Spain becomes a new low tax jurisdiction in 2014

Posted on Posted in Publications, Tax

Spain is well known to be a high tax jurisdiction, basically due to the fact that the both the Corporations Income Tax (“CIT”) and Personal Income Tax (“PIT”) have very high tax rates (30 % for the CIT and up to 56 % for the PIT). However, as from the 1st of January of 2014 a new and very interesting tax scheme has been introduced to boost investments in several territories. We will refer in this article to Ceuta and Melilla.

Ceuta and Melilla are Spanish sovereign territories located in continental North Africa bordering Morocco. These territories have been a part of Spain since the formation of the modern Spanish State (1492); therefore, as part of Spain in all respects, they are also a part of the European Union and the Schengen Area. The Spanish Tax Treaty network is fully applicable to these territories, as well as EU Directives.

Being located in the north of Africa, these two cities are a privileged gateway to do business with Africa and Arab speaking countries. Approximately 50 % of their population speaks Arab as mother tongue, although they have Spanish citizenship and are bilingual. Ceuta is only 70 km away from Tanger, the most important northern Moroccan city with an important tax free zone and just at an hour from the Iberian Peninsula.

Due to their specific geopolitical situation, these territories have always enjoyed a special tax status, which could be summarized in two features: 50 % of exemption of income or earnings sourced in these Territories and the inaplication of VAT and excises for goods and services imported, produced or rendered therein. Instead they have an special indirect tax, very much similar to VAT, but with tax rates much lower (from 0,5 % to 10 %).

Until December 31st, 2013 the 50 % exemption, either in the Corporations Income Tax (“CIT”) or Personal Income Tax (“PIT”) was limited to individuals or companies registered and domiciled in the territory of Ceuta or Melilla or acting thorough a Permanent Establishment in these territories. Besides this rather formal requirement, the Law required that the individuals or entities claiming such 50 % relief operated materially in the territories. In other words, paper companies or PO Box companies, having only a formal presence in Ceuta or Melilla could not enjoy the tax benefit.

This scenario has experienced a dramatic and far reaching change as from the first of January 2014, when the Law 16/2013, which modified article 33 of the CIT Act, came into force. Amazingly, these changes have so far largely been overlooked by most tax analyst and practitioners, although they actually imply that the effective Corporation tax rate could be as low as 7,5 % or even less for some activities (for instance, IP companies).

The approach of the taxation in Ceuta and Melilla is quite different from the one of most low tax jurisdictions. Instead of giving a tax relief for off shore profits, they limit the partial tax exemption to on shore profits, i.e., those profits which are deemed to be generated within the two territories. Therefore, the key issue is to determine under which conditions the profits of an entity are sourced in Ceuta or Melilla. And here comes the big change, especially regarding trading activities. Under the new regulations, income generated in trading activities are deemed to be obtained in Ceuta or Melilla as long as these activities are organized, controlled, managed and invoiced from these territories through a fixed place of business located therein, counting with a minimum staff.

In other words, having a minimum physical presence in Ceuta and Melilla would allow tax payers to qualify for the exemption. Thus, a small rented office and a part time employee handling the operations (receiving orders, organizing transport, invoicing…) would imply that the activity is deemed to be performed in Ceuta or Melilla and therefore enjoy the tax relief even if the goods never touch their territory. It is to be noted that the cost of living in Ceuta and Melilla is notably below the Spanish average so the rents and wages are very low indeed. In other words, the cost of the resources needed to qualify for the tax relief are much lower than in most low tax jurisdiction.

Activities other than trading (manufacturing, services…) can also enjoy the tax relief, although in this case the activity must be performed in the territories. The Law also provides specific rules to allocate to Ceuta and Melilla the profits of fishing, shipping and air transport. These criteria are based on the place of effective management of the company, the place where the contracts are closed and the place where the boats and aircrafts are registered. Basically it does not seem difficult to arrange matters so as to allocate 100 % of the profits to these operations in Ceuta and Melilla.

At this step it is not clear if income form intangible assets held by an entity registered in Ceuta or Melilla, such as an IP company, could enjoy the tax relief. The wording of the Law does not preclude this possibility, but since it always refers to profits derived from business activities it remains arguable whether pure passive income could benefit from this exemption. If finally this possibility is confirmed, a Spanish patent box company registered in Ceuta and Melilla would be taxed at an effective tax rate of 6 %, or even less if it qualities for the reduced tax rate applicable in 2014 and 2015 for newly incorporated companies.

Finally, the law concedes a mercy for loyalty. If the tax payer operates during at least 3 years in Ceuta or Melilla, as from the 4th year he would be entitled to apply the 50 % exemption not only to onshore profits, but also to off shore profits if at least half of its assets are located in Ceuta or Melilla. The off shore profits to which the tax relief would apply cannot exceed the amount of in shore sourced profits (for instance, if the tax payer obtains a profit of 100 in Ceuta and Melilla and a profit 200 off shore income, the 50 % tax exemption would only be applied to 200 – the onshore profit (100) and half of the off shore profit (100 out of 200).