareholders because these shareholders will not be taxed in Spain for the dividends and capital gains that they obtain out of the holding company. And this is what makes the holding regime very attractive, unless the shareholders are tax residents in a tax treaty jurisdiction. So, in that case, these benefits will not apply and they will be subject to tax at the standard 19% tax rate.

So we find that these holding companies have a very attractive tax regime. Plus, it's relatively easy to incorporate, to have a holding entity, we can have a limited liability company in Spain up and running in an average of 15-20 days at maximum, and the cost of maintenance is relatively low because there is not much to maintain in a holding company. So this has given rise to the proliferation of holding companies in Spain in the last years, I will say that there has been, not a baby boom, but a holding boom in Spain. And the situation currently is that we have very few precedents of the tax authorities challenging the holding regime, the application of the holding regime to Spanish companies. I cannot recall any case law, any resolution that is really challenging the application of the holding regime to Spanish companies. However, we all feel that this may start changing. We are all aware that there is a change of paradigm in international taxation, that we live in the post-BEPS era, and that things start changing and that we have all these anti-tax avoidance rules and regulations coming into force.

So, particularly concerning the anti-tax avoidance directive: What does it address? How may it be implemented in Spain? How will this affect holding companies? Just to give you a preliminary flavor, in Spain, we already have an economic substance requirement in our regulations for holding companies. This means that an entity that is willing to apply for the holding regime, its corporate object must include management of shares, but it must include the management of shares with the adequate level of human and material resources, which means an adequate level of economic substance. This is already in our regulations, and it is important also to assess if a company may be considered a passive entity, because a company that is considered a passive entity cannot benefit from the holding regime.

So, we already have this in our regulations. What we don't have in our regulations is what an adequate level of substance means. What is enough, in practice, to be considered that a holding company can enjoy from the regime? What we see is that there have been some tax rulings and case law developing these ideas. And, basically, it is stated that human and material resources are needed, but mostly human resources are needed. This means that there must be someone who takes care of the management, someone who is committed with the management, someone who knows the business, mostly of the underlying subsidiaries, and who can be devoted to the proper management of the shares, not the company itself. This person can be an employee, but can also be a member of the board of directors, could be a director of the company. So if this person that has proper knowledge of the business and is engaged in the business is already a director in the board of directors, we do not need an employee or someone external to take care of those functions. And, basically, the functions that this person needs to take care of is to make sure that he's going to exercise the rights as a shareholder. So this basically mean the rights of attendance to the shareholder meetings, the rights of exercising the voting, the rights to receive the proceeds from the company, the rights to get information from the subsidiaries, and these functions cannot be delegated to third parties so it has to be someone in the company, either a director of the company or an employee who takes care of those functions. And so you can see that, apart from that, there is not much requested for a holding company in order to benefit from the holding routine.

So I would say that's the perspective from Spain, as a residence state, as the state where the holding company is a resident of. But the perspective may be a little bit more different if Spain has to assess if a foreign holding company to whom a Spanish entity distributes in dividends has substance enough to be considered as a holding company for the purposes of the tax treaty interpretation, for the purposes of the parents subsidiary directive. And there we can see that our tax administration, our courts are a little bit more demanding. So, they are not only focusing on the economic substance of the holding entity, but they are also focusing on the reasons why that holding company exists in the structure. Why this holding company has been put in place, in that it’s stricter. If there are commercial reasons behind or these are only pure tax reasons behind.

And this is connected to the next point, because we have seen this discussion, particularly when there have been dividends distributions for the Spanish company to the European parent entity. And because of the implementation in Spain of the parent subsidiary directive, those dividends are supposed to be exempt from taxation. But here we see that particularly with the courts, but there are also some resolutions from the tax administration and some tax rulings that are challenging some of the structures, and they are challenging some of these structures mostly based on the specific anti-abuse provision that we have when implementing the parent subsidiary retroactively.

So here we have a game of anti-abuse provisions that we need to be aware of. First, we have the general anti-abuse provision in our general tax law. This anti-abuse provision is mainly focused on fráu légis and sham transactions rules. And this general anti-abuse provision is older or was in our system long time before the general anti-abuse provision of the ATAD directive. So, we don't need to implement the ATAD directive from that point because we already have this in our system and, as you may know, the ATAD directive is a minimum level protection, so we don't need to make any amendment on that point. But we do not only have this general anti-abuse provision, but we also have the special anti-abuse provision for dividends distributed to a European parent company. In Spain, we implemented the parent subsidiary directive but we also introduced this special anti-abuse provision a long time before the parent subsidiary directive was amended in 2015 to include one. And, according to this general anti-abuse provision, if the majority of the voting rights of the parent company are in the hands of non-European entities, then the exemption on the withholding tax will not apply unless there are commercial reasons for the existence of the parent company and this parent company has an activity. The wording of the anti-abuse provision was changed because of the introduction of changes in the parent subsidiary, but we already had these in place.

So now the question is whether, when we have these dividend distributions for the Spanish entity to the holding European company, can the authorities challenge the exemption based on the general anti-abuse rules or will they will always go through the special anti-abuse rules? What we see is that they always go through the special anti-abuse rules because it's way easier for them. If they want to go through the general anti-abuse rules, they will have to follow certain procedures and there is a more burdensome procedure to be followed from the tax perspective. So, what we see is that they will always apply the special anti-abuse rules.

The thing that you may be aware of is that recently there have been released the Eqiom SAS and Deister and Juhler cases. And, basically, those were cases that challenged the application of the anti-abuse provisions in France and Germany. And those anti-abuse provisions for dividends payable from French and German companies to other European entities with very similar wording as the Spanish anti-abuse provision. And in those cases, basically, what the court says is that there cannot be an application of the exception, an application of the anti-abuse provision space of legal presumptions. And the fact that the ultimate shareholders are not residents in the in the European Union cannot be taken as a legal presumption of the existence of an artificial arrangement. And the fact that the holding parent company does not have a very active business cannot be taken neither as a legal presumption of the existence of an artificial arrangement.

After these cases, we thought that in Spain we were in a better position, we thought that there could be a change from the courts perspective, how to approach these cases of dividends distributions from Spanish companies to European holding entities that ultimately have a non-European shareholders. But the truth is that after the Eqiom SAS and Deister and Juhler cases, we have had the Danish cases on beneficial ownership. This takes us back to the situation that we had before. So later on, if I have time, I will address a little bit further these Danish cases on beneficial ownership.

Another set of rules that are going to be amended as a result of ATAD and that will have a direct impact on holding entities are the CFC rules. In Spain we already have a very extended regulation about CFC rules, but these will be amended to what ATAD proposes. And the first thing to notice is that these changes will affect corporations. We also have CFC rules for individuals, but the directive does not affect individuals but only to corporations. We will see if the modifications to the individual tax regulations will come later on.

From the CFC perspective, I am assuming that most of you are engaged in taxation, but maybe it's not the case. Basically, the CFC rules, what they propose is to allocate income that is obtained from the foreign controlled company straight to the shareholder, even though that income has not actually flowed up to the shareholder. So even if you don't touch the income, because you are supposed to have straight direct access to that income, you will be taxed as if you obtained that income.

In Spain, the model of CFC rules that we have implemented is the model according to which only 13 types of income will be considered as tainted income. Under this model, what we find is that because of ATAD, we are in the need of allotting the types of income that will be considered as tainted income. So now we will be including income from financial listings, insurance, banking and other financial activities that are not carried out as an economic activity, and we’ll be also including income from the sales of goods and services that are agreed with later parties when that related party has none or very little economic value in the transaction. We will also have to include changes in relation to the exceptions to the CFC rules. Currently, what our regulation says is that if the CFC companies located in the European Union, as long as it is incorporated for sound business reasons, as long as it carries out business activity, then the CFC rules will not be applicable. Wee will enlarge these to include not only European companies incorporated in the European Union, but also companies included in the European Economic Area. This includes Norway, Liechtenstein and Iceland but most importantly maybe the UK in the future. And this has been modified as well to consider that the CFC rules will not apply as long as this company carries on a substantive economic activity supported with staff, employees, equipment, assets and premises. So there is a more specific requirement about the level of economic substance that the foreign company needs to have in order to avoid the application of the CFC rules.

We will also include some rules that we don't have at this point in relation to the permanent establishment, because currently in our regulations if we have a Spanish company with a permanent establishment abroad and this permanent establishment is in a low tax jurisdiction, we don't have any rules that obliges to implement CFC rules in Spain. But with the new amendments what we will have is that Spain will not apply the exemption on the income obtained by the permanent establishment. So, this will be abolished as long as the permanent establishment is located in a jurisdiction with a low tax rate. Basically, a low tax rate for us means less than 75% of our corporate income tax, our corporate income tax is currently 25%. And these deviates a little bit from the ATAD directive, which foresees a rate under 50% of the corporate income tax. But again, the ATAD is a minimal level protection so it’s ok if Spain wants to raise that threshold a little bit.

Finally, and most importantly, and which may have an important impact if the envisaged changes to the corporate income tax finally are approved, we may have to change our CFC rules to include as passive or tainted income dividends and capital gains from shareholdings, no matter whether the shareholdings qualify or not for the participation exemption under the standard circumstances. And this is a major change because if we finally implement the limitation to the participation exemption up to 95%, this means that if we have a Spanish company with a subsidiary that we control and that obviously may be taxed on dividends and capital gains at zero rate because of the participation exemption regime in its particular jurisdiction, then in Spain we will consider that this is a low taxed income and, therefore, we will include this in our taxable income, in our corporate income tax. So this is a change that currently with the 100% participation exemption in Spain has no impact in practice, but this will have an impact if the government finally decides to reduce the participation exemption to 95%.

About our exit tax regime, we already have rules on the exit tax. This basically means if we have a Spanish company that is just changing its tax residence out of Spain, we will tax on the capital gains from the difference between the market value of the assets of this company and taxable spaces of this entity. But what we will do is to again align our provisions with the ATAD directive. So we will be enlarging these to include some other cases that currently we don't foresee in our regulations.

You may know that ATAD directive is also considering to tax or make subject to exit tax the transfer of the assets from the headquarters to a permanent establishment in a different state. In the case of Spain, we consider that because Spain will still keep the rights to charge on the income of the permanent establishment, then there is no need to amend that in our regulations. The ATAD also foresees the application of the exit tax when there is a transfer of the assets from the permanent establishment to another country and we already have these implemented in our regulations so no need to change. Also, in the case of transfer or change of tax residence, unless the assets are affected to permanent establishment, which we already have implemented.

But there will be some other cases to be included in our regulations. For example, when we have a permanent establishment in Spain of a foreign company and there is a transfer of the permanent establishment to another jurisdiction, then we will have to apply the exit tax, which we don't have this currently in our regulations. Also, when there is a change on the exit tax because of the transfer to another state of the European Union, then the ATAD directive rules a payment in five years in five installments. We currently have a deferral system. And what we will do is to change that deferral system for the five-year installment system, and currently the directive foresees to step up in bases. So, if the company that is transferring to another jurisdiction has been subject to exit tax in the state of origin, then we will consider that for the purposes of determining what is the acquisition cost of the assets of that company, which currently we don't have in place. And, by the way, this has been creating a lot of problems for interpretation until this directive was released.

Finally I would like to, because I think this is directly connected to this topic, talk briefly about the Danish cases on beneficial ownership. I don't know if you have, I can imagine that you may have heard about this, but I’m also going to talk about how we consider this from a Spanish perspective, what the impact can be in Spain.

These are the cases. I'm not going to enter into the details of these but basically these are four cases for interest and two cases for dividends. The cases for interest were all dealt with in one single court resolution. In the case for interest, what we see is that we have these schemes, as you see on the screen. Basically, as you can see, there are payments of interest by Danish companies out to other entities in the European Union, but that are finally directly held by known European residents. So in the first case that you see on the screen, what we have here is that there were five private equity funds that have set up a group of companies which acquired an 80% of a Denmark entity, and none of these private equity funds were tax resident in the EU or in any countries that had a tax treaty with Denmark. Then the Luxembourg entities that you see on the screen on the left part issued bonds or preferred equity certificates that were subscribed by defense and the margin in Luxembourg for those were below 0.05%. Also, these Luxembourg entities have three part time employees.

Another of the cases refers to several private equity funds that invested in Luxembourg through a SICAR, which is a regulated vehicle and the SICAR participating in a Swedish holding company, and through another Swedish entity participated in a Danish operating company, and the funds came from the SICAR through Sweden to Denmark and, as you know, the SICAR is a regulated entity that has a fiscal regime, which includes exemption on the interest.

The third of the cases relates to a US business group that initially participated in a Danish entity through a holding company resident in Cayman. And in 2004 it carried out a number of business restructurings under which the shares in the Danish company were transferred to a Swedish company.

And the last case, there were four private equity funds organized under Jersey Limited Partnerships acquiring 66% of the capital of a Danish industrial group. This purchase was executed with the participation of a Luxembourg company that in turn financed the Danish group with a margin of less than 1%.

These are the cases related to the interest and you can see that they have many elements in common. The cases related to the dividends, the structure is very similar. At the end of the day, what we have is non-EU investors participating indirectly in Danish operating companies and again we have distribution of income up to the chain of companies that is not subject to tax in Denmark by application of the Danish provisions. Basically, what is discussed in these cases is: What is the interpretation of beneficial ownership under the European law? And what are the elements to appraise the existence of abuse of rights? Where is the burden of proof or where does the burden of proof lies? And what is the role of the application of the freedom of establishment and the free movement of capital in all these?

In relation to the beneficial ownership, in the case of interest, what has been stated by the courts in a very brief way is that the requirements of the beneficial owner in the interest royalties directive has to be interpreted in line with the OECD. So, even if there is no beneficial ownership, this means that basically if there is not a beneficial owner in the European Union, then the benefits of the directive cannot be granted. And this applies even though there is not an explicit concept of beneficial ownership in the regulations of the state shores, within this case, it’s Denmark. In Denmark, there is not such a provision of beneficial ownership, but there is a general anti-abuse provision that talks about the real income recipients doctrine.

So, how does this affect in the case of dividends? Well, in the case of dividends, the courts do not address the concept of beneficial ownership directly and this is because such a concept we cannot find in the parent subsidiary directive. However, what they say is that the lack of domestic rule against abuse does not affect the obligation of a member state to deny the benefits of directive, because the objective of the directive is to avoid the double taxation within a group of companies in the European Union. And these mechanisms of the parent subsidiary directive cannot be applied or were not conceived to be applied when the beneficial owner is not in the European Union.

So, what are the elements that need to be appraised in order to consider that there is an abuse of rights? This has been better developed in the cases related to the interest. In these cases, there is an objective element that needs to be considered, which is the formal observance of the conditions of the exemption, which achieves a result that is contrary to what is the purpose of the directive. And the results are a subjective element and both have to be appraised together, which is the way of obtaining a profit through an artificial creation of conditions. And there are a number of indications or evidences in order to evaluate if there is such a subjective element.

For example, in the case of the interest, whether there is an immediate transfer of the interest income from the recipient through the chain of companies, whether there is an insignificant margin of interest that is subject to tax. And whether there are changes in the corporate structures that are close to amendments in the local regulations with, well obviously, shows the intention to create an artificial arrangement in order to avoid the application of those changes. And what is also important is that, according to the court, the burden of the proof lies on the taxpayer that wishes to benefit from the provisions of the directive, from the provisions of the domestic exemptions. And the authorities, the tax administration doesn’t have the obligation to identify who is the beneficial owner instead of the company that is trying to apply those benefits. And I think that this is very relevant change of mind-set if compared to the Eqiom cases.

How may this be applicable in Spain? Well, what we find is that in the case of interest, we have an exemption on withholding tax on interest payable to European companies. And this exemption is not because of the transposition, implementation of the interest royalty directive but this is previous to that. We see also that we don't have a concept of beneficial ownership in that rule on the exemption on interest. So this leads us to think that if the tax authorities want to challenge the application of the exemption on interest payable to European entities, whether inside or not of the group, they need to go through the general anti-abuse provisions, which are, as I mentioned before, the fráu légis or the sham transaction rules, which need to follow a very specific procedure.

However, this gives us some reasons to be optimistic. What we have seen as well is that the Spanish courts in the case of tax treaty with Switzerland that does not have a beneficial ownership concept, the court has challenged the application of the exemption based on the tax treaty by applying a concept of beneficial ownership that is not existing in that tax treaty in particular. So what we see as well is that there is a lot of uncertainties, it is not certain how the courts can treat these cases in the future. But, of course, the general environment that we are living does not help to be optimistic.

What we see in the case of dividends is that, as I mentioned, we implemented an anti-abuse provision that was very similar to the French one and the German one in the end. And in the case of Eqiom and the Deister and Juhler cases, these provisions were challenged by the European Justice Court.

However, we see as well that the Spanish administration has been applying these special anti-abuse provision in a very automatic way. And we thought that, thanks to these Eqiom cases, we would be able maybe in the future to be more optimistic in applying the withholding tax exemption on dividends. However, we see now the Danish case, and we don't think that we can be that optimistic. So we have to be very cautious in in this kind of cases. I think the conclusion is that what we already know, but we don't get tired of repeating, which is things are changing. Things are changing faster than we expect, even though we have elections in between and we have to get ready for those changes and maybe it's a good time to revisit some of the structures and to make some thoughts and have some discussions on this.

Question from the audience: In the area of citizenship by investment and residency by investment, there's a lot of discussion on pre-immigration planning. I never see, in the articles that are written on this, a check to see on whether there are CFC rules. It seems to be fairly obvious from what you've been saying that you should check to see if there are CFC rules before acquiring tax residence in Spain. It's obvious that anybody moving to Spain to acquire tax residence who has a corporation in their home country need to be wary of the CFC rules.

Secondly, could you, in simple format, describe the exit tax rules for individuals who break tax residence with Spain? Say somebody is a tax resident of Spain, they have assets, I'm understanding from you there's an exit tax regime in place, if they were to move to Canada or American, how is that tax calculated?

Brígida Galbete: Okay. If you're talking about individuals being a tax resident in Spain, moving outside of Spain, yes, we have an exit tax as well. And this exit tax applies, first, if you have been tax resident in Spain for at least 10 years in the last 15 years, so it may not apply in all the cases. And also it applies if, for example, in the case of investments, you have shareholdings with a market value that in total is at least 4 million Euros, or individually considered is at least 1 million Euros if you have at least 25% on that. And basically the tax is calculated by the difference between the market value at the moment you exit and the acquisition cost, so it's like a transfer. It doesn't tax pensions, no.

Question from audience: For somebody who, say, moved to Spain 15 years ago and brought assets with him at that time, what is the basis for the calculation of the exit tax, the fair market value when they arrive in Spain or when they purchased the asset?

Brígida Galbete: That's a good question. What is the acquisition costs when you are acquiring the residence? Well, there are no clear guidelines. Actually, we don't have a step-up rule, not even for cooperation, which I think is the basic one. So I think that it may depend on how you brought those assets into Spain. But my first reaction would be, I don't think you can consider there is a step-up in basis for that. But I think that it also depends on the type of assets that you're thinking of.

Question from audience: Coming back to your point that Spanish courts will treat the fact that the beneficial owners of a holding company are outside of the EU that's already sufficient evidence of abuse unless there is some proof to the contrary of sound economic reasons or anything along these lines. Has there been any court practice in Spain on what constitutes sufficient counterevidence that might allow someone to argue that the tax residence should apply?

Brígida Galbete: Case-by-case analyses, yes, there have been a few cases on that. And it very much depends on whether you can explain the reason why the entities… so basically, because it has been used as a vehicle for investments in other entities as well, so it is used as a holding company not only for the specific purposes of that investment, but also it makes sense geographically maybe to have all the investments in the European Union through a Dutch company. We have seen that. It also depends on the time, whether it was a structure that was in place even before we already had all these rules. This can be considered also as evidence that the structure was obviously not incorporated because of the purposes of avoiding rules that didn't exist at that point in time. And also if this is a jurisdiction that allows to apply and incorporate regulations that we could not apply if doing this investment directly, if there are other shareholders, if this structure helps you to kind of have an easier way to have the relationship with the other shareholders and regulate the corporate aspects amongst them. And there are a few aspects to be considered again, case-by-case analysis, bring us the case and we will analyze it for you.

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