Madrid, 16 January 2013


New Protocol amending the current US-Spanish Tax Treaty

On January 14, 2013 the US and Spain signed a new protocol (the “Protocol”) amending the current 1990 tax treaty for the avoidance of double taxation (the “Treaty”).

The Protocol includes significant changes to foster the efficiency of reciprocal direct investment in the US and Spain. In particular, it brings withholding treaty rates and other provisions in line with the tax treaties in force between the US and the most significant European Union countries, effectively eliminating the need for complex and costly investment planning structuring.

In most cases, the Protocol eliminates taxation at source, creating relevant savings and increasing net yields. For dividends a 0% withholding rate applies for corporate shareholders controlling 80% of the voting stock (5% for holdings of 10% or more). Interest and royalty payments will not be longer subject to withholding taxes (limited exceptions apply in connection with certain US source interest). Capital gains will only be taxed at source on the disposal of real estate and real estate holding companies (subject to certain requirements).

The Protocol also reinforces technical mechanisms to avoid double taxation through Mutual Agreement Procedures (MAPs) and provides for arbitration to resolve tax issues. The treaty´s exchange of information clause is updated to current standards for this type of clauses.

The new wording of the Limitation of Benefits (the “LoB”) clause, which includes favorable exceptions such as the “headquarters company”, and the regulation of fiscally transparent entities and funds are also of interest.

The principal terms of the Protocol are summarized below.

1. Dividends

The Protocol leads to a significant reduction of taxation at source, as the current Treaty provides for a 10% withholding tax when the company receiving the dividend controls 25% of the voting rights, and 15% in other cases.

In accordance with the Protocol, withholding tax rates on dividends are:

i. 0% if the beneficial owner is a company which directly or indirectly owns shares representing more than 80% of the voting stock, and such shareholder has held the shares in the distributing company for a minimum period of 12 months prior to the distribution.

ii. 5% if the beneficial owner of the dividends is a company owning 10% or more of the voting stock; and

iii. 15% in all other cases;

Specific regulations apply to Spanish SOCIMIs and US REITs, and certain tax exemptions apply to distributions to pension funds.

2. Interest

In general, taxation at source is eliminated and thus no withholding taxes will apply to interest payments. Specific rules apply for US source contingent interest and loans related to US real estate mortgage conduits (REMICs).

Remuneration of a profit participation loan will qualify as interest under the Protocol, also benefiting from the exemption from withholding taxes.

The new provisions represent a dramatic change given that US lenders (not acting through PEs in Spain) will be fully exempt from withholding taxes on interest paid by Spanish borrowers, regardless of the term of the loan.

3. Royalties

Taxation at source is eliminated (except for permanent establishments) and thus no withholding tax will apply to royalty payments.

The measure is expected to be widely applauded by IT companies, pharmaceutical groups, multinational manufacturing companies in Spain and others. The Protocol’s entry into force will eliminate current withholding taxes ranging from 5 to 10%.

4. Capital gains

The Protocol significantly alters the approach to the sourcing and taxation of capital gains.

No taxation at source will apply on capital gains, except upon the disposal of real estate assets or shares in companies holding real estate assets or time-share rights (which, in Spain, would be subject to a 21% capital gains tax).

Furthermore, gains deriving from the transfer of licenses and intangible property will qualify as capital gains (and not as royalties), therefore exempt from taxation at source.

5. Branch tax

Article 14 of the Treaty, regarding the right to impose a 10% branch tax, will be eliminated. However, under article 10 of the Treaty, as amended by the Protocol, the US taxation of the “dividend equivalent amount” and the imposition of Spanish branch tax (up to a maximum rate of 5%) will be permitted in limited circumstances.

6. Limitation of benefits

The Protocol provides for a significantly amended limitation of benefits clause. The wording of the new clause covers numerous situations in detail. Among others, the following features are worth noting:

(i) the traded-company exception, by virtue of which a listed company automatically benefits from the Treaty, will now apply to companies listed not only in the US or Spanish stock exchanges, but also on “recognized stock exchanges” such as those of London, Frankfurt, Amsterdam, Toronto, Mexico City or Buenos Aires.

(ii) the inclusion of a “headquarters company exemption”, affording the Protocol’s protection and benefits to entities qualifying as headquarters for multinational groups (i.e. providing overall supervision to at least five jurisdictions, amongst other requirements);

(iii) a “permanent establishment triangular clause”, excluding permanent establishments located in third countries from the benefits of the Treaty and the Protocol if the PE is taxed at a reduced rate (i.e. less than 60% of the general tax applicable to the parent company).

7. Pension funds

The Protocol allows for the possibility of rolling the investment over to pension funds of the other contracting State (i.e. cross-border roll over) without triggering taxation, as taxation will be contingent upon the effective payment or distribution to the beneficiaries.

8. Mutual Agreement Procedure and Arbitration

Controversies regarding the interpretation of the Treaty and the Protocol will be resolved through MAPs.

In addition, the Protocol provides for mandatory arbitration to resolve matters submitted to a competent authority. Regulation of the arbitration procedure is extensive and detailed. The resolution of the arbitration panel -composed of three members- will be, with exceptions, binding.

9. Exchange of information

The exchange of information clause is updated to comply with current standards. No explicit reference is made to the future implementation of FATCA provisions. It is important to note that Spain and the US have agreed to implement FATCA through domestic reporting and reciprocal automatic exchange of information, also based on the Treaty currently in force. The new wording of the Treaty, as amended by the Protocol, should be sufficient to cover FATCA implementation.

10. Puerto Rico

In addition to the Protocol, a Memorandum of Understanding (MOU) has been signed by the US and Spain indicating that specific measures to avoid double taxation on investments between Spain and Puerto Rico will be adopted.

11. Fiscally-transparent entities

The Protocol and the MOU slightly amend the 2006 Competent Authority Agreement entered into by the US and Spain on the tax treatment of LLCs, partnerships and disregarded entities. Income obtained through fiscally-transparent entities will benefit from the provisions of the Treaty and the Protocol, provided that: (i) the income is allocated to a resident (as defined in the Treaty) for the purposes of its taxation in accordance with domestic provisions; (ii) the LoB exclusions do not apply; and (iii) the fiscally-transparent entity is organized in the US or Spain or in a State that has entered into an agreement for the exchange of tax information. It should be noted that the 2006 Competent Authority Agreement did not include the latter´s restriction.

12. The Protocol’s entry into force

The Protocol will enter into force three months after compliance with the domestic US and Spanish procedures required for approval and diplomatic notification.

 back to index

The information contained in this Newsletter is of a general nature and does not constitute legal advice