On Dec. 31, 2020, Spain’s State Budget Bill for fiscal year (FY) 2021 (the Budget Bill) was published in the Spanish Official Gazette after its prior approval by the Spanish Congress and Senate.
The Budget Bill entered into force on Jan. 1, 2021; specifically, with respect to the amendments for corporate income tax (CIT) purposes, the Budget Bill establishes that it enters into force for fiscal years beginning on or after Jan. 1, 2021.
The Budget Bill includes a number of tax measures aimed at increasing the tax revenues for FY2021. One key corporate provision reduces the participation exemption for dividends and capital gains earned by Spanish resident entities from 100% to 95%.
Amendments to the participation exemption regime for dividends and capital gains
The exemption applicable to Spanish tax resident entities earning dividends and capital gains from domestic and foreign qualifying subsidiaries is now limited to 95% of the income. The new law treats 5% of this income as non-deductible expenses.
Given that the standard CIT rate in Spain is 25%, the effective tax rate on dividends and capital gains derived by Spanish companies increases from 0% to 1.25% (5% non-exempt income multiplied by the 25% statutory tax rate). This 5% addback also would apply to dividends and capital gains generated within a Spanish tax group.
As a result of this amendment, all other provisions dealing with the avoidance of double taxation foreseen in the CIT Law are amended accordingly. In particular, the tax credit used to avoid double taxation for dividends and capital gains received by Spanish entities and the Spanish domestic exemption for European Union shareholders obtaining Spanish-sourced dividends or capital gains.
The new rules include a narrow exception for companies that are not part of a group and have a turnover of less than 40 million euros. These smaller entities are allowed to fully exempt dividends received from wholly owned subsidiaries formed on or after Jan. 1, 2021, but only during the three years following their incorporation year.
The Budget Bill also amends the minimum participation requirement such that the participation exemption will apply only if the Spanish holding company owns more than 5% in the relevant subsidiary and the investment cost is higher than 20 million euros. These specific amendments will come into force in financial years starting on or after Jan. 1, 2026 after a five-year transition regime, applicable if the subsidiary is already held before Jan. 1, 2021.
Finally, the Budget Bill also affects ETVEs (Spanish holding companies), but only with regards to the application of the participation exemption.
U.S. multinationals may experience an increase in the global effective tax rate, which may be significant if there is a chain of companies (e.g. Spanish holding, Spanish sub-holding, Spanish operating company, etc.) with a 1.25% tax resulting on each dividend distribution up the chain. Therefore, it is important for U.S. multinational groups to review their existing Spanish structures in order to mitigate such impact.
A U.S. multinational with Spanish subsidiaries in its structure, particularly a structure including a Spanish holding company, should review the anticipated transactions between the Spanish subsidiary and the Spanish subsidiary’s lower-tier entities to determine the impact that these changes may have on the multinational’s global effective tax rate. For example, a U.S. multinational’s Spanish holding company may not have established a deferred tax liability (DTL) for repatriated earnings in non-Spanish subsidiaries. Now, if material, the Spanish holding company may need to record a DTL to reflect dividends no longer exempt from Spanish CIT. This could potentially negatively impact the U.S. multinational’s global effective tax rate
Spanish CIT and territorial differences in the country
It is important to note there are two significant and attractive regions for businesses in the north of Spain that have special tax regimes given that they have the power to issue their own tax rules: the Basque Country (comprising the provinces of Álava, Guipúzcoa, and Vizcaya) and Navarra. The Spanish Constitution recognizes the right of the Basque Country and Navarra to legislate in tax matters and levy their own taxes separate from those that apply in the rest of Spain.
However, the regional governments have not introduced any amendments to their full participation exemption regimes. Furthermore, the CIT of the Basque Country legislation sets forth a very interesting tax scenario for holding companies. Basque regulations compare favorably with the regulations applied in the rest of Spain and in most other European countries.
In view of the above, it should be noted that the limitation of the exemption for dividends and capital gains from domestic and foreign subsidiaries from 100% to 95% established by the Spanish central government is not applicable in the Basque Country and Navarra. Consequently, companies based in the Basque Country and Navarra (i.e. having its legal domicile in such regions) will continue to benefit from the 100% exemption on dividends and capital gains.
Next steps and implications to U.S. multinational companies
Given the potential impact that some of the measures will have on structures with a Spanish holding company, multinational groups should review their structures and ongoing transactions to determine, not only the potential practical implications, but also the alternatives and timing potentially available to mitigate them.
