Host Country SPAIN. I. Background. A. Withholding tax obligations All the comments made in this paper concern

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1 Host Country SPAIN Eduardo Martínez-Matosas and Irene Durán Gómez-Acebo & Pombo, Barcelona I. Background A. Withholding tax obligations All the comments made in this paper concern the position of a nonresident operating in Spain without a permanent establishment ( PE ) in Spain. The basic rules governing withholding taxes in the context of nonresidents operating without a PE in Spain are contained in the Nonresidents Income Tax Law ( LIRNR ). The relevant provisions impose tax on Spanish-source dividends, interest, royalties, salaries and rents, as well as on other specified income and capital gains. 1 As the law defines withholding tax on income derived by non-spanish resident taxpayers as a final tax rather than an advance payment, such taxpayers will generally not be obliged to file a tax return declaring their income when tax has already been withheld. Accordingly, in general, income (and some capital gains) that is (are) subject to nonresident income tax (Impuesto sobre la Renta de No Residentes or IRNR ) is (are) also subject to withholding tax. However, no withholding tax is imposed on: 2 s income exempted under either domestic law or a tax treaty. There is, however, an obligation to withhold tax with respect to certain exempt income, such as dividends derived from EU pension funds that are equivalent to Spanish pension funds and dividends derived from qualifying EU undertakings for collective investment in transferable securities ( UCITS ); s income in the form of adistribution of share premium or resulting from areduction of share capital that is not derived through a tax haven; s income settled on or paid to an IRNR taxpayer, when evidence is provided of payment of the tax due or the applicability of an exemption. It is important to note that, if withholding tax has not been withheld on the grounds that the corresponding tax liability had (supposedly) been previously paid and subsequently it emerges that no payment has been made, the withholding agent will be responsible for payment of the tax; s dividends derived by a nonresident that is not resident in a tax haven from qualifying profits, i.e., profits derived by Spanish entities to which the Spanish holding company regime (Régimen de Entidades de Tenencia de Valores Extranjeros or ETVE ) applies. Such payments are not subject to Spanish taxation since they are considered to constitute foreign-source income; s capital gains. Certain capital gains, however, are subject to withholding tax, for example, capital gains derived from certain prizes, capital gains derived from the transfer or redemption of shares in the capital of certain UCITS 3 and capital gains derived from the sale of real estate. In the case of gains from real estate, the withholding tax constitutes a payment on account of the tax to be paid on the gains by the nonresident seller (3 percent of the consideration received by the nonresident from the sale of the real state); s income derived from the conversion of bonds into shares; and s income derived from the transfer or redemption of financial assets with a fixed return that are represented by book entries and are traded on an official Spanish secondary market. Proof of payment of the tax must be provided by submission of the relevant form by the taxpayer or its representative. Alternatively, proof of the admissibility of an exemption must be provided in the form of documents evidencing the circumstances giving rise to the exemption. 4 In general, the amount withheld will be equivalent to the actual IRNR due. The individuals and entities that are obliged to withhold tax from payments to nonresidents ( withholding agents ) are almost the same as those that are obliged to do so in the context of personal income tax ( IRPF ) and corporate income tax ( IS ). Withholding agents comprise the following persons: s a Spanish resident entity, including an entity subject to the attribution of income regime (i.e., basically an entity without legal personality, see II.C.1., below); s a Spanish resident individual who carries on economic activities; s an IRNR taxpayer with a PE in Spain; s an IRNR taxpayer without a PE in Spain, with respect to employment income paid by it and other income subject to withholding tax that constitutes a deductible expense in calculating its income; 12/13 Tax Management International Forum Bloomberg BNA ISSN /13 Tax Management International Forum Bloomberg BNA ISSN

2 s a designated representative (under the relevant legislation) acting on behalf of a non-spanish EU private insurance company operating under the freedom to provide services, in relation to transactions carried out in Spain; s the issuer of the instruments, with respect to income derived from the amortisation or redemption of financial instruments. However, where the performance of such transactions is entrusted to a financial institution, the financial institution will be obliged to withhold the relevant tax s the management company, in relation to the redemption of participations in an investment fund; s the person that pays, in the case of prizes. As already noted, anonresident taxpayer will not be obliged to file a tax return declaring income with respect to which tax has been withheld. Nor will such a taxpayer be obliged to file atax return with respect to items of income that are subject to Spanish withholding tax but are exempt from such tax under the provisions of atax treaty between Spain and its country of residence. It should be noted that when an amount of tax is not withheld because of an exemption or a reduction in the rate of withholding tax provided for in an applicable tax treaty, this must be justified by atax residence certificate issued by the tax authorities of the treaty partner country expressly stating that the taxpayer concerned is a resident of that country as defined in the treaty or, where applicable, by the appropriate form established in the orders that develop Spain s tax treaties. It should be noted that apayer of income accruing to a nonresident without a PE in Spain and a depository or manager of assets or rights where these activities are not carried on through apeinspain are jointly and severally responsible for the payment of tax liabilities with respect to the income they pay or the income from the assets or rights deposited or managed. 5 However,there is no such joint and several responsibility (i.e., such a payer is solely responsible) for liabilities arising from the obligation to withhold taxes. Where applicable, a nonresident taxpayer is entitled to claim a refund of withholding tax withheld in excess. Withholding tax must be withheld at the time of accrual of the relevant income or gains, specifically: s with respect to ordinary income, withholding tax is payable on the date on which the relevant payment is due or on the date of payment if this is earlier; s with respect to capital gains, on the date on which the capital gains arise; s with respect to deemed income from real estate, on the last day of the relevant tax period (December 31); and s in other cases, on the date on which the relevant payment is due. B. Income tax reporting requirements As already noted in I.A., above, nonresident taxpayers are not obliged to file tax returns declaring income with respect to which tax has been withheld. However, reports must be filed by nonresident taxpayers that: s derive certain capital gains; s are deemed to derive income from the ownership of urban real estate (this requirement applies only to individuals); s receive payments made by individuals who are not withholding agents (for example, proceeds derived from the renting of real estate when the tenant is an individual who rents the real estate for purposes other than carrying on an economic activity); or s wish to request a refund of excess withholding or payments on account with respect to a tax liability. The forms to be used to declare the receipt of income by nonresidents without a PE in Spain are as follows. s Form 210: this is used to report any type of income or gains (only one type of income per form) derived by a nonresident without a PE in Spain, where no withholding tax applies to the income. s Form 213: nonresident entities that are tax haven residents and hold, under any title, real estate or rights to the use of real estate located in Spain are liable, on an annual basis, to aspecial tax on property amounting to 3 percent of the assessed value (valor catastral) of the real estate concerned Form 213 is used to report the value of such real estate. The forms to be used by withholding agents are as follows. s Form 211: this is used by purchasers (whether resident or nonresident, and whether individuals or entities) of real estate located in Spain from nonresidents without a PE in Spain. Such a purchaser is required to withhold and deposit the statutory percentage of the sale proceeds, or to make a corresponding deposit of a percentage of the agreed consideration as a payment on account of the tax that will subsequently have to be paid by the nonresident seller. The seller can deduct the tax withheld from the tax due on the net capital gains. If the tax withheld is more than the tax due, the seller can claim a refund. s Form 216: this is used by individuals or entities required to withhold from, or make payments on account with respect to, any income (except income arising from the transfer or redemption of participations in investment funds) paid to nonresidents without a PE in Spain. s Form 117: this is used by individuals or entities required to withhold from, or make payments on account with respect to, income arising from the transfer or redemption of participations in investment funds paid to nonresidents without a PE in Spain. s Form 296: this is an annual summary of the withholding taxes and payments on account reported on Form 216. s Form 187: this is an annual summary of the withholding taxes and payments on account reported on Form 117. It should be noted that the Bank of Spain and registered organisations subject to the regulations on financial transactions with foreign countries that hold Spanish accounts opened by nonresidents must provide the Spanish tax authorities with the relevant information relating to such accounts on Form 291. To be able to file atax return, ataxpayer or withholding agent must have a Tax Identification Number 66 12/13 Copyright 2013 by The Bureau of National Affairs, Inc. TM FORUM ISSN

3 (Número de Identificación Fiscal). In certain cases, it is mandatory to file the above forms over the Internet. For this purpose, a user certificate (certificado de usuario) must be installed in the user s browser to generate the electronic certificate accepted by the Spanish tax authorities. It should be noted that certain individuals and companies (i.e. lawyers, accountants) are authorised to file tax returns on behalf of third parties. In order to file areturn for athird party, such an individual or company must have the third party s user certificate installed in his/its browser. Payments of tax must be made to the relevant participating entities, which are certain banks that collect the taxes payable to the Spanish tax authorities. In certain cases, forms can also be filed with the participating entities, which then transfer the forms to the tax authorities. However, when electronic filing is mandatory, the participating entity will assign a code (Número de Referencia Completo or NRC) associated with the payment made, which the taxpayer/ withholding agent must enter on the appropriate form. II. Application of Spanish withholding and reporting rules to cross-border payments A. Compensation paid to Exec for Spanish services 1. Withholding tax obligation Broadly speaking, an individual is deemed to be a Spanish tax resident if he or she meets any of the following criteria: s the individual remains in Spain for more that 183 days during the calendar year; s the main base or center of the individual s activities is, directly or indirectly, in Spain. For these purposes, the law takes into account only economic interests/activities and not other links (i.e. personal links) that an individual may have to Spain. It is generally understood that the center of economic interests of an individual corresponds to the place where he or she effectively works (in the case of an employee or a self-employed individual) or where his or her main wealth is located (in the case of an individual whose main source of income is of apassive nature). It should also be noted that both the Spanish tax authorities and the Spanish Courts have also considered the country where income is sourced to be akey element in determining an individual s center of economic interests; and s the individual s (non-legally separated) spouse and minor dependent children qualify as Spanish tax residents under either of the above criteria: in this case, Spanish tax residence is presumed, unless proof to the contrary is provided. Exec will be considered a nonresident if he spends less than 183 days in Spain in Year1, assuming that: (1) Exec has received income from FCo from January to August (in other words, the majority of his income comes from Country Xand not from Spain); and (2) Exec is not married and does not have minor children or, if he is married and has minor children, they are nonresidents in Year 1. As noted in I.A., above, nonresident individuals are liable to IRNR on their Spanish-source income. Employment income is considered to have a Spanish source when it derives from a personal activity carried on in Spain. Consequently, Exec will be taxed on the salary paid by HCo (for the period from September to December of Year 1) at aflat rate of percent. 6 Since salaries are not one of the categories of income with respect to which withholding is not required, HCo will have to withhold the relevant withholding taxes. If Country Xhas atax treaty with Spain that follows the OECD Model Convention, the consequences will remain unchanged. The OECD Model grants the treaty partner country the exclusive right to tax employment income received by one of its residents from the exercise of an employment in Spain if the following conditions are fulfilled: s the nonresident employee is present in Spain for a period not exceeding 183 days in any 12-month period; s the remuneration is paid by (or on behalf of) an employer that is not resident in Spain; and s the remuneration is not borne by apethat the nonresident employer has in Spain. Since, in the present case, the second of the above conditions is not fulfilled, the salary received by Exec would be taxed in Spain and HCo would, therefore have to withhold tax from that salary. HCo will have to use Form 216 to report and pay the tax withheld from the salary paid to Exec for the period from September to December of Year 1. If HCo qualifies as alarge Business, Form 216 will have to be submitted on amonthly basis within 20 calendar days from the end of the month to which it relates. If HCo is not alarge Business, Form 216 will have to be filed on aquarterly basis. HCo will also have to submit the annual form (Form 296) within 20 calendar days from the end of the year to which it relates or, incertain cases, before January 31 of the following year. B. Royalties paid on sublicense 1. Withholding tax obligations Spanish domestic law provides that royalties with respect to property or rights used in Spain paid to nonresidents by Spanish tax residents or by Spanish PEs of nonresidents are subject to IRNR. Articles 10, 11 and 12 of the OECD Model Convention provide that certain types of income (respectively, dividends, interest and royalties) paid by a company resident in one Contracting State (the source state ) to a resident of the other Contracting State (the residence state ) can qualify for reduced (or no) sourcestate taxation, provided the recipient of the income (in the residence state) is the beneficial owner of the income concerned. In this respect, many of Spain s tax treaties provide that a non-spanish resident recipient of Spanish-source dividends, interest or royalties can benefit from such relief if, in addition to being aresident of the other Contracting State, it is also the beneficial owner of the income concerned. 12/13 Tax Management International Forum Bloomberg BNA ISSN

4 The purpose of the beneficial ownership provision is to avoid abuses consisting of the use of conduit or legal artificial structures to benefit from a tax exemption or reduction provided for by the law that would otherwise not apply. The provision makes it clear that the source state is not obliged to give up taxing rights over dividend, interest or royalty income merely because that income is received directly by a resident of a country with which the source state has concluded a tax treaty. Neither Spanish domestic tax law nor the OECD Model Convention defines the term beneficial owner. Nor is the term defined in the Commentary on the OECD Model, which is frequently relied on for interpretative guidance by the Spanish tax authorities and the Spanish Courts in reaching their decisions and judgments. In this context, it is worth pointing out that the OECD Report on Double Taxation Conventions and the Use of Conduit Companies concludes that a conduit company cannot normally be regarded as the beneficial owner; though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties. The Spanish tax authorities and the courts have aligned themselves with a trend towards equating beneficial ownership with a broad anti-abuse clause, as exemplified, for instance, in the decisions of the Spanish High Court dated July 18, 2006 and July 20, 2006 (which concerned similar facts). The facts in the first case were that a Spanish company made payments to ahungarian company for the use of, or the right to use, image rights with respect to one of its football players. The Hungarian company then transferred almost the full amount of the payment (99 percent) to adutch company. Under the terms of the Spain-Hungary tax treaty, no withholding tax was withheld by the Spanish company. The Spanish tax authorities took the position that the Hungarian company was interposed in order to take advantage of the exemption from withholding tax on payments for image rights provided for in the treaty.the authorities took the position that the Hungarian company could not be considered the beneficial owner of the royalty payments because: (1) there was a contract for the sub-licensing of the image rights; and (2) the Hungarian company paid almost the entire amount of the royalty payments to the Dutch company after receiving them from the Spanish company. The position of the Spanish tax authorities was upheld by the Court. In the case at hand, if SisterCo were considered the beneficial owner of the royalties derived from HCo, such royalties would be exempt from Spanish withholding tax under the Spain-Country X tax treaty. However,asthe facts of the case at hand are very similar to the facts in the cases discussed above (i.e., the Hungarian conduit cases ), the Spanish tax authorities would probably conclude that the beneficial owner of the royalties is FHoldCo instead of SisterCo and that the interposition of SisterCo is an arrangement for purposes of avoiding the percent withholding tax that would be imposed on the royalties if they were paid directly to FHoldCo. In conclusion, in principle, HCo would not have to withhold tax on its payment of royalties to SisterCo under the terms of the Spain-Country X tax treaty. However, for the reasons explained above, the Spanish tax authorities might, at some point, claim such withholding tax from HCo (in its capacity as withholding agent). In order to report and pay the withholding tax on the royalties paid to SisterCo (or to declare such royalties exempt from withholding tax), HCo would have to use Forms 216 and 296 as explained in II.A.2., above. C. Interest paid by HFund to Lender 1. Withholding tax obligations For purposes of this paper, the partnerships involved will be considered fiscally transparent entities. Although the term partnership isnot used as such in Spain, Spanish law recognises a number of kinds of entity that are, to some extent, similar to partnerships. An entity without Spanish legal personality, such as a joint ownership, the estate of a deceased person or a civil company,is taxed in accordance with an attribution of income regime, under which income, whether distributed or not, is taxed in the hands of the members of the entity on acurrent basis. For purposes of this paper, such an entity is referred to as an EAR. Spanish domestic law distinguishes between an EAR formed in Spain (a Spanish EAR ) and an EAR formed abroad (a foreign EAR ). Under Spanish law, aforeign EAR is aforeign entity whose nature is identical or analogous to that of aspanish EAR. 7 ASpanish EAR may or may not perform an economic activity in Spain each of these situations will have different Spanish tax consequences. Likewise, a foreign EAR can be classified as aforeign EAR with a presence in Spain or as aforeign EAR without apresence in Spain. The criteria for having a presence in Spain are similar to those for having a PE in Spain (i.e., a place of business in Spain or a Spanish agent). It is the authors understanding that HFund would qualify as a Spanish EAR that performs an economic activity in Spain. On the other hand, provided Lender is a partnership incorporated abroad and has no place of business or agent in Spain, and assuming that its nature is identical or analogous to that of a Spanish EAR, for Spanish tax purposes, Lender should be treated as aforeign EAR with no presence in Spain. As already noted, in general, the income of an EAR, whether distributed or not, is taxed in the hands of its members on a current basis. Nevertheless, there are some exceptions to this treatment for nonresident members of an EAR. The Spanish tax treatment of such an entity and its nonresident members depends on whether the entity is formed in Spain and on whether it carries on an economic activity in Spain. Thus an EAR, such as HFund, that is formed in Spain and carries on an economic activity in Spain is not a taxpayer for IS or IRNR purposes. The Spanish resident members of an EAR are liable to IRPF or IS, as appropriate, on the income obtained by the entity and the nonresident members are subject to IRNR. On the other hand, aforeign EAR without apresence in Spain is also not subject to IS or IRNR. In /13 Copyright 2013 by The Bureau of National Affairs, Inc. TM FORUM ISSN

5 stead, its Spanish resident members are again subject to IRPF or IS and its nonresident members are subject to IRNR with respect to any Spanish-source income of the entity. The members are taxed in proportion to their interests in the income of the entity as follows: (1) if all the members are entities subject to IS or nonresidents with a Spanish PE, the attributable income is determined in accordance with the IS rules; (2) if any member is a nonresident (whether an individual or a legal entity) without a Spanish PE, the attribution of his/its share is determined in accordance with the IRNR rules; and (3) if any member is aspanish resident individual, his attributable income is determined in accordance with the IRPF rules. As noted in I.A., above, entities subject to the attribution of income regime are required to withhold tax where the income concerned is subject to withholding tax. Interest paid to non-spanish residents is subject to withholding tax at the rate of 21 percent unless a lower rate applies under a tax treaty. If the interest is paid is to aresident of another EU Member State, a tax exemption will generally be available. In the case at hand, HFund borrows funds from Lender. Since Country Z has not signed a tax treaty with Spain, the Spanish domestic rules would apply to interest paid by HFund to Lender, so that such interest would, in principle, be subject to withholding tax at the rate of 21 percent. In the case at hand, provided Lender is an EAR with no presence in Spain so that all the income obtained by Lender is taxable in the hands of its members, the country that will determine whether an exemption or a reduced rate of withholding tax is applicable will be the country(ies) of residence of Lender s members. Thus, if these members are resident in another EU Member State, such interest will be exempt from IRNR. 8 Otherwise, the interest will be subject to withholding tax. In the light of the above it can be concluded that: (1) HFund and Lender would probably be treated as EARs for Spanish tax purposes; (2) Spanish EARs are liable to withhold tax on income subject to withholding tax and interest is not atype of income that is not subject to withholding tax; (3) the interest paid to Lender would be exempt from IRNR on the portion corresponding to any non-spanish resident members that were resident in an EU Member State, and subject to IRNR on the portion corresponding to any non- Spanish resident members that were not resident in an EU Member State; and (4) HFund would have to withhold a final withholding tax at a rate of 21 percent on the portion corresponding to the non-eu members or at areduced rate if so provided under an applicable tax treaty. According to the fact pattern, three members of Lender are Spanish tax resident individuals. Therefore, interest paid by HFund to Lender on the portion corresponding to these individuals will be subject not to IRNR but to IRPF. In either case, the interest would be subject to withholding tax at arate of 21 percent. However, where the recipient is subject to IRPF, the withholding tax will not constitute a final tax since a Spanish tax resident individual must submit a personal income tax returns on the basis of which the interest will be taxed at rates ranging from 21 percent-27 percent. 9 Generally, a Spanish EAR or a foreign EAR that carries on an economic activity in Spain or whose annual income exceeds EUR 3,000 must submit Form 184, on which the income derived by the entity and the portion corresponding to each of its members must be reported. However, a foreign EAR that derives Spanishsource income without carrying on an economic activity in Spain is not required to file Form 184. Consequently, HFund will be obliged to file Form 184, but Lender will not. As discussed in II.C.1., above, HFund would have to withhold afinal withholding tax at the rate of 21 percent (or a lower treaty rate, if applicable) on interest paid to Lender on the portion corresponding to Lender s non-eu resident members. The forms to be used would be Form 216 and Form 296 (see II.A.2. and II.B.2., above). Regarding the interest paid by HFund to Lender on the portion corresponding to Lender s Spanish resident members, the forms to be used would be Form 123 and the annual summary Form 193. The deadlines for submitting these forms are the same as those applying to Form 216 and 296 (see II.A.2. and II.B.2., above). NOTES 1 According to current Spanish domestic law, the withholding tax rate applicable to dividends, interest (and capital gains) is 21 percent and the withholding tax rate applicable to other types of income is percent, although these rates may be reduced under the terms of an applicable tax treaty. 2 LIRNR, Art and RIRNR, Art Capital gains derived from the transfer or redemption of stocks or shares of listed investment funds governed by Regulation 35/2003 regarding mutual investment institutions, Sec. 49, passed by Royal Decree 1309/ RIRNR, Art LIRNR, Art As of Jan. 2015, the rate could be reduced to 24 percent. 7 LIRNR, Arts. 35 to Unless Country Zisa blacklisted tax haven for Spanish tax purposes. 9 The first EUR 6,000 are taxed at 21 percent, the next EUR 18,000 at 25 percent and the excess over EUR 24,000 at 27 percent. 12/13 Tax Management International Forum Bloomberg BNA ISSN