Why Spain? Why Austria?

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1 Briefing Overseas investments by Brazilian corporations Summary In this briefing we look at how the Austrian and Spanish domestic tax regimes for holding companies may be relevant when structuring international investments from Brazilian corporations, particularly when combined with the favourable provisions of the double tax treaties that Austria and Spain have entered into with Brazil. For more information please contact Michael Sedlaczek T E Miguel Lorán T E Madrid information: T Freshfields Bruckhaus Deringer llp 1

2 Introduction. Austria and Spain have many aspects in common concerning corporate taxation, and they also have certain particular characteristics of benefit to the Brazilian investor. When it comes to structuring international investments from Brazilian corporations, both jurisdictions have a double tax treaty with Brazil with favourable tax provisions. The combination of those tax treaties with each jurisdiction s own tax regime for holding companies or with their network of tax treaties with third countries, gives rise to a number of interesting opportunities. At the same time both jurisdictions are members of the European Union, and in that context are within the scope of a number of initiatives aimed at coordinating tax measures and the response of tax authorities to similar issues. Aspects such as Financial Transaction Taxes, taxation of debt restructurings, transfer pricing issues, anti-avoidance and economic substance, are issues currently under review. This summary focuses on features of the Spanish and Austrian tax regimes that may be relevant when considering a cross-border transaction with Brazil. The specific use of either of the two jurisdictions in a structure involving Brazil will require further analysis, not only of the tax aspects in the relevant jurisdiction, but also of the interaction with Brazilian legal and tax aspects. Why Spain? There are three levels of taxation in Spain, namely, the central government, the governments of the 17 autonomous regions and the municipal governments. For the purposes of corporations, the main taxes applicable are three: corporate income tax (CIT), Value Added Tax (VAT) and transfer tax /stamp duty/ capital duty. Two specific tax regimes are also applicable for the regions of Navarra and the Basque Country. Holding companies There has been always some confusion surrounding the notion of holding companies and the special tax regimes associated with entities of this type. In Spain, as in many other jurisdictions, all legal entities enjoy a very broad participation exemption on income derived from investments outside Spain. An ordinary Spanish entity, fully taxable on ordinary income, used as a holding entity would therefore enjoy this beneficial regime under certain conditions. These ordinary entities, when paying dividends to their non-spanish shareholders, will apply withholding taxes at the relevant domestic or double tax treaty rates. On the other hand, there is a special regime in the Spanish Corporate Income Tax Act (CIT Act) specifically for holding activities (Entidad de Tenencia de Valores Extranjeros, ETVE) with certain characteristics. This regime may be opted into on a yearly basis. It is not a final option and can be cancelled at any time. Under this regime, a similar participation exemption as for ordinary entities would be applicable and, in addition, a withholding tax exemption on dividends paid to non- Spanish shareholders is applicable under certain conditions. This distinction is important, since some jurisdictions, like Brazil, have tried to tackle tax favourable regimes, such as the ETVE, but a similar participation exemption regime can be achieved with ordinary entities or by electing not to be treated as an ETVE. Equity Capitalisation The incorporation of companies, capital increases, and contributions by shareholders which do not consist of a capital increase are fully exempt from capital duty, while the dissolution of companies and capital reductions trigger a capital duty of 1 per cent. The acquisition of shares is, as a general rule, exempt from Spanish VAT and transfer tax. 2 Freshfields Bruckhaus Deringer llp

3 Corporate Income Tax The taxable income for CIT purposes is based on the worldwide income (ie, revenues and gains minus expenses and losses) disclosed in the accounting records of the company, adjusted in accordance with the specific rules contained in the CIT Act. Taxable income is generally subject to a 30 per cent tax rate, although in the case of small companies whose turnover of the previous year was below EUR 10 million, this rate is reduced to 25 per cent of taxable income for the first EUR 300,000 and 30 per cent of taxable income for the excess. As a general rule, financial expenses are deductible. However, a recently approved new limit on interest deductibility has replaced the old Spanish thin cap rule. Under this new provision (applicable for all tax periods starting as from 1 January 2012), as a general rule, net interest expenses (ie, interest expenses minus interest income) shall only be deductible up to the limit of 30 per cent of the annual operative profit (ie, EBITDA, although adjusted with certain special tax rules); though the first one million Euros is always deductible. Participation Exemption As indicated above, foreign sourced dividends distributed by non-resident companies to ordinary Spanish resident companies may be exempt, under the participation exemption regime, when the following requirements are fulfilled: 1. a direct or indirect participation in the non-resident company of 5 per cent or more has been uninterruptedly held during the year prior to their payment (except in the case of ETVEs where this requirement will also deemed fulfilled if the acquisition price is greater than 6 million Euros); 2. the non-resident company is subject to a tax comparable to CIT during the tax period in which the dividends distributed are obtained, or is resident in a jurisdiction with which Spain has signed a treaty to avoid double taxation with an exchange of information clause, so long as the foreign company is not resident in a jurisdiction deemed to be a tax haven under the Spanish regulations; and per cent or more of the profits of the non-resident company originate in business activities carried out outside Spain. Capital gains arising from the transfer of participations in a non-resident company should be exempt, so long as, (i) at the time when the shares are sold, the direct or indirect participation of 5 per cent or more has been held uninterruptedly during the past year, and (ii) the other requirements set out above are fulfilled during the entire shareholding period. If some of the latter are not fulfilled at all points of the shareholding, a mechanism is set out to adjust the exemption. In addition, if the purchasing company is a resident in a jurisdiction deemed to be a tax haven under the Spanish regulations, this exemption shall not apply. ETVE Regime ETVEs are defined as resident companies that have a physical organisation with employees, whose objective is to supervise and manage direct or indirect participations in nonresident companies. This regime is optional so it is necessary to inform the tax authorities if one wishes to benefit from it. The ETVE regime is not available to certain entities whose main business is to manage movable or immovable property not used for business purposes and where more than 50 per cent of their share capital is owned directly or indirectly by ten or fewer shareholders (or by a family group) for at least 90 days in the financial year. This regime is based on (i) a participation exemption on foreign-sourced dividends and capital gains made by the ETVE, identical to the ordinary participation exemption, and (ii) a tax-free redistribution of such income to its resident and non-resident shareholders, while being considered an ordinary taxable entity in all other respects. Freshfields Bruckhaus Deringer llp 3

4 Tax consolidation regime According to the CIT Act, a group for tax consolidation purposes consists of a controlling company (ie the parent company) and one or more dependent subsidiaries, irrespective of the activities of each. The controlling company must be a resident company (or a qualifying permanent establishment of a non-resident company) which owns, directly or indirectly, at least 75 per cent of the dependent company or companies. If the dependent company is a listed company, the qualifying shareholding is 70 per cent. Both these shareholdings have to be held from the first day of the tax period in which the tax consolidation regime is intended to be applied and throughout the whole tax period. It should be noted that if a group decides to apply this regime, all the dependent companies (as defined above) will have to be included in the tax group. The tax consolidation regime must be approved in the general shareholders meeting of each of the companies involved, including both controlling and dependent companies. Since the application of this regime is optional, the parent company has to inform the tax authorities of these approvals before the beginning of the financial year in which the consolidation is intended to take place. If tax consolidation is granted, profits and losses within the group are eliminated, and therefore only the income deriving from transactions with third parties is subject to CIT on a consolidated basis. Tax losses of companies prior to the period of consolidation can only be offset against the group taxable base within the limit of its individual taxable base. The limit on interest deductibility described above has a specification for tax consolidated groups. The net financial costs of a company prior to becoming part of the tax group can only de deducted up to a limit of 30 per cent of the operational revenue of said company. Double tax treaty between Spain and Brazil According to the Spanish Non-resident Income Tax Act, Spanish-source dividends and interest are subject to 21 per cent withholding tax. However, the double tax treaty (DTT) entered into between Spain and Brazil contains several beneficial provisions in this respect. Dividends distributed from Spain to Brazil are subject to 15 per cent Spanish withholding tax. Regarding Spanish-source interest, the DTT Spain-Brazil establishes a 15 per cent withholding tax rate. The DTT also sets out that in the case that a special relationship exists between the payer and the beneficial owner or between both of them and some other person, when the amount of the interest exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of the DTT shall apply only to the last-mentioned amount. Moreover, the DTT Spain-Brazil contains tax sparing or matching credit provisions (eg, for Spanish-source interest income received by a Brazilian resident, Brazil is obliged to credit Spanish tax of at least 20 per cent even if the tax which has effectively been paid is lower). Therefore, Brazilian investors may profit from a deemed credit amount on their tax liability on Spanish-source interest income. According to the DTT, capital gains realised by a Brazilian investor in a Spanish subsidiary can be taxed in Spain. There are certain tax exemptions applicable to disposals of shares listed on the stock exchange. 4 Freshfields Bruckhaus Deringer llp

5 Holding activities and Spanish VAT aspects Supplies of goods and services in Spain are subject to VAT at a standard rate of 21 per cent (reduced rates may apply, ie, 10 per cent and 4 per cent), unless an exemption applies (eg, for financial services). VAT issues have to be observed, especially where cost charges are concerned. Even cross-border charges may trigger Spanish VAT. If the recipient of the service is not entitled to recover VAT (eg, pure holding companies), additional costs are created. VAT issues can arise where cost charges within a group of companies are concerned; they may be mitigated by careful tax planning (eg, by making a holding company a management holding entity providing services against consideration). Why Austria? Austrian Holding Companies and their Equity Capitalisation Austria does not have specific tax law provisions for holding companies; they are taxed as any other Austrian company. A capital duty of 1 per cent is levied on equity contributions to domestic corporations (including the capitalisation by the issuance of hybrid capital) upon their establishment or an increase in their share capital. Such duty is generally not levied in case of a contribution that is made by an indirect shareholder (Großmutterzuschuss), provided no new shares are issued. Consequently, it is common practice in Austria that the capitalisation is effected by an indirect shareholder, anticipated by establishing a two-tier structure. Moreover, no capital duty is triggered in certain cases of reorganisation covered by the Austrian Reorganisation Act (Umgründungsteuergesetz), eg mergers are exempt from capital duty if the transferring corporation has existed for at least two years at the day the merger is filed with the Commercial Register (Firmenbuch) or contributions, eg of qualifying shares, are exempt if held for two years at the time of contribution. Corporate Income Tax The Austrian Corporate Income Tax Act (Körperschaftsteuergesetz, the KStG) provides for a general, flat corporate income tax rate of 25 per cent. All corporations (even if they are in a loss position) must pay minimum corporate income tax (eg a limited liability company (Gesellschaft mit beschränkter Haftung): 1750/year, a joint stock company (Aktiengesellschaft): 3500/year). Expenses that have a direct economic connection to tax exempt increases in assets or to tax exempt (investment) income are not deductible as a business expense for tax purposes. Interest cost from the financing of the acquisition of shares that fall within the scope of the domestic or international participation exemption or the exemption for international portfolio participations in non-austrian corporations (see below) and are held as business assets is tax deductible. The provisions allowing for the deductibility of interest from the debt financed acquisition of shares (ie Sec 11(1)(4) KStG) do not apply in case of intra-group acquisitions of shares. As a consequence, it may be necessary to consider any envisaged post-acquisition restructuring already before an acquisition to secure the most tax effective financing for the acquisition. Participation Exemption Under the Austrian domestic participation exemption, an exemption from Austrian corporate income tax at the level of the Austrian resident corporate shareholder applies inter alia to profit shares (dividends) of every kind from participations in Austrian corporations (including in the form of jouissance rights (Genussrechte)). The amount of the participation held in the dividenddistributing corporation and the holding period are irrelevant. The Austrian domestic participation exemption applies only to dividends and not to capital gains from the sale of the shares. Freshfields Bruckhaus Deringer llp 5

6 Moreover, (a) profit shares (dividends) from participations in non-austrian corporations that meet the requirements of Article 2 of the EU Parent/Subsidiary Directive as well as (b) in non-austrian corporations that are comparable to Austrian corporations and are resident in a state with which Austria has entered into an agreement on mutual assistance and that are not covered by the Austrian international participation exemption (see below) are exempt from corporate income tax at the level of the Austrian resident corporate shareholder. The so-called exemption for international portfolio participations applies only to dividends and not to capital gains from the sale of the shares. Under the Austrian international participation exemption, dividends derived by an Austrian resident corporation from a non-austrian corporation are exempt from Austrian corporate income tax, if (a) the Austrian receiving corporation directly or indirectly holds at least 10 per cent of the nominal share capital (or participation rights) of the dividend distributing company; (b) if the dividend distributing corporation is an EU corporation qualifying under Article 2 of the EU Parent/Subsidiary Directive or is comparable to an Austrian corporation for corporate tax purposes; and (c) the dividend receiving corporation has held the shareholding in the dividend distributing corporation for an uninterrupted period of at least one year. Apart from dividends, the international participation exemption also covers capital gains from the alienation of a participation in a non-austrian corporation. However, this exemption of capital gains (and correspondingly the non-deductibility of capital losses) from Austrian corporate income tax does not apply if the shareholder opts out of the tax-neutral treatment of capital gains (and capital losses) and elects instead for the tax-effective treatment of capital gains (and capital losses) from the international participation. Actual and final capital losses upon liquidation or insolvency of subsidiaries covered by the international participation exemption may, however, be deducted, but must be reduced by the distributions made by the subsidiary within five years prior to the liquidation or insolvency. Participations qualifying under the domestic or international participation exemption as well as under the exemption for portfolio participations cannot be effectively depreciated to their lower going concern value (Teilwertabschreibung), if the taxpayer cannot prove that the reduction in value results from an event other than a distribution of dividends or a repayment of equity by the corporation in which the participation is held (ausschüttungsbedingte Teilwertabschreibung und ausschüttungsbedingter Verlust). In case of such proof and in case of a loss following a sale of the participation at lower going concern value, participations qualifying under the domestic or international participation exemption (but only if opted for tax-effective treatment, of the international participation) as well as under the exemption for portfolio participations can be depreciated to their lower going concern value or a loss from the sale may be utilised over a period of seven years for tax purposes. The Austrian exemption for portfolio participations in non-austrian corporations as well as the international participation exemption are granted only if the foreignsource dividends are not tax deductible at the level of the dividend distributing subsidiary. Moreover, these exemptions are subject to an anti-abuse provision. In case of portfolio participations in non-austrian corporations, abuse of law is assumed if the non-austrian corporation (a) is not directly or indirectly subject to a corporate income tax in its country of residence that is comparable to the Austrian corporate income tax; (b) is subject to a corporate income tax that is comparable to the Austrian corporate income tax, but its rate is less than 15 per cent; or (c) is subject to a comprehensive exemption from taxation in its country of residence. With regard to international participations, abuse of law is assumed if the predominant (more than 50 per cent) business object of the non-austrian corporation (directly or 6 Freshfields Bruckhaus Deringer llp

7 indirectly) is the generation of passive income (which does not include income of commercial leasing companies operating on non-austrian markets and income of credit institutions) and if the foreign subsidiary s income is not subject to foreign tax comparable to the Austrian calculation of the taxable base as well as the tax rates (ie not in excess of 15 per cent). In all these situations a switch-over from the credit method to the exemption method applies. Group Taxation Regime The Austrian KStG provides for a group taxation regime, which allows a parent corporation to pool earnings and losses of its Austrian and losses, however net profits, of its non-austrian group companies. The following prerequisites have to be met for a tax group to be created: The members of the group must be corporations or cooperative societies that are subject to unlimited corporate income tax liability in Austria or comparable foreign first-tier subsidiaries held by an Austrian group member of the Austrian parent corporation; The group parent corporation may be: (a) a cooperation, a cooperative society, an insurance or a credit institution subject to unlimited corporate income tax liability in Austria; (b) one of certain corporations resident in another EU Member State or comparable foreign corporations with their place of effective management or corporate seat in an EEA Member State that are subject to limited corporate income tax liability in Austria and maintain an Austrian branch registered with the Commercial Register, provided the participations in the group members are attributable for Austrian tax to this Austrian branch; or (c) a participation association (Beteiligungsgemeinschaft) consisting exclusively of corporations referred to in this subparagraph which are not members of another tax group. A dual resident corporation may only be the group parent corporation if it maintains an Austrian branch registered with the Commercial Register and the participations in the group members are allocable to this Austrian branch; The direct or indirect shareholding in a group member must be more than 50 per cent of the nominal share capital and the voting rights of the group member; The participation in a group member must be held for the entire business year of that entity; The tax group must exist for at least three years; and The representatives of the group parent corporation and all corporations that are to form part of the tax group must sign an application for recognition of the group by the tax authorities (Gruppenantrag). If the tax group has been successfully created, generally 100 per cent of the profit or loss of each domestic subsidiary is allocated to the tax group parent irrespective of actual participation in and/or distribution of dividends. If a group member corporation leaves the group before it has been a member of the group for a period of three years, all tax consequences relating to the group taxation regime must be reversed to put the corporation in the position in which it would have been had it never been a member of the tax group. Losses of a non-austrian subsidiary may only be allocated to the group parent corporation pro-rata the actual participation in the non-austrian and will be recaptured if the foreign losses become useable in the non- Austrian subsidiary s country, eg if the foreign subsidiary subsequently generates profits. Similarly, losses will be recaptured if the non-austria subsidiary that incurred the losses is sold or the tax group ceases to exist. If a non-austrian tax group member leaves the tax group, a final recapture applies. Such final recapture covers the entire foreign losses (irrespective of whether already used Freshfields Bruckhaus Deringer llp 7

8 in Austria to set off profits or carried forward at the level of the group parent) that have been utilised in Austria but not recaptured until that time. Other than for Austrian group members profits of non-austrian group members may not be aggregated under an Austrian tax group. Goodwill attached to a newly acquired shareholding in an operating corporation that is subject to unlimited tax liability in Austria, has to be depreciated over a period of 15 years as of the acquisition of the participation if such shareholding is included in an Austrian tax group. According to the legal definition in Sec 9(7) KStG, goodwill is considered the difference in relation to the shareholding between the equity in terms of company law (financial accounting) plus hidden reserves in the non-depreciable fixed assets and the purchase price relevant for tax purposes, amounting to a maximum of 50 per cent of this purchase price. Double tax treaty between Austria and Brazil The DTT between Austria and Brazil contains several beneficial provisions. Dividends distributed from Austria to Brazil are subject to withholding tax of 25 per cent, which rate is, however, reduced to 15 per cent. Pursuant to Art 23(2) of the DTT Austria-Brazil, Brazil may not tax dividends received from Austrian corporation, if the Brazilian parent holds at least 25 per cent of the nominal share capital of the Austrian company paying the dividend. However, corporate dividends distributed out of funds that were previously contributed as equity for Austrian tax purposes (eg corporate dividends sourced from the dissolution of unrestricted capital reserves from previous shareholder contributions) would qualify as a repayment of equity for Austrian tax purposes that is not subject to Austrian withholding tax at all and not subject to (limited) corporate income tax up to the amount of the contributed equity or acquisition cost of the shares in the Austrian corporation. Capital gains realised by an Brazilian investor in an Austrian subsidiary are subject to 25 per cent corporate income tax in Austria. Corporate income tax is levied by way of tax assessment. Under the DTT Austria-Brazil gains from the alienation of shares are within the scope of Art 13(3) which provides that both Brazil and Austria have the right to tax capital gains from the sale of Austrian shares. The DTT Austria-Brazil would therefore not prevent Austria from levying Austrian corporate income tax on capital gains realised by Brazil investors upon a sale of shares in an Austrian company. Based on Art 23(1) DTT Austria-Brazil we would expect that Brazilian tax authorities should grant a credit for Austrian corporate income tax levied on any capital gains realised upon such sale of shares (this needs to be assessed in details by an Brazilian tax counsel). Moreover, the DTT Austria-Brazil contains matching credit provisions. Eg for interest income from Brazilian sources received by an Austrian resident Austria is obliged to credit Brazilian tax of at least 25 per cent even if such tax is lower or not levied at all under the Brazilian domestic tax law. Thus, Austrian investors may profit from a (fictitious) credit amount on their Austrian tax liability on Brazilian-source interest income. Conversely, interest from government bonds may only be taxed in the source state. Due to the fact that Austria does not subject interest from Austrian sources on bonds payable to non-residents to withholding tax and limited tax liability a Brazilian investor may generate interest from government bonds free of tax. 8 Freshfields Bruckhaus Deringer llp

9 Activities and economic substance for Austrian VAT purposes The question of economic substance and the scope of activities may have relevance for Austrian VAT purposes, particularly as regards the question whether the Brazilian investor will be qualified as an entrepreneur for Austrian VAT purposes and is, as such, entitled to input tax relief (ie the entitlement to deduct VAT it suffers on the supply of goods and more importantly services to it). The activity of a pure holding company, limiting its substance and activities to the pure ownership of shares in other companies (ie subsidiaries), is not considered a taxable activity for Austrian VAT purposes. Conversely, an active holding company (providing certain intra-group services, ie administrative, financial, accounting, IT and/or technical services to its subsidiaries and other group companies) is considered entrepreneurial. Any person or entity that independently pursues an economic activity with or without the intention to make profits qualifies as a taxable person for Austrian VAT purposes, ie as an entrepreneur (Unternehmer). Provided that the place of performance of such supplies is within Austrian, the supply of non-exempt goods or services by entrepreneurs is subject to Austrian VAT; conversely, any VAT suffered on supplies to such an entrepreneur may be deducted by that entrepreneur (provided the supplies acquired by the entrepreneur are not exclusively used to effect VAT exempt supplies). freshfields.com Freshfields Bruckhaus Deringer llp is a limited liability partnership registered in England and Wales with registered number OC It is authorised and regulated by the Solicitors Regulation Authority. For regulatory information please refer to Any reference to a partner means a member, or a consultant or employee with equivalent standing and qualifications, of Freshfields Bruckhaus Deringer llp or any of its affiliated firms or entities. This material is for general information only and is not intended to provide legal advice. Freshfields Bruckhaus Deringer llp,, 35512

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