Impairment losses of investments in subsidiaries disallowed for tax purposes

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The Government has proposed a new bill, which will come into force retroactively as from January 1st, 2013, which will disallow the deduction of Impairment losses of investments in subsidiaries, once passed by the Parliament.

Currently, the investment in a subsidiary, either domestic or foreign, must be tested for impairment every tax period. If the tax basis of the subsidiary for the parent company exceeds the net asset value of the former, a tax deductible loss can be claimed by the latter. This tax deduction is independent from the accounting loss that eventually the parent may have registered in its books. For accounting purposes the impairment is ruled by IAS 39 which basically compares the carrying amount of the sub and the present value of expected future cash flows discounted using the current market interest rate.

To avoid double computation of losses, once at the subsidiary level and again at parent company level – indirectly through the impairment loss- the new bill just disallow the tax deduction of every impairment loss derived from investment in subsidiaries. As a consequence, the loss at parent company level is deferred until de sub is wound up or sold. To avoid aggressive tax planning, several anti – abuse measures are adopted. For instance, the loss motivated by the sale of a company to other group company is also deferred until that company is subsequently sold to a third party not belonging to the group.

Obviously the reversal of impairment losses of previous years will not be taxable.

This new regulation is intended to enhance the tax revenue form Corporation Tax and affects primarily to large Spanish multinational groups (Telefonica, Santander…) whose effective tax rate was as low as 8 %, meanly due to the effective use of impairment losses. However, a side effect of the measure is that it deprives Spanish Holding Companies of one of the advantages it had over other Holding Companies. Spain was one of the very few countries that allowed the deduction of interest expenses and impairment losses linked to investments in foreign subs, while at the same time declaring exempt dividends and capital gains derived thereof.