According to the Directorate General of Taxes, exempt dividends and capital gains obtained by foreign holding companies do not have to be declared in Spain.
Controlled Foreign Company (CFC) regimes are traditionally anti-abuse rules aimed at avoiding the deferral of taxation of income – normally of a “passive” or non-business nature – in controlled foreign entities resident in territories with nil or low taxation. In accordance with this purpose, in any CFC regime, at least the following requirements should be met with respect to the corresponding foreign subsidiary: (i) legal and/or economic control over such company; and (ii) lower taxation of such company compared to that which would apply if it were resident for tax purposes in the territory in which its parent entity is resident.
In relation to this second requirement, article 100.1.b) of the Spanish Corporate Income Tax Law (CIT Law) requires a comparison between the effective taxation borne by the foreign subsidiary and the taxation that would have been borne by the same company had it been resident in Spain. If that comparison shows that the taxation of the non-resident subsidiary is 75% lower than the taxation that would be applicable in Spain in relation to the income in question, and the other requirements of the CFC regime are met, the corresponding income must be reported under the Spanish CFC regime.
As is well known, section 10 of article 21 of the CIT Law (introduced by Law 11/2020, of 30 December, on the General State Budget for 2021 and applicable for tax periods starting on or after 1 January 2021), established that the amount of dividends and positive income obtained on the transfer of shares to which the exemption of said article 21 applies will be reduced by 5% as management expenses. In other words, in practice, this income is generally taxed in Spain at 1.25% (tax rate of 25% applied to 95% of the income).
The introduction of this legislative amendment opened up two interpretations as to the nature of the exemption in Article 21 of the CIT Law: (i) either it was a rule that limited the amount of the exemption quantitatively (to 95%) (i.e. we were dealing with a “partial exemption”); (ii) or it was a rule that restricted only the deduction of certain expenses, estimated on a notional basis at 5% of income, but without affecting its full exemption status. In those structures in which a Spanish company participated in foreign operating entities through an intermediate holding entity, the aforementioned technical discussion on the nature (full or partial) of the exemption would therefore have a relevant impact on the application of the Spanish CFC regime by the Spanish parent company. This is so:
i. If it was considered that in Spain the dividend (or capital gain) was partially exempt, taxed at an effective rate of 1.25%, the comparison with the tax of the foreign investee (0%) would result, a priori, in the latter being lower than 75% of that applicable under the Spanish CIT Law (1.25%). In other words, the requirement of article 100.1.b) of the CIT Law could theoretically be understood to be met.
ii.If, on the other hand, it was understood that article 21 of the CIT Law regulates a full exemption, although limiting the deduction of portfolio management expenses, it could be argued that the taxation of the dividend was the same in both countries (0%) and, therefore, that the requirement to report the transparent income was not met.
In our post of 26 October 2021, we already stated that the first interpretation could be technically debatable, as the Directorate General of Taxes (DGT) has finally concluded in its binding resolution V2138-24 of 3 October..
In accordance with this interpretation, the DGT concludes that, in the case in question (Spanish holding company holding 96% of a Chilean holding company that receives dividends from its operating subsidiaries, which are 100% exempt in Chile), it will not be understood that the dividends obtained by the Chilean holding company have been taxed at less than 75% of the taxation that would have corresponded in Spain, since in both countries such income enjoys full exemption. Therefore, the DGT concludes that there is no obligation to declare those dividends under the Spanish CFC regime.
Consistently, according to the DGT, if the Spanish holding company were to transfer its shareholding in the Chilean holding company, the limitation contained in article 21.5.c) of the CIT Law would not apply, by virtue of which the exemption is not applicable to income derived from the transfer of shareholdings in entities that meet the requirements of the CFC regime (provided that at least 15% of their income is subject to that regime). The DGT concludes by emphasizing the incompatibility of the exemption regime with the international double taxation deduction, an issue expressly raised by the consulting entity.
In short, this recent DGT ruling offers a relevant interpretation on a technical issue that had generated controversy since the introduction of the rule limiting the deduction of portfolio management expenses in the participation exemption regime of article 21 of the CIT Law.
