The incoming Corporation Income Tax reform in Spain

Posted on Posted in Publications, Tax

Last week a commission of tax experts delivered his report on the Spanish Tax Reform. Generally speaking the experts propose to reduce the weight of direct taxes and Social Security Contributions and to increase indirect taxes to offset the loss of the tax revenue. This post focuses on the amendments in the Corporate Income Tax (“CIT”).

The big picture is easy to grasp. The experts propose to broaden the taxable base and at the same time to reduce the tax rate. Overall, the tax burden should remain basically unchanged, but the tax should be more neutral and competitive. The experts draw the attention to the fact that the key  decision driver to most investors is the tax rate, rather than the effective tax cost. Therefore, the only way to reduce the tax rate without affecting the tax revenue is to limit the so-called tax expenses (reductions, allowances, reliefs, tax credits…).

Regarding the taxable base there is a fundamental change. Currently the CIT taxable base is the profit before taxes.  This figure is then adjusted to account for non deductible expenses or non taxable income. The experts propose to use as taxable base a figure very similar to the  EBITDA. Therefore, the accounting expenses for interest, depreciation and amortization would be partially or totally disregarded for tax purposes.

Regarding the deductibility of financial expenses, the change proposed by the experts is huge. Currently, the net interest deductible are 1 million Euro or 30 % of the operating profit ,the higher. Net interest exceeding these limits can be carried forward for 18 years and deducted within the same legal limits.

On the contrary  the experts propose to link the deductibility of interest to the debt to equity ratio, rather than to the operating profit. In this respect, it is believed that to prevent excessive indebtedness  the ideal debt to equity ratio should be 1, i.e., the same amount of equity and debt. The interest corresponding to the excess of debt over this ratio will not be deducible at all, without the possibility of carrying forward the amount not deducted. They also propose to fix an absolute limit of Euro 1 million. These limits would not apply to banks and insurance companies.

Likewise, impairment losses of non current assets, whether tangible, intangible or financial, would be deferred until the assets are sold or  otherwise cancelled from the balance sheet.

Regarding amortization, they propose a substantial extension of the useful live period  of most assets and to stop any scheme allowing free or accelerated amortization of assets.

Most tax credits, if not all, will follow the same fake. The experts suggest that the loss of tax revenue derived from these tax credits is very high, but it is unclear if they really have any material influence on the tax payers decisions (promote research and development activities, the renewal of fixed assests…). The practical evidence shows that most tax payers never apply these tax reliefs, which are applied basically by large companies.

The other side of the coin is the reduction of the tax rate. Currently Spain has a CIT rate of 30 %, which is among the highest of the European Union. The experts propose to reduce this rate to 20 %. The reduction of the tax rate poses a very challenging issue because it reduces the value of the  deferred tax credits and liabilities, which could trigger to an excess or deficit of taxation in future tax periods. The expert’s report deals with this issue proposing some measures to offset the tax and accounting implications derived thereof. A complete explanation of these measures goes far beyond the purpose of this post.

Finally, the experts propose to finish the dual CIT system currently in force, one for the Small and Medium size companies (“SME”) with a turnover of less than 10 million Euro and the one applicable for the bigger companies. SME have a beneficial tax treatment such a reduced tax rate of 25 % on the first 300.000 €, free amortization schemes…This special tax treatment is counter productive because it is an incentive not to grow and become more competitive as this growth will imply a higher tax cost.