How To Change Tax In Spain

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1 Important tax changes in Spain for 2015 On August 6 th 2014 Spanish parliament acknowledge receipt of four draft tax bills to be discussed and approved before the end of the year, and enter into force on January 1 st The wording of these drafts includes some minor changes to the ones published in June this year, so most of our comments in July s newsletter are still valid. We have highlighted in this edition those changes for the reader s convenience. As of end September 2014 the laws are in discussion at the parliament, where they will most likely be approved without relevant changes, as the government holds absolute voting majority. That said, there are some changes that will take place during this process (because they are promoted by the party in power), which affect two taxes that were originally not included in the reform. The reason is that in Sept 3 rd the European Court of Justice ruled against Spanish Inheritance Tax (IHT) rules as being non-compliant with EU legislation, so the government has been forced to include some changes in IHT and also in Wealth Tax (WT) What s in the reform for Spanish HNWI clients? Spanish government publicly announced that this tax reform was aimed at reducing taxes to boost growth in Spain. And it is true that the proposals formally reduce income and corporate tax rates, but they also include some measures that can have important consequences for Spanish HNWI clients. At first reading, it seems these are the relevant changes (or things unchanged ) relevant for private banking clients: o Wealth Tax and Inheritance Tax are now included in the reform. o Marginal income tax rates are reduced at 45% and corporate ones to 25%. However, the income threshold to reach the new marginal maximum is significantly lower (from 175,000 EUR to 60,000) o The dual base approach in Income Tax is maintained: savings income tax rate is reduced from 27% to 24% in 2015 and to 23% in Savings Income threshold is increased from 24,000 EUR to 60,000 EUR. o o Capital gains in shares and funds hold for less than one year will not be taxed at marginal income tax rate from Jan 1 st 2015 Assets acquired prior to 1994 will be now fully taxed on gains if sold after Jan 1 st 2015, without deductions New: Wealth Tax and Inheritance Tax are included 1

2 Life insurance in the tax reform Life insurance products are not affected by the tax reform in its current draft wording. The law creates a new product for retail investors, which can be structured as life insurance or as bank deposit, but its low limits (maximum 5,000 EUR contribution per year), makes it a very retail product. That said, there are two changes in the tax reform (not listed above) that could mean a significant advantage for life insurance solutions for HNWI. The first one greatly diminishes the attractiveness of competing international investment vehicles, while the second one offers a new advantage for life insurance. First change: CFC rules for international funds Spanish Tax law foresees in its current wording that non-spanish companies or investment vehicles will be subject to CFC rules (attribution of income to its Spanish shareholders) if they are domiciled outside the European Union, a single person or family owns more than 50% and the company is subject to a corporate tax less than 75% of Spanish corporate tax. The tax reform widens the scope of this rule to include vehicles domiciled in the European Union if the taxpayer owning more than 50% cannot demonstrate that they were created for a valid economic reason and have an economic activity. In the draft bill sent to Parliament it has been included a clear definition of which investment vehicles are affected by these rules: those not in compliance with EU Directive 2009/65/CE of July 13 th 2009 (the UCITS Directive). Although in a conference with tax experts in Madrid, the Spanish Director of Income Tax confirmed that their opinion is that EU harmonized funds would not be affected by this rule, the new wording is more restrictive, as EU harmony is limited to a single Directive, clearly identified in the tax law. As this Directive establishes, its focus is in collective investments management and the activity of management of individual portfolios of investments is an investment service covered by Directive 2004/39/EC. Accordingly this tax reform will greatly impact well-known non-harmonized wealth planning vehicles (SIF, SPF, QIF, etc) in financial centres like Luxembourg, Ireland or more recently Malta, when they have been used to wrap individual portfolios of clients or families. New It is important to highlight that the wording only applies to collective investment vehicles harmonized with that Directive. Whether or not a fund or Sicav is registered at Spanish CNMV for its sale in Spain is not relevant for tax purposes. In that sense, it is also important to notice that, in case of vehicles with compartments, the 50% ownership rule will apply to each compartment, as several rulings from the DGT have confirmed. Additionally, the attributed income under this rule will be part of the general tax base and not considered savings income, so it could be taxed at marginal rates (up to 45%) and included in the joint base for wealth tax purposes (raising possible effective taxation up to 60%). This change did not come as a surprise, as this CFC rule was already applicable for Spanish companies under Corporate Tax Law, and Spanish law firms had issued warnings that the different treatment between companies and individuals had no reason to exist, so it was likely to end in the reform. Local Spanish SICAVs and EU 65/2009/CE harmonized ones are not affected by this proposed change and keep their advantages for Spanish clients. But for those Spanish clients willing to diversify internationally their wealth, compliant life insurance solutions offered in free rendering of services from Luxembourg, like the ones Swiss Life (Luxembourg) proposes since 2006, appears to be one of the best options for Spanish HNWI. 2

3 Second change: Exit Tax The second important change for HNWI clients in the reform did come as a surprise: the introduction of an Exit Income Tax. If the reform is finally approved, from January 1 st 2015 Spanish residents moving their tax residence outside the EU or EEA will be subject to a capital gains tax on unrealized gains in their holdings. The main provisions of this tax are: o It applies to clients who have been tax resident in Spain at least ten of the last fifteen years before changing residence AND New: ten of the last fifteen years Own more than 4,000,000 euros in relevant assets Own more than 25% in a company worth 1,000,000 EUR o Relevant assets are ONLY shares (either listed or not) and investment funds. It does not apply to other assets like bonds, real estate, life insurance o The tax base will be the difference between the market value at exit and the acquisition cost o These gains will be taxed as capital gains, at maximum rate of 23% (24% in 2015) o The reform foresees anti-abuse rules for taxpayers relocating first to another EU or EEA country and then moving outside the EU or EEA If approved, this reform makes life insurance solutions the best investment tool for international mobile Spanish tax residents, like professional sportsman, multinational company executives, entrepreneurs, etc, as they could profit from life insurance tax deferral advantage, while capitalizing their gains and not being taxed on relocation. 3

4 Inheritance and Wealth Tax Due to a recent EU Court of Justice ruling against Spain on its inheritance tax system, the government has introduced a last minute change in the reform which affects these two taxes. It deals with the fact that when those taxes were applied to non-spanish residents, in certain situations they were not allowed to use tax benefits of the Spanish regions, which are normally granted to their residents. New In summary the changes are as follows: Inheritance Tax Residence of deceased Residence of Heirs Type of Assets Applicable tax law Spanish region where a higher value EU Spain Any (not real estate) of assets is located Spain EU or EEA Any (not real estate) Any EU or EEA Life insurance Spanish region where the deceased person was resident Spanish region where the insurance company has its domicile or Spanish region where the contract was signed (if company is not resident in Spain) Gift Tax Residence of donor Residence of beneficiary Type of Assets Applicable tax law Any Spain Real estate in Spain Spanish region where real estate is located Any Spain Real estate in the EU Spanish region where the beneficiary person is a resident Any EU or EEA Any (not real estate) in Spain Spanish region where assets have been most time during last five years It is important to notice that there is one case which has not been included and could be very important: when the deceased person was non-spanish and EU or EEA resident, his/her heirs are Spanish resident but the inheritance does not include any assets whatsoever in Spain (ie just financial assets in a Swiss bank). In that case, the inheritance will continue to be taxed at full rates according to Spanish normal rules, without any regional tax benefits. 4

5 Final change There are a few HNWI clients that could be particularly affected by this tax reform if approved. The new law will abolish a compensation scheme put in place to mitigate the effects of inflation on capital gains and also to grandfather some tax advantages that where in force until This means that clients holding assets (particularly shares, funds and real estate) bought before 1994, will now be fully taxed on all capital gains if the asset is sold after January 1 st The only option left for these clients to consolidate the tax deductions would be either to sell the assets before that date or to enter into a transaction that is considered as a sale from a tax point of view,: subscriptions in kind in funds or companies, or payment in kind of premium to life insurance. Conclusion At the time of writing this newsletter, a few days after the draft of the tax reform was announced, it is possibly too early to foresee what the final outcome will be, after the necessary parliamentary discussions and amendments. But it seems from what it has been announced that the Spanish government is seeking to increase taxes on wealth income and that life insurance, not being affected at all by the reform, will play an important role in HNWI wealth planning strategies for Spanish residents in the near future. In this scenario, the local Spanish experts of Swiss Life (Luxembourg), Jesús Cano and Joan Mir, with more than 20 years combined experience in life insurance solutions in Spain, will be the best partner for local and international private banks and independent financial advisers. 5