Review undermines Transfer Tax on Spanish real estate
June 2010 International Tax Review
The Anti-abuse Rule has made it difficult to avoid the payment of transfer tax when buying real estate assets in Spain. However, investors who have paid the tax may be entitled to a refund if the rule is found not to comply with European law, explains Carlos Duran Haeussler of Uría Menéndez
As a general rule, the transfer of shares is exempt from transfer tax (TT) and VAT in Spain. In contrast, the transfer of real estate is generally subject to and not exempt from TT, when the transferor is not acting in the course of its business, or VAT, in all other cases, and as such they can represent a significant cost for property acquirers.
In the 1970s, this legal framework encouraged taxpayers planning to transfer Spanish real estate to avoid TT or VAT by contributing the property to a wholly-owned subsidiary (usually, a newly formed entity) and subsequently selling the shares in the subsidiary to the party wishing to purchase the real estate. Structuring the transfer of real estate as a share deal, instead of directly transferring the property, avoided TT or VAT under the exemption covering the transfer of shares and offered the acquirer significant cost savings.
However, in 1977, the Spanish legislature reacted to this practice (which at the time was described by the regulations as a legitimate tax avoidance alternative or, in Spanish, an economía de opción) and passed an anti-abuse rule to close the loophole (the Anti-abuse Rule).
The extensive case law and numerous publications about it are evidence that the Anti-abuse Rule has proved to be one of the most controversial provisions in the Spanish tax system. It has also represented a significant source of revenue for regional governments to which TT revenue is assigned. However, after more than three decades, the Anti-abuse Rule may be facing the beginning of the end, thanks to EU tax rules.
1. The Anti-abuse Rule
Under the existing version of the Anti-abuse Rule in article 108 of the Securities Market Act, regardless of whether or not the parties have a tax avoidance aim, TT applies to the transfer of shares if, basically, two conditions are met:
- The transferred shares are in a "real estate company", that is, a company in which Spanish real estate assets account for more than 50% of the total assets. For these purposes, not only land and buildings qualify as real estate assets, but also machines, installations, tools and other instruments affixed to the ground that are used for economic activities; and
- As a consequence of the transaction, the acquiror obtains direct or indirect control (more than 50% of the share capital) of the real estate company.
In these cases, the acquiror of the shares must pay TT at a rate ranging from 6% to 7% (depending on the region where the underlying real estate assets are located) on the proportion of the market value of the underlying real estate assets that the acquired shares represent. Any increase in the controlling interest also triggers TT on a proportional basis.
The Anti-abuse Rule also applies to the transfer of shares received as consideration for the contribution of a real estate asset to the share capital of an entity when less than three years elapse between the contribution and the transfer of the shares.
The Anti-abuse Rule has become a major concern for international and Spanish investors intending to acquire a company or a group of companies engaged in business activities that involve the ownership of significant real estate assets (for example, hotel chains, companies in the renewable energy industry and hospitals). When calculating the yield on their investments, they do not always anticipate bearing a 6% or 7% tax cost on the market value of the real estate assets indirectly acquired through the acquisition of the shares (a significant cost that could potentially make the return on the investment unattractive).
2. Under examination
The Anti-abuse Rule is being scrutinised by the European Court of Justice (ECJ). On September 24 2009, the Spanish Supreme Court requested a preliminary ruling on whether the rule complies with EU regulations and, in particular, with Directive 69/335/ECC (now replaced by Directive 2008/7/EC), taking into account that TT is levied automatically, even if the parties to the transaction were not seeking to avoid tax, and irrespective of whether or not the real estate assets are used for a business activity.
The European Commission has also formally requested Spain to change its tax provisions on the transfer of securities. The Commission considers that the imposition of TT on contributions to the share capital of real estate companies when the contributor, as a result of the contribution, obtains a position that allows it to exercise control over the real estate company or, if control is already held, increases its shareholding in the company (in addition to the 1% Capital Duty paid by the company increasing its capital), is contrary to the Capital Duty Directive (2008/7/EC).
The preliminary ruling has taken the form of a reasoned opinion (second step of the infringement procedure provided for in article 258 of the Treaty on the Functioning of the European Union). If Spain does not respond satisfactorily, the Commission may decide to refer the matter to the ECJ.
It is noteworthy that in an additional provision to Law 11/2009 of October 26 2009 on Real Estate Investment Trusts, the Spanish government itself announced its intention to review the Anti-abuse Rule to ensure it complies with EU regulations.
3. Potential tax refunds
Spanish tax practitioners are following the outcome of these two proceedings closely. If the ECJ holds that the Anti-abuse Rule is illegal or forces its overhaul, not only will this have a positive effect on the acquisition of shares in Spanish real estate companies in the future, but, most importantly, taxpayers may have grounds to file for a refund of TT paid on past transactions.
While the limitation period in Spain for tax purposes is four years, in cases where a tax provision is declared unconstitutional, the limitation period does not begin on accrual, but rather when the judgment is published. In other words, if the ECJ held that the Anti-abuse Rule contravenes the EU rules, TT refunds could be sought for transactions that took place more than four years ago. In principle, delay interest would also be applied.
As for the procedures to claim refunds, besides the common tax refund procedures set out in the General Tax Law, taxpayers may opt to seek compensation from the Spanish government for state liability arising from the failure to comply with EU laws. Further to the ECJ's doctrine in its judgment of January 26 2010 (C-118/08), taxpayers do not have to go through the regular tax refund procedures but may directly sue their government for damages.
In the past, the Anti-abuse Rule has been applied to many transactions dealing with the acquisition of Spanish real estate companies and both domestic and international investors have incurred significant TT costs as a result.
Predicting the position that the ECJ and European Commission will take in the review proceedings is not an easy task. However, it seems that the Anti-abuse Rule will be overhauled and this could open the door to requests for refunds of TT paid while the provision was in force.
International tax practitioners and in-house tax counsel who have dealt with the Anti-abuse Rule in the past or who expect to do so in the future should follow these proceedings closely and be mindful of the tax refund opportunities that these developments may produce.