What do international developers need to know when joint venturing with a local partner in Spain?
28/2/2007 Real Estate Forum
An alternative which allows the international developer to reduce its capital gains taxation in Spain is funding the joint venture through profit sharing loans
The Spanish real estate market is growing rapidly. International developers have found that there is still a lot more room for development in Spain. US, Australian and European developers looking to get involved in commercial developments in Spain usually enter into joint ventures with local partners, either to develop specific projects or to build a number of them. The benefits international developers can obtain when joint venturing with a local partner to develop real estate projects are well known to the readership. This article seeks to guide international developers on the specific challenges they will face when joint venturing with a local partner in Spain.
For tax reasons, the international developer usually (i) channels its interest in the joint venture through a Dutch entity (which is only acceptable to the Spanish tax authorities if such entity has some substance), and (ii) looks to set up a number of special purpose vehicles, so that each of the specific developments (e.g. office buildings) is owned by a different project company. The purpose of this structure is to facilitate the future sale of the developments to different investors through the sale of shares in each of the project companies, which does not trigger capital gains tax for the international developer in Spain. Local partners are usually reluctant to set up a number of project companies to facilitate the sale of shares in each of those companies. The main reason is that structuring the sale as a share deal does not offer any tax benefits to the local partner, who must pay capital gains tax regardless of whether the sales are structured as share deals or as asset deals.
If the Spanish partner does not agree to incorporate a number of project companies to facilitate the sale of shares, an alternative that allows the international developer to reduce its capital gains taxation in Spain is funding the joint venture through the granting of profit sharing loans, which do not trigger stamp duty tax (as opposed to capital increases). In addition, interest accrued on these loans (at a floating interest rate linked to the performance of the joint venture company) is tax deductible by the joint venture and tax-free for the international developer; thus, it could entail an important reduction in the capital gains tax payable by the international developer in Spain. Although the Spanish partner will not be particularly interested in this formula, it may be open to it given that it has a neutral tax impact for the local partner: the payment of interest qualifies as an expense for the joint venture company and as income for the Spanish partner.
Once the tax structure has been defined by the parties, it is time to agree on the type of corporate entity to be used. Joint venture companies are usually set up as sociedades de responsabilidad limitada, which are comparable to US LLCs, require an initial low capital amount, fulfillment of few formalities and paperwork, and offer increased flexibility. Some local partners may prefer to set up a sociedad anónima, which is comparable to a US corporation, for purely image-related reasons. Sociedades personalistas (partnerships) are sometimes used in the interests of the international developer, but this is far less common. The purpose of using partnerships is to secure the tax consolidation of the joint venture company and the international vehicle.
When drafting and negotiating the joint venture agreement:
a) The international developer will probably need to accept conditions that give the joint venture access to the international developer’s sales networks outside of Spain. The local partner will usually try to shape the Spanish joint venture as a testing ground for joint future developments outside of Spain, particularly in Central and Eastern Europe;
b) Clauses dealing with funding (and, specifically, with the consequences arising from the parties failing to provide the agreed funding) tend to be particularly controversial. If the international developer is not convinced of its local partner’s financial strength, it should look to negotiate an option to subscribe any new shares that are not paid-up by the local partner, or to grant the joint venture company the loans that should have been granted by the non-funding partner, retaining the ability to convert such loans into capital; and
c) When the Spanish partner has a contractor company within its group, it will attempt to ensure by contract that its contractor company will be retained by the joint venture to carry out the construction works. Since the international developer will be looking to obtain the best market conditions, a balance will need to be sought, so that both the local partner is comfortable and third party contractors are not discouraged from submitting their bids.
While negotiating the joint venture agreement, the applicable turnover and market share thresholds will need to be checked in order to determine whether any filings need to be made to the antitrust authorities under European or Spanish regulations. When carrying out developments through a joint venture, particular attention must be paid to regional regulations that govern planning, zoning and retail licensing (and sometimes even specific condominium schemes, as is the case in Catalonia). Identifying the appropriate local partner with the skills needed to deal with these local issues is very important.