Taxation of the sale of shares in Spanish companies

In a recent landmark judgment, the Spanish Supreme Court (Justice Emilio Frias) has ruled that European Union Companies selling their shareholding in Spanish companies are entitled to apply the underlying tax credit to reduce their tax liability on the gain obtained, even if the Law does not grant that relief.

To understand the significance of this ruling, it is important to recap the taxation of capital gains, both for domestic and for nonresident tax payers.

According to the domestic legislation a Spanish company disposing of a substantial shareholding (participation of at least 5 % of the voting rights) in other Spanish company is entitled to apply a tax credit to account for the retained earnings of the subsidiary obtained during the ownership period. For instance, let us say that a Spanish company gets a capital gain of 1.000 selling its stock in other Spanish company, where the retained earnings of the Subsidiary at the time of the disposal are 500. Then the taxable amount is determined as follows:

Taxable base: ;1.000

Gross tax payable (30 %): ;300

Tax credit (500 * 30%): ;150

Tax due: ; 150

Therefore, the practical effect of the tax credit is to avoid taxing the part of the capital gain which is attributable to the reserves of the subsidiary.

However, if the parent company is nonresident, then the capital gain is determined by the difference between the acquisition cost and the disposal proceeds. Then, a flat tax rate (currently 21 %) is applied to get the tax liability. No tax relief to account for the economical double taxation is granted to foreign tax payers.

The practical impact of this tax treatment is somehow limited by the existence of the Tax Treaties and the domestic legislation itself.

Firstly, the Spanish domestic legislation declares exempt the capital gains obtained on the disposal of shares in Spanish companies by taxpayers who are resident in other European Union member States. However, the exemption does not apply where (i) the tax payer has a substantial shareholding (a participation of, at least, 25 % of the share capital during the year preceding the disposal) or (ii) more than 50 % of the subsidiary’s assets consist of real estate located in Spain.

It is also well known that article 13 of the tax treaties following OCDE model establish that gains on the sale of shares can only be taxed by the State where the seller is resident. However, this rule has a few exceptions concerning (i) the gain of shares deriving more than 50 % of their value of immovable property located in the source State (ii) gains on the disposal of substantial shareholding in other companies. Many of the Tax Treaties signed by Spain include such exceptions, granting the Kingdom of Spain taxing powers on these capital gains, even if they derive from the disposal of shares.

In short, it cannot be ruled out that a European Union company selling shares of a Spanish company is taxed in Spain on the gain obtained. As explained, this could trigger double taxation, because nonresident tax payers are not given the underlying tax credit relief.

This was the case with the French company Brambles, whose case was finally decided by the Supreme Court. The Supreme Court upheld the claim of Brambles on the grounds that the Spanish legislation with regard to gains arising from the sale of shares of Spanish companies by other European Union companies imply a breach of the European Treaty since it is clearly discriminatory. The Court cited several judgments of the European Court of Justice (Denkavil, Gerritse, Ashler) considering that there is not any objective reason to deprive EU companies from applying the underlying tax credit.