A word of caution: since this article was written in October 2013, many legal changes have taken place, as is common with tax matters. In particular,in 2015 the Spanish Corporation Income Tax experienced a major overhaul as a consequence of the Law 27 /2014. Therefore, some matters included in this post many no longer be in force. Having said that, the new Corporation Tax Law of 2015 kept the basic features and the structure of the former Law, so you if you just want to have a grasp and basic understanding of the Spanish Corporation Tax you will find this article informative and useful.
I strongly recommend that you read our post about the changes introduced by the Law 27 / 2014, which came into force in January 2015, in the our post about the changes in the Spanish Corporation Tax reform of 2015.
The corporation tax is a direct and personal tax that is levied on corporate income. Applies throughout the Spanish territory, without prejudice to the special regimes of the Basque Country, Navarra and the Canary Islands.
More info: read about tax regime of the Canary Islands
Taxpayers must meet two qualities:
- Corporation Tax only applies to legal persons, except partnerships . Therefore, individuals are not subject to this tax, but to the Personal Income Tax. However, certain entities without legal personality: Mutual Funds, Pension Funds, Private Equity Funds, are subject to the Corporation Tax as well.
- Only legal persons resident in Spain are liable to this tax. In other words, non resident corporations or legal entities are not subject to the Spanish Corporation Tax but to the Income Tax for Non-Resident Tax Payers.
In this respect, a corporation is deemed to be resident in Spain if any of the following criteria applies:
- They are incorporated according to the Spanish laws
- Their domicile (i.e. registered office) is situated in Spain.
- The center of effective management is situated in Spain (place where lies the management and control of all its activities).
As an anti – abuse measure, when an entity is resident in a tax haven (that is, it is included in the black list of tax havens) it may be presumed, unless and otherwise probed, that such an entity is resident in Spain in the following cases:
- When their main assets, directly or indirectly, consist of goods located in Spain or rights that are to be exercised in the Spanish territory.
- When its main activity is developed in the Spanish territory.
The general rule is that the tax year shall coincide with the accounting year of the entity, but may not exceed 12 months.
However, there are a few special rules. The period shall expire in any case:
- When the organization is expired or wound up
- Where there is a change of residence of the entity residing in Spanish territory to abroad (exit tax)
- When the legal transformation of the organization takes place
Note that if a company moves to other territory, it shall be taxed on non realized capital gains. This special tax treatment has been challenged by the European commission, at least when the company moves to other EU member State.
Read more: exit tax challenged by the European Commision .
The Corporation Tax return must be lodged within 25 calendar days after 6 months after the conclusion of the tax period. In the general case, where the tax period coincides with the calendar year, the declaration for the tax must be filed between th 1 and 25 July of the following year.
As a general rule, the Corporation Tax taxable base is the profit (or loss) before taxes determined applying the general admitted accounting principles, reduced by the compensation of tax losses from previous years. Therefore, the profit or loss is the difference between revenues and expenditures of the tax period. Revenues and expenses are assessed following the accrual method, as opposed to the cash method.
Income and expenditure are recognized for tax purposes when registered in the accounting records. However, the Act exempts certain items from this principle: For example, depreciation of assets associated with R & D or of goodwill. Likewise, in long-term credit sales, the tax on the profit derived from these transactions can be deferred until the sale is cashed.
In general, income is determined according to accounting rules. However, certain items are excluded from taxation. Particularly, dividends received from Spanish and foreign subsidiaries or capital gains from the sale of shares in these subsidiaries, provided the parent company owns an interest of, at least, 5% of the share capital. Likewise, profits from foreign permanent establishments are exempt providing certain conditions are met.
60 % of the net income (ie,gross income minus expenses) from certain intangible assets (patents, plans…) is exempt.
Read more: the Spanish Patent Box
Also, certain grants and grants approved by the European Union are excluded from the tax base.
Some transactions are dealt with for tax purposes differently to their accounting treatment. Some transactions are taxable, even though according to Spanish GAAP, their result is not recognized in the accounting books. (for example, non-commercial asset’s swaps or non-monetary contributions to other companies). In some cases, the difference between tax and accounting principles refer to the time of recognition of the result (for example, the case of long-term credit sales)
Also, the tax law allows to deduct from the taxable base the effect of the inflation on the sale of real estate. Thus, the tax payer is entitled to update the acquisition value for tax purposes ,to avoid taxing monetary capital gains tax.
In theory, all expenses which are charged to the profit and loss account under the Code of Commerce, the General Accounting Plan, and other accounting rules are deductible , except those in which the tax Law expressly provides for the non-deductibility. It is therefore a closed list of nondeductible expenses.
However, in practice, to be tax-deductible, expenses must meet certain additional requirements:
- necessity: In the sense, that they are necessary expenses for the activity. In other words, only expenses that are connected to the normal course of business of the company can be deducted.
- Justified: it has complete invoices, lists, receipts, etc.
- Registered in the books: following the principle of accounting inscription, which has already been outlined above.
- The expense must pertain the the same tax period in which the tax payer claim its deduction. Nevertheless, if a expense is registered in the books in a later period, its deductibilty is allowed for tax purposes, as long as its recognition is not deferred for more than four years(current statute of limitations period).
Regarding the list of non deductible expenses, the law currently contains the following items:
- Corporation Tax . As already explained, the taxable base is the accounting profit before taxes. Therefore, as the Corporation Tax is an expense, it must be eliminated to determine the taxable base.
- Dividends and other payments to the shareholders, either in cash or in kind (for instance, attendance bonuses for Meetings and the like). This exclusion is very traditional, but useless in practice, because dividends and similar payments are not even registered as expenses, but as a distribution of profits.
- Sanctions and fines of any nature. The reasoning behind this exclusion is that a company does not need to infringe the law to do business. At the same time, it tax payers were allowed to deduct sanctions, 30 % of their amounts would be paid by the rest of the tax payers.
- Losses suffered on bets and games. This is self explaining
- Gifts, donations and free grants. However, payments to suppliers, customers and employees are indeed deductible if the amount is reasonable and related to the business of the company
- Contributions to Internal funds of pensions.
- Expenses paid to residents tax havens. In these cases, the Act establishes a presumption, but the taxpayer can prove the reality of good or service received. In other words, there is a reverse charge proving mechanism.
- Interest on related party loans used to finance intra group reorganizations. Read more about that in our article interest on related party debts disallowed for tax purposes.
- Layoff payments to company employees in excess of the amounts awarded by the law, as long as they exceed one million Euros per person. Thus, if the pay off does not exceed that amount, the full payment could be deducted. But if the payment exceeds that figure, only the legal payment could be deducted. Note that this rule is addressing high flyers (CEO; CFO…of big companies) whose redundancy payments are frequently immoral. Note that Management employees are awarded by the law only 7 days of salary per year worked.
- Bad debts allowance; receivables with related parties, public entities and secured credits cannot are not allowed to be deducted for tax purposes. Moreover, other receivables can only be deducted if they are overdue for six months or more when the term for six months from the expiration of the obligation, or that the debtor is declared for bankruptcy, or finally that the obligations have been claimed in court, are the subject of litigation or arbitration. Small and medium size companies (turnover of less than 10 millions the previous year) are allowed to create a tax-deductible allowance for receivables equal to the 1 % of the outstanding receivables balances at the year end. Read more: bad debts allowance modified in 2015
- Impairment of investments in subsidiaries: As from January 1st, 2013, the impairment losses derived from investments in subsidiaries are not deducible for tax purposes. Likewise, the reversal of the loss in any subsequent year shall not be taxable. Read more about this issue: impairment losses from subsidiaries disallowed for tax purposes.
- Interest expense: interest payable can only be deducted up to the 30 % of the company operating profit or 1 million Euros (the lower). The non deductible amount can be deducted, with the same limits, in the following 18 years.
Depreciation are one of the items of expenditure whose purpose is to spread the cost of an asset among its useful life. The Law allows to calculate depreciation of tangible and non tangible non current assets, following any of the following methods:
- The straight line method. The Law provides the percentages acceptable for tax purposes, depending on the type of asset and the kind of business the company is engaged in. If the assets are used in more than one shift, then the percentage can be multiplied by the number of shifts. For example, a van can be depreciated using a percentage of 16 %. However, If the van is used 16 hours per day, then it could be depreciated at 32 %. However, if due to the nature of the asset it is obvious that the percentage approved by the Law already took into account a higher level of usage, then the percentage cannot be increased. For instance, the percentage of a refrigerator cannot be increased, because it is built to be working permanently. Small and medium size companies can multiply by 2 the percentages of depreciation.
- The reducing balance method, in its two versions applying a constant percentage on the net asset value or the number of digits.
- The effective depreciation method, which normally involves depreciating an asset according to its usage. For instance, according to the machine hours worked or the number of units produced.
Nevertheless, tax payers can submit to the Tax Office a special plan of depreciation if they feel that none of the above methods duly reflect the actual usage of an asset. If the Tax Office does not approve the plan within three months, which sadly is normally the case, the plan is deemed to be approved.
Some assets, such those used in Research & Development activities (except buildings) can be freely depreciated. From time to time in order to boost the investment in new assets, the Government approves plans to allow the freedom of depreciation for newly constructed or acquired assets, normally subject to the condition that the tax payer maintain ist work force. In 2013 there are not any plans in this respect. However, small and medium size companies are entitled to apply the freedom of depreciation to any new non current asset as long as they increase their work force. The amount to which new assets can be freely depreciated is EUR 120.000 per every full-time employee hired. Sadly, many small companies are unaware of this option, and do not apply it. Note that most start-ups could apply the incentive, because they normally hire staff.
Read more: deprectiation rates for fixed assets
Provisions and impairments
Business frequently must account for the occurrence of future events that could result in a loss (lawsuits, administrative fines, restructuring…). The likelihood of occurrence of such future events determine the accounting treatment. If the likelihood of occurrence of the event is slight then, the loss is deemed to be remote and no charge to the Profit and Loss account is required. Instead it is treated as a contingency and informed in the notes to the financial statements. In other cases, the likelihood of the loss is much higher, and then the company may decide to create a provision charging the Profit and Loss account for the estimated loss (generally discounting the future value of the liability). Finally, business may face actual liabilities but for which the amount or timing of expenditure is uncertain. These obligations result from past events and according to the International Accounting Standards are the true “provisions”. Therefore, it is important to keep in mind that the accounting term “provisions” only refers to this type of liability. Present liabilities (either legal or constructive – or implicit) whose timing and / or amounts are uncertain but can be reliably measured.
The Spanish Corporation Tax Act is extremely reluctant to accept the deduction of certain provisions, specially those arising from constructive obligations. Note that these obligations do not result from the Law (are not legal or contractual obligations) but derive from third parties assumptions. Even if the tax payer’s policy is to fulfill said assumptions for reputational or commercial reasons, the tax man feels that he is not to be bound by this fact. Likewise, the “provisions” that do not meet the accounting criteria to be considered as such, are not allowed for tax deduction. This mainly affects contingent liabilities, where there is not an actual liability resulting from a past event, but a potential loss dependent on the occurrence of a future event.
Specifically, the Law does not allow for the tax deduction of the following provisions:
- Provisions to cover implicit or tacit obligations.
- Provisions for long term payments to the personnel. However, the contributions
- of the promoters of pension plans will be deducible
- The costs relating to onerous contracts, that is, contracts in which the cost of meeting the obligation exceed the economic benefits expected to be received therefrom.
- Provision for restructuring cost, except if they relate to legal or contractual obligations and not merely implied.
- Provision to account for sales returns
- Provision for payments based on equity instruments, used as a means of compensation to employees, whether in cash or satisfied by delivery of such instruments.
- Provision for environmental activities will be deductible only if approved by the Tax Authorities
- Product warranties: the estimated cost for the repair or replacement of defective products can be deducted as long as it does not exceed the average cost of the current year and previous two ones.
Arm’s length rules
Spanish law follows the guidelines of the OECD in this area. Therefore, transactions among related persons or entities necessarily be valued at market value.
To determine the fair market value the following methods are admissible:
- Method of the comparable uncontrolled price.
- Method of the cost-plus
- Resale price method
- Profit split
- Net margin profit margin method
The Law requires that related party transactions are properly documented. The main advantage of documentation is that it helps to avoid penalties , which otherwise can reach 15% of the difference between the agreed price and the market value.
Previous years tax losses
Tax losses can be carried forward for 18 years. No carryback is allowed, though. In case of a substantial change of ownership in an inactive company, the offsetable tax losses are reduced by the amount of the losses suffered by previous shareholders on the disposal of the shares of said company.
Main tax incentives
In the last few years the tax incentives have been dramatically reduced. This fact is due to two reasons: the need to enhance the tax revenue and because some of this incentives were deemed to be contrary to the European Union Treaties. Actually, the main incentives which remain in force in 2013 are:
- Research & Development Tax credit: cost incurred in Research and Development (“R&D”) projects enjoy a tax credit of 25 %, although the tax credit can be as high as 42 % in some cases. However, the application of this tax credit is limited to the 60 % of the tax liability prior to the application of the tax credit. The excess can be applied in the next 18 years. To know more about this tax credit, please kindly refer to our post: research and development cash tax credit
- Reduced tax rate for capital gains arisen on the disposal of certain assets when the proceeds of the sale are reinvested in the business.
- Capital gains derived from the sale of tangible or non tangible non current assets and shareholdings in subsidiaries are taxed at the tax rate of 18 %, as long as the proceeds of the disposal are reinvested in qualifying assets. The assets that qualify for re investment are: new tangible or non tangible non current assets and shareholdings in other companies, as long as the parent holds at least 5 % of the voting rights of the latter. The reinvestment must be done in a period which starts the year prior to the disposal (that is, you can buy first and sell subsequently) and three years following the selling date. The newly acquired assets must remain in the company for five years (real estate) or three years (all other assets), unless the useful life of these assets is shorter. In this latter case, the assets must remain during its useful life.
Apart from this tax incentive, small and medium size companies (turnover the previous year under 10 Million Eur), can apply to the new acquired assets an accelerated depreciation scheme of 3 times the standard depreciation rate.
The general tax rate is 30 %. However, small and medium size companies (turnover less than EUR 10 million the previous year) are can apply the 25 % tax rate to a taxable base between 0 and 300,000 euros. The excess is taxed at the general tax rate of 30%.
As a temporary measure for the year 2013, small business which create jobs, car reduce the applicable tax rate by 5 percentage points in two brackets, ie 25% and 20% respectively. The requirements for consideration of small business are:
- turnover of less than 5 million Euros.
- average of less than 25 workers.
In order not to hinder the operations of corporate restructuring (mergers, splits, etc..) having business purposes , the Law has a special regime. In essence, this system uses the formula to defer capital gains on these transactions, so that assets received by the beneficiary are valued for tax purposes for their historical cost (carry over basis). In other words, in deferred taxable transactions, the assets acquired can not be stepped up in value, regardless of the way the deal is registered in the books.
Also, the shareholder of the companies entering into the reorganization transaction, either individuals or legal persons, can defer the capital gains resulting from the transaction until they dispose the shares received.
The key features of this tax are as follows:
- It is a voluntary scheme.
- Not subject to any prior authorization by the tax administration. Only requires that the transaction is communicated to the Tax Office.
- It operates a transmission ex lege to the acquirer of the all the rights and tax obligations of the transferor (for example, the right to offset previous years losses, tax credits…)
- The tax deferred transaction is not applicable when the primary purpose is fraud or tax evasion (tax motivated).
The Corporation Tax Act provides for a consolidated tax regime of voluntary application, so that a group of companies can elect to be taxed as a single entity. In this way, they can offset the positive and negative results obtained by the various Group companies. Likewise, the result of the transactions among group companies is disregarded until they are realized to outside entities.
The requirements for the application resulting from the tax consolidation regime are:
- Companies must have legal form of corporations and be subject and not exempt from income tax.
- Only subsidiaries resident in the Spanish territory are included in the tax group. However, Permanent establishments of non-resident companies located in Spanish territory may be considered the parent entity of the group.
- Only subsidiaries in which the parent has a direct or indirect shareholding of at least 75% of the share capital on the first day of the tax period in which this tax regime is applied can be included in the tax group. The percentage is reduced to 70% in the case of companies whose shares are traded in a stock exchange.
- The application of this tax regime is completely independent from the obligation to present consolidated financial statements. Furthermore, the perimeter of both groups are not likely to coincide. In the consolidated financial statements every company in which the parent holds more than 50 % of the voting rights are included, regardless if they are domestic or foreign. However, in the tax group, only resident subsidiaries in which the parent holds, at least, 75 % of the voting rights are included.
Read more: the new regulations of tax groups in 2015