Foreign business selling goods or services to Spanish customers only have to pay taxes in Spain if they have a Permanent Establishment in Spain. One of the main legal vehicles to do business in Spain is through a branch. Generally speaking a branch would be considered a Permanent Establishment. In this article we discuss the tax implications of setting up a branch in Spain
Is the branch a Permanent Establishment in Spain
According to the Spanish domestic legislation a branch of a foreign company is considered a Permanent Establishment in Spain. Therefore, it is a taxable entity and the profits attributable to the branch shall be, in principle, subject to the Income Tax. In this respect, Spain follows the “separate entity approach” whereby the branch is taxed as if it were a completely separate entity from the head office. However, this principle is not always followed consistently, as we will see below.
Read on to learn more about the profits attributable to a Spanish branch
A branch can be engaged in any business activity, like manufacturing, trading, providing services or can only be a registered entity without any actual activity. Sometimes, foreign entrepreneurs set up a branch in Spain to facilitate the opening of a bank account, getting a Customs Number (called EORI) or getting an EU- VAT number. In some cases, the branch is engaged in a business which is the core business of the company it belongs to, but in other cases the branch is devoted to auxiliary or preparatory activities, like keeping merchandise for display, storage or delivery of goods.
When the head office is located in a country which has signed a Tax Treaty with Spain it is important to determine what kind of activities the branch is performing. It these activities are deemed to be of preparatory or auxiliary character, then according to the wording of article 5 of all the Tax Treaties signed by Spain, following the OCDE Model, the branch will not be considered a Permanent Establishment. Of course, if the branch is not involved in any particular trade, that is, it is only a registered entity, the same principle applies.
However, when there is not a Tax Treaty protecting the foreign head office, the Spanish domestic legislation does not exclude branches engaged in auxiliary or preparatory activities from being considered a Permanent Establishment. Since these activities are not normally income generating, the Spanish Law contains a particular provision to determine the taxable base. Thus, the taxable base is 15 % of the cost incurred by the branch plus any passive income obtained (interest, royalties, capital gains).
The distinction between core business and auxiliary activities is crucial to determine the existence of a Permanent Establishment.
It is generally accepted that the core business of any company is focused in the sale event. So if a branch is engaged in selling activities or in any other activity directly supporting the sales of the head office its activity would be a core business activity. On the contrary, activities carried out before the sale (market research, advertising, storage…) or after the sale (delivery, invoicing, managing receivables, technical support…) could be considered of auxiliary character. However, there is a grey zone in which the existence of a Permanent Establishment is arguable. For instance, receiving and handling orders, making repairs, test of machinery and marketing activities are often viewed as core business activities determining the existence of a Permanent Establishment.
Profits attributable to a branch in Spain
When the branch is involved in core business activities it is considered a Permanent Establishment and the profits attributable to it are taxable in Spain. The taxable base is determined according to the accounting records of the branch, which is obliged to keep a separate accounting system to register the transactions of the branch. In Spain the deduction of any payment made to the head office (notional interest on internal loans, royalties, rents or management services) is strictly disallowed. I this regard, Spain adhere to the principle that no expenses can arise within the same legal entity.
The prohibition is rather strict; contrary to other jurisdictions, interest paid on third-party loans borrowed by the head office are not deductible for the branch, even if it can be showed that the proceeds of the loan have been used to finance the activities of the Spanish branch.
When the head office transfers merchandise to the Spanish branch for the sale of the latter, it must be valued at fair market value, that is, not only at cost but including a reasonable mark up. As already said, if the head office transfers a fixed asset to the Spanish branch, any payment for the right to use that asset is disallowed, but the branch could claim a depreciation allowance. The fixed asset would be valued for depreciation purposes at fair market value.
When the branch transfers merchandise or any other asset to the head office or other foreign branch, it must recognize an immediate profit for the difference of the cost and the fair market value, even if the asset has not been sold to a third party. This is very controversial, since clearly an internal transaction within the same legal entity should not be taxed. Recently, this rule has been amended with regard to head offices (or other branches) located in other EU members. In these cases, the transfer will be taxed only when the asset is sold by the recipient entity to a third party.
Although internal payments to the head office are disregarded for tax purposes, the Law allows that a reasonable proportion of the general and administrative expenses of the head office are attributed to the Spanish branch. This allocation must be based on the turnover, direct cost or investment in fixed assets, whatever it is decided by the tax payer, but he criterion selected must be maintained consistently.
Permanent Establishments of foreign entities located in Spain are taxed on their worldwide income, although they can apply the foreign tax relief in the same way than Spanish corporations. Note that the Spanish branch of a foreign company cannot benefit from the Tax Treaties signed by the Kingdom of Spain, since it is a nonresident entity.
The tax rate applicable to a branch is the standard Corporate Income Tax rate, which currently is 25 % . Also the Law contains a 19 % withholding tax on the remittances of profits to the head office, but this tax is not applicable to EU head offices or where a Tax Treaty applies.
How to set up a branch in Spain
Branches do not have a legal personality different to that of their home office. Thus, the branch liability exposure extends to its parent by operation of law.
The legal requirements to set up a branch are minimal:
- Corporate enterprises may open branches at any location in Spain or abroad. The opening of a branch by a foreign company requires the execution of a public deed, which must be registered at the Commercial Registry. Together with the deed it must also be registered the following documents: those evidencing the existence of the head office, the current by-laws, its directors and the decision to open the branch.
- It must have a legal representative who is empowered by the head office to administer the affairs of the branch. Apart from this requirement there are no formal governing or management bodies.
- It must have an allocated capital, which is not subject to any minimum amount requirement.
- It must prepare the Annual Accounts related to the branch’s activities and file them in the relevant Commercial Registry.
Aside from the obvious differences in terms of internal structure and organization, a branch operates much like a company in its dealings with third parties.
The main differences between a branch and a subsidiary are the following:
- Branches do not have a legal personality.
- There is no minimum capital.
- Non-monetary contributions can be made freely.
- A branch does not have a decision-making body in the form of a board or meeting, since its legal personality is that of the parent company.