Spain's new tax regime for funds

Author: | Published: 25 Apr 2003
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Collective investment vehicles (CIVs) were regulated in Spain on December 26 1984 under Law 46. The Law and its subsequent amendments created a new framework that contributed to the success of these vehicles. By 1999 there were 2,477 collective investment vehicles holding assets representing around 44% of the annual Spanish gross production.

CIVs are either financial institutions or real estate investment vehicles. In turn these may either be companies or funds. The real estate investment funds and companies as their name would imply invest in properties which are to be leased. The financial institutions may be either long-term or short-term investment companies or funds. Investment companies investing in long-term securities are called Sociedades de Inversión Mobiliaria de Capital Fijo while those investing in short-term securities are known as Sociedades de Inversión Mobiliaria de Capital Variable. Similarly investment funds are divided into Fondos de Inversión Mobiliaria which invest in long-term securities and Fondos de Inversión en Activos del Mercado Monetario which invest in short-term securities.

Investment companies have legal personality and their capital is represented in shares. Investment funds lack legal personality and their wealth is represented by participating fund members. Although fund members are the actual legal owners of the fund's assets, companies are allowed to manage the fund's wealth.

Around 96% of investments in Spain are held by investment funds.

Law 46 and the taxation of Spanish investment vehicles

Both investment companies and investment funds are taxable entities for corporate income tax purposes. CIVs do not have to distribute income or profits to the share or participation holders. CIVs set up and ruled by Law 46 are not therefore transparent. This applies indifferently to investment funds despite their non-legal personality.

However, most of the European tax systems have incorporated the see through approach to their legislation for investment funds. Germany, Austria, the Netherlands, the UK and Switzerland consider investment funds as transparent. Therefore any gain or income obtained by the fund is exempt. In these cases, dividends obtained by the fund are effectively not taxed against the participation holder by granting a tax credit and interest obtained by the fund is effectively taxed against the investor at the usual rates. The aim of this transparency is to avoid double taxation.

Other countries such as Belgium, France, Greece and Luxembourg tax the investment funds at very low rates or even zero rates. Italy and Portugal have special taxes on income/gains of investment funds of up to 10%. Spain has chosen to tax investment companies and funds as entities but the tax rate amounts to 1%, provided that the investment vehicle falls within the Law 46 regulations. However, resident individuals cannot avoid double taxation entirely.

The 1% rate of financial institutions also applies to real estate investment companies and funds which must invest in real estate located in urban areas destined for leasing and at least 50% of the total assets must be personal homes or buildings occupied by senior citizens and students.

Investment companies and funds are registered with the Spanish stock market regulator, the Comisión Nacional de Mercado de Valores (CNMV), and require much higher investment levels than investment companies.

Taxation of non-residents investing in Spanish collective investment vehicles

As a general rule, dividends and interest paid to non-residents by Spanish entities and gains obtained by non-residents from securities issued by Spanish entities are subject to tax at a rate of 15%.

Notwithstanding the above, the taxation of the non-resident will be different in each of the following scenarios:

  • A resident in an EU Member State transfers or reimburses quotas, shares or participations in a financial Spanish collective investment company or fund. Any yield obtained would be considered an exempt gain, not subject to withholding tax.

Please note that in this case a distribution of dividends from the investment company or fund will be subject to 15% tax unless the recipient can benefit from a reduced rate as per a double taxation agreement or it can benefit from the parent-subsidiary Directive. In practice, Spanish investment funds do not distribute dividends although it would be possible under our legislation.

  • A resident in a state with a double taxation agreement in effect with Spain, including the exchange information clause, transfers or reimburses quotas, shares or participations of an investment fund quoted in a Spanish stock exchange. Any gain would be exempt.
  • A non-resident obtains income from an investment fund to which Law 46 does not apply. In this case, any profits obtained by the fund will effectively be directly obtained by the non-resident and the usual tax rules for non-residents will apply. In other words, an investment fund which at any point does not fulfil the requirements of Law 46 becomes transparent. In this case, any profits obtained by the fund are allocated to the holders. More importantly, the yield obtained by the quota holder is no longer considered a gain and there is no possibility to claim exemptions described in 1 and 2.
  • A non-resident receives income from a foreign investment company or fund contracted through a Spanish financial dealer. This would fall outside the scope of Spanish tax.
  • A resident in a State with a double taxation agreement in effect with Spain, regardless of the inclusion of an information exchange clause, transfers or reimburses shares or quotas in a Spanish collective investment vehicle ruled by Law 46. This gain is exempt but a significant limitation applies. In contrast with scenario 2, if the assets of the investment vehicle consist mainly of Spanish real estate and the double taxation agreement allows taxation in Spain of entities holding mainly real estate, the gain will be subject to Spanish taxes even if the non-resident is resident in an EU territory.
  • A resident of a territory classified as a tax haven obtains income or gains from an investment company or fund. The resident will be taxed at a rate of 15%, even if the investor may be exempt under any of the previous scenarios.

In this regard, it is worth noting that there exists an opportunity for tax havens which wish to avoid being short-listed. The regulations associated with the reform of the 2003 Budget Law set out that any tax haven which signs an agreement of information exchange with Spain will be automatically excluded from the short list from the effective date of the agreement. This provision is in line with what the OECD offers to low taxation regimes to become more transparent.

  • In any other scenario or if the recipient does not provide a certificate of tax residency in an EU member state or in another state with a double tax convention in effect, any income or gain will be subject to 15% withholding tax.

However, if the recipient is a non-resident individual who obtains a gain from the sale or redemption of participation in a collective investment vehicle which was acquired before 31 December 1994, the non-resident will still benefit from a reduction on the gain of 14,28% for each year of ownership achieved before that date. This reduction of the gain will be considered upon assessing any withholding tax.

The withholding tax is collected by the investment company, the management company of an investment fund, or in certain cases the recipient will account for it. The tax is assessed as an amount equal to 15% of the difference between sale and subscription prices.

Although this article aims to describe in general terms how returns from investment companies and funds are taxed, there are certain particular cases that are worth commenting on:

  • In June the European Council set out the basis of a new tax system for returns on savings. The new system guarantees a flow of information between Member States or a minimum tax on returns obtained in Austria, Belgium and Luxembourg of up to 35%.

The proposed Directive will also apply to CIVs. When income and gains are obtained from investment companies and funds which have credits or other similar securities as more than half their assets, returns will be treated as interest for the purposes of the Directive and not as gains or dividends.

The Directive tries to prevent institutions and individuals from investing in investment companies and funds in order to avoid application of the Directive on Savings. It would be easy to transform interest from securities into dividends and gains obtained from collective investment vehicles that initially were not within the scope of the Directive on Savings. Under the draft of the Directive setting out the basis for the new system of taxation, income from investment companies and funds are dealt with as interest if most of their assets consist of credits. The draft's 50% limit might be too low to achieve the purpose of the proposed Directive but it was a political decision taken to exclude certain investment vehicles originating from France and Luxembourg.

  • Double tax conventions may protect non-residents from the withholding tax on returns obtained from investment funds and companies, especially if they are dealt with as gains. Nobody disputes that collective investment companies that enjoy legal personality may themselves benefit from the double tax convention if they are a resident in the corresponding state. However, funds are transparent entities in most countries, have no legal personality and are just a form of collective investment. The question is whether an investment fund is a taxable person for the purposes of a double tax convention.

As each country has its own regulations and each double tax convention differs, the matter should be addressed on a case-by-case basis. However, if internal regulations or the double tax convention do not expressly grant the status of taxable person to a foreign investment fund, they should be dealt with as transparent.

In Spain, it is only clear that investment funds regulated by Law 46 are taxable persons. It might also be that other CIVs regulated by Directive 85/611/CEE would also be given this status although there is no clear provision to that effect. Any other investment fund is transparent.

Effective beneficiary clauses, included in most double tax conventions, allow states to see through entities that claim the advantageous provisions of a double tax convention. Considering that even in those states where investment funds are not transparent the tax burden of the fund is very low or nil, it is the sort of scenario where the clause might be applied. Effectively this means that the issue of whether an investment fund is a taxable person who may benefit directly from the double tax convention provisions is not that relevant. The Spanish Tax Administration may always request information on the holders of the investment fund and deny the benefits of the tax convention when the investment fund is used as a means to avoid the withholding tax of the effective beneficiary.

Finally, the internal foreign-controlled company (CFC) rules should also be considered in structuring an investment in Spanish collective investment vehicles as they are taxed at a 1% corporate income tax rate.

Tax on foreign investment funds investing in Spanish real estate

Foreign investment funds that own real estate in Spain will become a transparent taxable person for the purposes of the non-residents income tax if their activities constitute a business exploitation.

Real estate income can be taxed as investment income or as business income. Income obtained by foreign investment funds would normally be taxed gross at a 25% tax rate. However, provided that sufficient presence is established in Spain, the investment fund might be taxed as a taxable person performing business activities and in this case only net income is taxed at a 35% tax rate.

As a transparent taxable person for the purpose of the non-residents income tax, the fund has its own tax obligations such as filing an annual self-assessment in representation of all non-resident fund holders. However, the fund shall prove that any of the non-resident holders may benefit from a double tax convention in order to apply a reduced rate.

A special case applies to German open investment funds. These funds cannot hold assets in German law and therefore all its assets are held by the management company in its name. In this case, the Spanish administration overrides the trust agreement between the fund and its management company and, thus, is dealt with as stated above.

Spanish residents' income from foreign collective investment companies and funds

As described before, gains generally receive more tax advantages than income in the Spanish tax system. This explains why the Spanish investment funds do not distribute dividends to its holders.

Returns obtained by Spanish individuals and entities from foreign collective investment institutions regulated by Directive 85/611/CEE, incorporated and domiciled in another EU member state, and registered with the CNMV for the purposes of being distributed to Spanish nationals would be considered either dividends or gains.

In the case of individuals, dividends will be taxed at the marginal rate but gains on assets held for more than a year will only be taxed at 15%. In addition, gains on assets owned before December 31 1994 can benefit from the above referred reduction of 14.28 % for each year of ownership achieved by that date. Corporations will be taxed at the general tax rate.

As of January 1 2003, there has been a major development in the tax system applicable to earnings obtained from collective investment institutions although it is only effective for Spanish resident individuals. It also has big implications for subscribers of EU foreign investment funds.

The new legislation sets out that earnings obtained by resident individuals on the reimbursement of investment fund participations, as well as in the transfer of shares in investment companies with more than 500 partners, (as long as the participating partner has not held more than 5% of the company capital within the previous 12 months) will not be computed for income tax purposes when the proceeds obtained in the reimbursement or transfer are reinvested in the participations or shares of another collective investment institution. The new shares and participations will keep the value and acquisition date of the shares or participations transmitted or reimbursed.

The tax postponement is also applicable to partners or participants in collective investment institutions regulated by Directive 85/611/CEE, incorporated and domiciled in any member state of the European Union and registered with the CNMV as long as: (i) entities registered with the CNMV carry out the commercialization; (ii) the above-mentioned limits on the number of partners and the proportion of capital is respected in each commercialized sub-fund.

No withholding tax shall be applied to the earnings obtained when the tax postponement is applicable.

Special rules also apply to Spanish resident individuals and companies holding participation in collective investment institutions incorporated in tax havens. The difference between the market value and the acquisition value of the participation shall be allocated to the Spanish resident. The acquisition value is increased by the amount of previous allocations. The Spanish legislation presumes this difference to be 15% of the acquisition value. Luxembourg funds ruled by Directive 85/611/CEE are not included in these provisions.

Returns obtained from investment funds not regulated by the Directive 85/611/CEE might not be treated as gains or dividends. Spanish internal legislation might treat them as interest income although it will depend on the type of income received and the double-tax agreement in force, if any.

Returns on hedge funds are normally considered gains for tax purposes and they will be taxed as described above. However, certain hedge investments aimed at covering business risks might be dealt with as business income.

Conclusions

Capital investment will continue to aim at investment funds, especially those not attracted by the proposed Savings Directive. Spanish investment vehicles regulated by Law 46 and European collective investment institutions within the scope of Directive 85/611/CEE will benefit from an advantageous tax regime in Spain and in other EU Member States. Certainly, a uniform tax treatment of the funds within the EU will help to avoid capital investment flow due to tax motives. However, uniformity will not occur in the near future.