The special tax regime for Spanish holding companies

Posted on Posted in Company Law, Publications, Tax

A Spanish Holding Company   is a standard company, that is, a private limited company (“SL”) or public limited company (“SA”), which include in its business purpose, among others, the management of foreign subsidiaries. In this post, I   will refer to these companies as ETVE’s for their Spanish Acronym Entidad de Tenencia de Valores Extranjeros.

Upon request, the ETVE can opt for the application of a special tax regime that allows it to enjoy key tax advantages, especially for foreign investors. As we will discuss in detail afterwards, these advantages make the Spanish ETVE among the most useful tools worldwide for international tax planning.

To enjoy the special tax status the Law only requires that the ETVE has the necessary staff and material means to manage its investments in its foreign affiliates. Although the fulfilment of this requirement has been debated for long, it is now clear that the law only requires a minimal infrastructure to exercise the rights of the ETVE as shareholder, as opposed to supervise and control the activities of the affiliates. Since a shareholder in basically entitled to collect dividends and vote at the shareholders meetings, it is generally understood and accepted, even for the Courts, that a minimum substance would be enough. For instance, the ETVE does not need to hire qualified staff to control its investments if one of the members of the Board can do that job. So this requirement should be seen as an anti-abuse rule to avoid pure artificial entities (“paper companies”) from enjoying the special tax status of the ETVE.

Tax advantages of the ETVE

An ETVE has the following key tax advantages:

  • It can enjoy the participation exemption regime for dividends and capital gains
  • Most expenses are deductible even if they are connected with its foreign shareholdings
  • Being standard resident companies, they can apply all the Double Tax Treaties (“DTT”) signed by Spain
  • Dividends distributed by the ETVE to his nonresident shareholders are not taxable
  • Capital gains on the sale of the ETVE are not taxable if they can be attributed to foreign source profits

The participation exemption (completely revised as from January 2015)

Under the participation exemption rules, dividends received either from domestic or foreign subsidiaries, or capital gains from the sale of shares in these subsidiaries, are nontaxable provided:

  • The parent company owns an interest of, at least, 5% of the share capital or, otherwise, the cost of acquisition of the latter is over 20 million Euros.
  • The participation in the subsidiary must have been held for at least one year before the dividend is collected or the shares sold. This period of ownership can be completed after the dividend is collected.
  • With regard to dividends and capital gains coming from foreign subsidiaries a further requirement must be met. The subsidiary must be subject to a tax similar to the Spanish Corporate Income Tax with a nominal tax rate of at least 10 %, or be resident in a country with ta DTT with Spain.

Note that no effective taxation of the subsidiary is required, because the Law refers to the nominal tax rate and specifically ignores the application of any exemptions, reliefs or allowances that the subsidiary may be entitled to apply. Moreover, according to the new regime, the subsidiary need not be engaged in any business activities, although in this case some caution is needed to avoid the application of Controlled Foreign Corporation or CFC rules. For more information on this topic, see our post about the Spanish regime of CFC.

Likewise, profits from foreign permanent establishments are exempt a long as they are subject to a tax similar to the Spanish Corporate Income Tax with a nominal tax rate of at least 10 %, or be resident in a country with ta DTT with Spain.

The deduction of expenses

In most countries holding companies are not allowed to deduct expenses connected with their participations in subsidiaries. The rationale of this rule is evident: since the income derived from said investments is exempt the expenses linked to them should also be disregarded for tax purposes. This is not the case of Spain. In Spain we have an asymmetric treatment of income and expenses linked to foreign holdings. While income (dividends and capital gains) from qualified subsidiaries is exempt, most expenses directly or indirectly connected to the management or ownership of the former are allowed.

There are, however, some exceptions:

  • Impairment losses of subsidiaries are not allowed. The loss can only be accounted for when the shares are actually sold. Furthermore, if the acquirer is other group company, the loss is deferred until the shares are resold by the latter to a third party not belonging to the group or the selling or buying companies leave the group.
  • Interest expense is limited to 30 % of the EBITDA of the parent company. This limitation affects all the Spanish tax payers, not only ETVE’s. However, since many acquisitions are highly leveraged this limitation is likely to affect more the ETVE’s than other companies. In this respect, it is noteworthy saying that dividends from qualified holdings are included in the EBITDA, so a careful planning of the flow of dividends coming to the ETVE may limit the impact of this rule. In any case, the ETVE will be entitled to deduct up to 1 million Euros of interest expense.
  • Interest from intra group financing is disallowed if the proceeds of the loan are used to finance the acquisition or investments in other company of the group. To know more about this issue, kindly refer to our post about the limitation of expenses on related party loans.
  • Finally, the losses arisen on the sale of shares must be reduced by the amount of the exempted dividends collected from the shares sold. For a further explanation of the operation of this rule read our post about the tax losses on the sale of shares of Spanish companies. Note that this rule also applies to all the tax payers, not only ETVE’s, although due to their activities ETVE’s are likely to be affected more frequently.

Since most of the expenses of the ETVE are allowed for tax purposes, it is obvious that they can reduce the overall taxable profit of the group. However since most of the income of the ETVE is likely to be exempt, to take advantage of the losses of the company it would be necessary either  (i) to attribute to the ETVE other income generating activities or assets or (ii) to include the ETVE in a tax group. Note that since January 2015 two Spanish companies with the same foreign parent can apply for group taxation. See our post about the new regulations for the Spanish tax groups.

ETVE’s and foreign investors: treatment of outbound dividends paid by ETVE’s

Without any doubt the key advantage of using ETVE’s in international tax planning is that dividends distributed by the ETVE to his nonresident shareholders are not taxable, unless the shareholder is located in a low tax jurisdiction. Unlike in the EU parent subsidiary Directive, if the ETVE shareholders are resident in other EU member State it is completely irrelevant who controls the latter. So even if the majority of the voting rights of the EU parent of the ETVE are held by non EU residents, the dividends paid by the ETVE would still be nontaxable. In this respect applying for the ETVE status may help to overcome the anti-abuse clause to the Parent Subsidiary Directive.

Likewise, capital gains on the sale of the ETVE are not taxable if they can be attributed to foreign source profits. In other words, retained earnings from the ETVE built with foreign source dividends or capital gains can be deducted when calculating the taxable capital gain in Spain.

ETVE’s can also be used as conduit finance companies. Note that according to the Spanish legislation interest paid to EU residents are no subject to withholding tax even if the recipient is not the beneficial owner and regardless the fact that the interest is taxed in the hand of the recipient. On the other hand, finance companies owned by the ETVE, even if located in a low tax jurisdiction, would not trigger the application of CFC rules as long as the finance company has some substance and is engaged in intra-group financing.

As a conclusion, Spanish ETVE’s enjoy a very favorable tax status that make them a very useful tool for international groups, especially considering the wide range of DTT signed by Spain