As from January 2017 the participation exemption regime has been modified. Before the legal change, Spain was one of the few countries with an asymmetric treatment of gains and loses derived from the sale of shares of qualifying subsidiaries. While the gains arisen on the sale of such subsidiaries were exempt, the losses were allowed for tax deduction.
Before 2013 the regime was even more generous, since even unrealized losses (i.e. impairment losses) were allowed for deduction.
The new tax treatment has restored the equilibrium, as from January 2017 the losses arisen on the sale of qualifying subsidiaries are no longer deductible for tax purposes. However, the losses experienced on the sale of non-qualified companies are allowed for deduction, since the capital gains would also be fully taxable. The rule is therefore quite simple and logic: capital gains or losses arisen from the sale of qualifying subsidiaries have no tax effect at all; capital gains or losses arisen from the sale of non-qualifying subsidiaries have full tax effects.
For instance, if a Spanish parent company sells his 5 % stake on a foreign subsidiary which is subject to taxes (at least at a nominal tax rate of 10 %), the hypothetical gain or loss experienced would not have any tax impact. The gain will be exempt or the loss would not be allowed for tax deduction.
However, this apparently logical regime has a hidden surprise, were the asymmetric tax treatment persists, but for the worse. We refer to the case of foreign subsidiaries located in low tax jurisdictions subject to a nominal tax rate below 10 %. If the Spanish parent company has a substantial ownership in the low tax jurisdiction sub (participation of at least 5 %), then the capital gain would not be exempt, but the hypothetical loss could not be deducted. If there is a profit the tax payer must pay the tax, but if he has a loss it is not allowed for deduction.
This new tax surprise is somehow tempered by a more flexible approach to the losses arisen on the liquidation of subsidiaries. With the new rules, this loss can always be deducted, although dividends received during the ten years period preceding the liquidation will reduce the amount allowed for tax deduction, as long as these dividends were exempt.
The interaction of these two rules give some room for tax planning. If a Spanish company has a loss-making subsidiary in a low tax jurisdiction and has an offer for the company, it should consider selling the foreign underlying business, rather than the shares. Once sold the assets of the subsidiary, the latter would be wound up and the loss taken by the Spanish Parent company.