November 1, 2022
Spanish tax authorities deny interest deductions on debt to fund a share premium distribution, overall transaction declared as abusive in binding report
In the context of a tax audit procedure, the Spanish tax authorities (STA) challenged, in a binding report, the tax deductibility of financial expenses derived from debt used to fund a share premium distribution.
The challenge was based on the application of the GAAR, on the grounds that by using several "intermediary" entities and carrying out a series of consecutive intra-group transactions, the taxpayer achieved an anticipated distribution of future profits and generated financial expenses which reduced the tax burden in Spain.
In order to substantiate a challenge based on the Spanish GAAR, the STA are required to follow a more onerous specific procedure which requires consultation with an Advisory Committee whose conclusion is binding for the tax audit teams This Alert examines the report issued by such Advisory Committee on 1 September 2022 (the Report1).
Going forward (i.e., for transactions carried out from the date of publication of the Report), cases that are substantially equal to the one in the Report and successfully challenged by the STA based on GAAR could potentially entail penalties.
Case under analysis and approach followed by the STA
The instant case refers to a tax audit procedure related to the Corporate Income Tax (CIT) deductibility of financial expenses registered by a Spanish holding company derived from debt used to fund a share premium distribution to its shareholder. As a result of the transactions, the Spanish holding reduced its tax burden in Spain.
The transactions audited by the STA were implemented through the following steps:
Spain HoldCo considered the financial expenses derived from the debt used for distributing share premium as tax deductible on the basis that the relevant financial expenses were only limited by the general earnings stripping rule.
The Spanish tax auditors considered the relevant financial expenses as non-deductible for CIT purposes based on: (i) the lack of economic substance of the intermediate entities (Dutch HoldCo1, Dutch HoldCo2 and Spain HoldCo); and (ii) the abusive or artificial nature of the series of consecutive intra-group transactions which generated the share premium in the hands of Spain HoldCo and the debt immediately borrowed, aiming solely to anticipate future profits and generate financial expenses for the Spanish tax unity in an improper form.
Upon realizing that the GAAR could be applicable, the STA initiated the specific procedure established in the law. The application of this anti-abuse rule requires a mandatory and favorable report, which is binding for the tax audit bodies, from an Advisory Committee composed by members of the Tax Agency and the General Directorate of Taxation.
Decision of the GAAR Advisory Committee
The GAAR Advisory Committee considered that Dutch HoldCo1 and Dutch HoldCo2 qualified as mere intermediary companies on the basis that they shared with Dutch ParentCo the same registered office and directors, they were incorporated on the same date (one month before the granting of the debt to Spain HoldCo), they had no employees, and their only asset was their indirect shareholding in Spain OpCo.
In addition, the GAAR Advisory Committee considered that the incorporation of Spain HoldCo, as direct shareholder of Spain OpCo, had no economic-substantive rationale, insofar as this entity had no employees, its only asset was the shares in Spain OpCo and the loan granted to the latter, and that the "services" Spain HoldCo rendered were limited to re-invoicing, without any mark-up, the management services provided by Dutch ParentCo.
On the basis of the above, the GAAR Advisory Committee found that the incorporation of the intermediary entities in the chain (between Dutch ParentCo and Spain OpCo) and the different transactions carried out during 2013 (contribution of Spain OpCo and the granting of a loan to Spain HoldCo) were unnatural and improper for the intended transaction (i.e., the transfer of 49.99% interest in Spain OpCo to a third party).
The GAAR Advisory Committee concluded that the true purpose of the actual steps taken was to anticipate a future profit (unrealized profit) for Spain OpCo shareholders by generating a financial expense at the level of the Spanish tax unity, thereby reducing the tax burden in Spain, since in the absence of the generation of the share premium and the debt borrowed by Spain HoldCo, Spain OpCo would not have been able to carry out the corresponding profit distribution.
The reports of the GAAR Advisory Committee constitute a roadmap for tax audit teams to assert the artificial nature of the transactions carried out by taxpayers in order to deny the application of tax benefits based on the GAAR.
Application of GAAR may also have relevant implications on the applicability of penalties. Any arrangement or structure that is deemed as substantially equal to those which the STA have publicly designated as abusive could be subject to penalties (50%-150% of the tax due), if the Spanish taxes are accrued and payment to the Spanish Treasury is due after the publication of the Report.
Considering the distinctive features of the instant case, it seems unlikely that it is directly applicable to other cases, which would expectedly rarely be substantially equal. However, the approach followed by the Advisory Committee in the Report reveals a new trend by the Spanish tax authorities to use GAAR to challenge the use of intermediate entities and the structuring of genuine transactions that generate a tax advantage.
In this context, groups planning to carry out transactions involving entities whose role could be considered as a mere intermediary entity and/or transactions which may entail a tax advantage should carefully consider the criteria set forth in the reports of the GAAR Committee and adopt a consistent "audit-ready" approach by identifying the good fact patterns and anticipating any weaknesses in relation to the business and legal rationale of the involved entities an intended transactions, and preparing contemporaneous supporting documentation to reinforce their position.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Abogados, Madrid
Ernst & Young LLP, Spanish Tax Desk, New York
1 Report No. 9/2022, of the GAAR Advisory Committee. Corporate Income Tax. Financial expenses derived from debt used for share premium distribution.