The Canary Islands tax free regime

Posted on Posted in Publications, Tax

The new tax regime of the Canary Islands (Corporation Tax rate of 4 %) has largely been overlooked by most tax professionals, although it is by far one of the most interesting ones currently in force. This regime is called Canary Special Zone (“Zona Especial Canaria” or ZEC). The title of the regime is somehow misleading, because the tax status is not restricted to any particular geographical location, but applicable to all the companies established in the whole Canary Islands territory. In other words, the Canary Special Zone is equivalent to the Canary Islands.

The Canary Islands form part of Spain to all effects and this has several relevant tax implications. In particular, EU Directives and the Tax Treaties signed by Spain are fully applicable in the Canary Islands, except the VAT Directive which is not applicable.

The ZEC tax regime has been expressly approved by the European Commission until 2026, and could be – and is expected to be- extended even farther.

 Requirements to qualify for the ZEC status

To qualify for the ZEC status the following requirements must be met:

  1. The registered office and place of effective management must be in the Canary Islands
  2. At least one director or, in the case of branches, a legal representative resident in the Canary Islands.
  3. Their corporate purpose is to perform in the Canary Islands certain economic activities. However, the company or branch can be engaged in other activities to which the special tax regimen will not be applicable. Currently, and this is one of the key differences with the previous regulations, the qualifying activities include most of manufacturing, trading, warehousing, transport, telecommunications and services activities. Any activity is deemed to be performed in the Canary Islands if the goods manufactured or distributed are delivered from the Canary Island territory or the services are rendered through premises located therein.
  4. To invest in the first two years since its registration in the acquisition of property, plant, equipment or intangible assets in the Canary Islands for the following amounts: On the islands of Gran Canaria and Tenerife, 100,000 euros; On the islands of El Hierro, Fuerteventura, La Gomera, Lanzarote and La Palma, 50,000 euros. Said investments must be effectively used to perform the business activities carried out by the taxpayer.
  5. To hire within the six months following its registration 5 employees (or 3 in the smaller Islands)

Tax incentives granted to companies enjoying the ZEC status

Basically there are two main tax incentives:

The tax rate applicable is 4 %.

Note, however, that the taxable profits to which the reduced tax rate is applicable is limited to  EUR 1,800,000 plus EUR 500,000 for each additional employee hired over the statutory requirements – 5 or 3 employees depending on the Islands-.

Example 1:

A ZEC company has a taxable profit of 1,500,000; then the reduced tax rate would be fully applicable. The tax liability would be 60,000 = 1,500,000 * 4 % (not bad !).

Example 2:

A ZEC company located in Fuerteventura has a taxable profit of 2,500,000 and 3 employees; then the reduced tax rate would only be applicable to 1,800,000 and the remaining taxable profit, i.e. 700,000, taxed at the 25 % standard tax rate  . Therefore, the tax liability would 247,000 = 1,800,000 * 4 % + 700,000 * 25 %.

Example 3:

A ZEC company located in Tenerife has a taxable profit of 5,000,000 and 10 employees;

The reduced tax rate would be applicable to 1,800,000 plus 500,000 for each additional employee hired over the statutory requirements, which are 5 in Tenerife. Therefore, the reduced tax rate would be applicable to an additional taxable profit of 2,500,000 (5* 500,000). Thus, the qualifying taxable profit is 4,300,000 (1,800,000 + 2,500,000).

The remaining taxable profit, i.e. 700,000, would be taxed at the 25 % standard tax rate

Therefore, the tax liability would 347,000 = 4,300,000 * 4 % + 700,000 * 25 %.

Outbound dividends paid by the ZEC

The second main tax benefit regards outbound dividends paid by the ZEC entity to her foreign shareholders.  Dividends paid by a ZEC, out of qualifying profits , to her foreign parent company are not taxable is Spain unless the parent company is located in a tax haven or resident in a non-cooperative tax jurisdiction. To qualify as a parent company it must hold at least 5 % of the share capital of the ZEC for at least one year before the distribution of the dividend.

Likewise, capital gains derived from the sale of the ZEC shares by her foreign shareholders are not generally taxable. Finally, interests paid by the ZEC entity to foreign individuals or entities are not taxable in Spain.

In view of the above, it is safe to say that the Canary Islands have much more to offer than just good weather throughout the year, gorgeous beaches and affordable prices!