It is still too early to ascertain all the legal and tax consequences arising from the UK decision to leave the European Union (“EU”). But for sure the Brexit is going to impact the tax status of UK citizens living in Spain, either temporarily or permanently. The final impact would depend very much on the outcome of the negotiations between the EU and the UK, so many scenarios are still possible. In this article I shall be assuming a quite pessimistic approach, which is that a full exit takes place, whereby the UK becomes a third country in respect to the EU to all legal effects. . I will focus in this article on the implications regarding the Inheritance and Gifts Tax.
In Spain, the Inheritance and Gifts Tax (“IHT”) has a dual system. Thus, we have two sets of legal sources, the general state law and the regional regulations. The general state law applies to non-residents, while the regional regulations apply to residents in Spain. Although it can be somehow challenging in some cases determining the applicable law, the general rule is that the Law ruling the taxation of an inheritance or gift is the one where the tax payer lives.
In most regions inheritance by close relatives of the deceased (namely, spouse and children) is not taxable or only taxed lightly due to numerous exemptions, allowances and reliefs. However, if the deceased or / and the heirs are nonresidents, all these tax reliefs are not applicable, resulting in the inheritance being fully taxed with respect of the assets of the deceased located in Spain.
Therefore before the 1st January 2015, regional regulations (applicable only to residents in these regions) were much more beneficial to the taxpayer than the State regulations (applicable to non-residents) which entailed discrimination between European residents and non-residents. In view of this fact, the European Commission sued the Kingdom of Spanish before the Court of Justice of the European Union. The Court (case C-127/12) ruled that Spain had breached the European Treaty (article 63 of the EU Treaty and also 40 of the EEA Treaty) by discriminating nonresident tax payers.
As a consequence of the Court decision, Spain had to change his legislation so that inheritance or gifts involving other EU and European Economic Area (EEA) – Iceland, Liechtenstein, and Norway- member states residents are currently treated exactly as if the tax payer were resident in Spain. In other words, EU / EEA residents can avail from the allowances and reliefs stablished in the regions where their properties are located, when they let such properties to their spouses or children. The Court decision also opened the floodgates for thousands of claims of refunds to the Spanish Tax Office for the IHT already paid by EU / EEA residents, because the rulings from the European Court of Justice had a retroactive effect.
It is noteworthy saying that the legal change introduced in Spain in 2015, which still prevents residents of non UE /EAA member states from enjoying the tax benefits established in the regional regulations, may not be fully compliant with the Court decision. Articles 63 of the EU Treaty and 40 of the EEA Treaty, which declare the freedom of movement of capitals, extend this basic freedom also to nonmember States, albeit with some limits. However, at least in the short term, it does not appear that the Spanish Authorities are even going to consider broadening the scope of the legal change to include residents of third countries.
Considering the above it is clear that, following the UK exit from the UE, UK residents could no longer enjoy the tax treatment awarded by the Spanish legislation to residents in other EU /EEA member states. The general state Law would be applicable to them, as it was before 2015, triggering full taxation of their inheritance or donations to their spouse and children.
However, things may not be as bad. Firstly, one of the base exit scenarios is that the UK joins the EEA. Then, the Brexit would not have any material effect on the IHT, since EEA citizens also enjoy the same tax treatment as Spaniards. Secondly, many UK citizens owning properties in Spain are actually living in Spain most of the time (pensioners, in general), so they have become residents in Spain for tax purposes. These tax payers would also remain unaffected by the Brexit – in this particular issue- because tax matters are driven by the residence status and not for the citizenship. In other words, UK citizens who are resident in Spain can enjoy exactly the same tax benefits than the rest of the resident tax payers. And finally, since the Brexit can take quite a lot of time to materialize, UK home owners have time ahead to plan and prepare for the worst, if this were to happen. Some tax planning strategies can be, and may be should be, put into place to reduce the hypothetical tax impact of the Brexit.