The Spanish advantage

Carlos Durán.

October 2012 International Financial Law Review


In the last decade, the trading relationship between China and Latin America has been outpaced by a dramatic increase in Chinese foreign direct investments in Latin America motivated by several political and financial factors. Most experts predict Chinese investments in the region are about to enter a period of substantial growth.

Due to the unfavourable tax treatment in China of foreign source dividend income or capital gains, Chinese outbound investments have usually been channelled through offshore jurisdictions such as Hong Kong, the British Virgin Islands or the Cayman Islands. However, these territories are considered tax havens in most Latin American countries and are not tax efficient for holding Latin American subsidiaries.

This article discusses the main reasons why it could be more tax-efficient for Chinese companies to make their outbound investments in Latin America through an offshore holding company. In particular, it examines the tax advantages of using Spanish holding companies in view of the new tax treaty between Spain and Hong Kong.

1.      Economic ties between Asia and Latin America

Asia and Latin America are among the world’s fastest growing regions and there is little argument that, in relative terms, they have shown great resilience to the current global economic crisis.

According to the World Bank’s forecast, the regional GDP in Asia (of which China accounts for about 80 percent) will grow by 7.8 percent in both 2012 and 2013, whereas growth in Latin America’s GDP is expected to ease to 3.5 percent in 2012, before picking up once more to 4.1 percent in 2013. In contrast, the World Bank’s projections for the U.S. and the Europe look less promising: the U.S. economy is expected to grow by 2.1 percent in 2012 and 2.4 percent in 2013, while the Euro Area will suffer a contraction of 0.3 percent of its GDP in 2012 and growth of 0.7 percent in 2013.

The sustained growth during recent years in Asia and Latin America is attracting foreign investment from other regions where domestic consumer demand is decreasing (notably, the U.S. and Europe) thereby seeking to profit from large and dynamic domestic markets.

Simultaneously, but at a much faster pace and on a larger scale, the good economic prospects in these two regions are boosting trade and investment ties between Asia (and, in particular, China) and Latin America themselves. As the OECD puts it in one of its papers on the subject, “Latin America is looking towards China and Asia—and China and Asia are looking right back”.

From Christopher Columbus to the “Zou chu qu

Trade between Asia and Latin America is not new. The commercial relationship between these two continents can be traced back to the late 15th century when Columbus accidentally arrived at America when looking for a new route to East Asia. However, the trading relationship did not develop substantially until the period following World War II, when Japan’s export-led growth boosted the demand for raw materials supplied by Latin American countries.

The emergence of China in the early 2000s marked a turning point in the trade relationship between Asia and Latin America. The correlation between a rapidly growing, resource-scarce China on the one side and a resource-rich Latin America on the other, have paved the way for bilateral trade that follows a “commodity-for-manufacturing” pattern. In exchange for its demand for raw materials and commodities, China exports manufactured goods to Latin America.

Today, China is Latin America’s second largest trading partner, after the U.S.

The emergence of China as a leading investor in Latin America

The trading relationship between China and Latin America has been outpaced by a dramatic increase of Chinese foreign direct investments (FDI) in Latin America.

China's FDI spree began to take off in the past decade, spurred on by several factors which will continue to drive an increase in outward FDI in the years ahead and which will ultimately lead to the emergence of China as a major global direct investor:

  • In 2000, the Chinese government launched the “Zou chu qu” campaign (which means “going out”) to promote overseas investments aimed at securing energy resources, opening access for Chinese companies abroad and diversifying the country’s foreign exchange reserves. During recent years, Chinese government agencies have progressively eased and simplified the requirements and procedures Chinese enterprises have to follow in order to invest overseas.
  • The rapid expansion of the Chinese economy in recent decades has ended China’s autarky with regard to raw materials and forced state-owned enterprises to carry out resource-seeking investments, promoting the outbound investment to deploy the cash reserves accumulated through exports and profits at home.
  • Unlike in the past, Chinese corporations now hold strong cash positions and quality investment opportunities in the domestic overheated market are scarce.
  • The current exchange rate incentivises overseas acquisitions as the appreciation of the renminbi makes purchasing power higher in relative terms.

Although total Chinese outbound investment is still small relative to the size of its economy, most analysts believe that the country is on the verge of ramping up acquisitions and investments in new greenfield facilities around the world in the coming decades, continuing the trend initiated in the mid-2000s. A recent study published by Rhodium Group and China International Capital Corporation (CICC) (China Invests in Europe, June 2012) confirms this, as Chinese FDI into Europe tripled in 2011 to US$10 billion and Chinese companies are in the early stages of a global shopping spree that could see them spend as much as US$250-500 billion in Europe by 2020.

By contrast, Chinese FDI in Latin America is quite a recent phenomenon. Following an extended period of high commodity prices, Chinese FDI have only really taken off only since 2010 (in 2010 China invested twice as much in Latin America - US$ 15 billion - as it did over the previous two decades combined). China is now the third largest investor in the region, after the U.S. and Europe.

While the FDI in the region in 1990s and 2000s were predominantly originated in the U.S. and Europe, the subsequent decade may see China overtake the leading role and become the major foreign investor in Latin America. Brazil, Argentina, Peru, Mexico, Chile and Colombia are the main recipient countries of Chinese investments, of which over 90 percent has been targeted at extractive industries. In the coming years, following the same trend that Japanese and Korean outward FDI had in the recent past, and which were also initially concentrated on natural resources, it is expected that Chinese FDI in Latin America will tap into other sectors such as infrastructure and manufacture.

2.      Tax structuring of Chinese investments in Latin America

Going global requires proper legal and tax planning and Chinese corporations must address challenging issues in Latin America to avoid common pitfalls.

Traditionally, domestic tax laws in capital-importing countries (developing nations) provide high withholding tax rates on cross-border payments to foreign taxpayers. High withholding tax rates help these countries increase their tax revenues. In general, this holds true in Latin America, where most countries apply high withholding tax rates on the repatriation of source income to foreign investors.

For this reason, Chinese investors in this region should work on setting-up efficient tax structures from the outset that allow for the repatriation of income (in the form of dividends, interest, royalties or gains), reducing or eliminating, where possible, the tax leakage in the source country and hence increasing the after-tax return of their investments.

One of the first questions that arises when working on the legal structuring of the investment is whether the new investment or acquisition of a existent business or company should be made directly from China or whether it would be more efficient to interpose an intermediate holding company. In most cases, using a holding company will be the right choice. Of course, when choosing the optimal holding jurisdiction, Chinese investors will have to consider general antiavoidance rules (GAAR) that may serve the local or foreign tax authorities to challenge the use of conduit companies on “treaty shopping” grounds, or on the basis of lack of a valid business purpose for structuring the investment through a third country.

Chinese investors can benefit from using Spain as a platform to invest in Latin America by setting up a Spanish holding company to hold their subsidiaries in the region (just as many U.S., European and even Latin American multinationals have successfully done in the recent past).

Benefits of using a holding company to invest in Latin America

Depending on the country of tax residence of the investor, using an intermediate holding company to invest in Latin America can maximize the tax efficiency of the structure and ensure legal protection of the investment.

An ideal holding entity for investment would be resident for tax purposes in a country that at least meets the following three requirements:

1. It would have an extensive and favourable tax treaty network with Latin American countries, under which taxation in the country of source of income to be repatriated in the form of dividends, interest, royalties or gains would be reduced (if not eliminated).

2. It would have an attractive holding regime under which dividends and capital gains derived from Latin American subsidiaries would be exempt under the “participation exemption regime” (thus avoiding the taxation of overseas profits and creating a tax-free pool of funds to maximize reinvesting capacity). Moreover, profits would be distributable to foreign shareholders in the form of dividends without tax leakage (no withholding tax on dividends) and capital gains on the transfer of the holding shares would not be taxable in the country of residence of the holding entity.

3. It would have an extensive Bilateral Investment Treaty (BIT) network with Latin American countries that protects against the unfair treatment of foreign investments, inherently mitigating any possible political reaction. BITs are agreements between two countries for the reciprocal encouragement, promotion and protection of investments in each other's territories by companies based in either country. Treaties typically cover the following areas: scope and definition of investment, admission and establishment, national treatment, most-favoured-nation treatment, fair and equitable treatment, compensation in the event of expropriation or damage to the investment, guarantees of free transfers of funds, and dispute settlement mechanisms (both state-state and investor-state).

Logically, if the country of residence of the investor does not fulfil these requirements, it is not an optimal platform from which to directly invest in Latin America and the next question in such cases is where the offshore holding company should be incorporated.

China as a platform to invest in Latin America is not tax efficient

Strictly from a tax perspective, China is not an optimal jurisdiction from which to directly invest in Latin America.

Firstly, China has a poor tax treaty network in the region. Specifically, China has only signed tax treaties with Brazil, Cuba, Mexico and Venezuela (the terms of which are not particularly favourable). As a result, income directly flowing from other Latin American countries to China is taxed at source in accordance with domestic rates, which are generally higher that the rates applicable under a tax treaty.

Secondly, China does not have an attractive holding regime. In fact, the Chinese domestic tax treatment of income derived from outbound investments in Latin America (generally, in the form of dividends or capital gains upon divestment in the overseas subsidiaries) is not efficient. Chinese corporations are taxed on their world wide income at a rate of 25%. Foreign source income is also subject to the 25% Corporate Income Tax (CIT) rate, but the Chinese company is entitled to apply a foreign tax credit for taxes paid abroad to avoid international double taxation (that is, the same profits generated by the Latin America subsidiary being taxed twice: initially, in the country of source when the subsidiary earns operating profits and, subsequently, in China when profits are received as dividends by the Chinese parent company).

In practice, the foreign tax credit method implies that the parent company still must pay taxes in China on dividends received from foreign subsidiaries, or gains realized on their transfer, if underlying taxes in the country of source have been below the 25% Chinese CIT rate.

The inefficient tax treatment of foreign source income in China is one of the reasons why Chinese corporations making outbound investments usually invest through foreign vehicles incorporated in offshore jurisdictions which have a territorial tax system. Under a territorial tax system, income generated by a company is only taxable if it has been generated within the borders of a given jurisdiction (in other words, income generated overseas is not subject to income tax). By interposing a holding entity and postponing the payment of dividends to the Chinese parent company, the tax burden of the additional Chinese CIT can be easily deferred (conversely, if dividends are received by the Chinese company, they become immediately taxable up to 25%, enabling the application of a foreign tax credit, as described).

For instance, in 2010, more than 70% of Chinese FDI outflows were channelled through Hong Kong, the British Virgin Islands and the Cayman Islands. The problem with Chinese companies using these offshore vehicles to directly invest in Latin America is that most countries regard them as tax havens. Indeed, offshore territories are usually blacklisted in Latin America and under domestic anti-abuse tax rules income flowing to these territories is customarily subject to higher tax rates. For instance, while Hong Kong does have an efficient holding regime, it currently lacks a comprehensive tax treaty and an extensive BIT network to underpin its holding regime. Furthermore, Hong Kong is considered a tax haven by many Latin American countries and therefore, generally speaking, using a Hong Kong holding entity would not provide a tax-efficient investment window into Latin America. Consequently, direct investment by companies in Hong Kong and China into Latin America is often not very tax efficient.

Finally, China has a relatively large BIT network in Latin America (it has concluded investment treaties with nine countries, namely, Argentina, Chile, Ecuador, Uruguay, Peru, Bolivia, Cuba, Mexico and Colombia). However, most of these BITs were negotiated and signed when China was predominantly a destination for inbound investment and, in some cases, they provide limited fair treatment rights and investment dispute resolution mechanisms for outbound investments in Latin America.

Advantages of the Spanish holding structure

Unlike China, Spain meets the three requirements mentioned above and therefore constitutes a tax efficient jurisdiction from which to directly invest in Latin America.

Spain has the most extensive and favourable tax treaty network with Latin American countries in the world (Spain has entered into tax treaties with Argentina, Barbados, Bolivia, Brazil, Chile, Colombia, Costa Rica, Cuba, Ecuador, El Salvador, Jamaica, Mexico, Panama, Trinidad and Tobago, Uruguay and Venezuela).

Spain boasts one of the most attractive holding regimes. A Spanish holding company or “Entidad de Tenencia de Valores Extranjeros” (better known by the Spanish acronym “ETVE”) is a standard Spanish company which is subject to 30% tax on its income, but entitled to a participation exemption on qualifying foreign sourced dividends and capital gains.

In addition to these standard features of a holding company, the ETVE regime offers a substantial advantage vis-à-vis other appealing European holding company locations (such as the Dutch or Luxembourg holdings), because dividends distributed by the Spanish holding company to non-Spanish resident shareholders are exempt from Spanish withholding tax on dividends. In addition, capital gains triggered by a non-resident shareholder on the transfer of its interest in a Spanish holding company are not subject to the Spanish 21% capital gains tax to the extent that such capital gains (indirectly) arise from an increase in the value of the foreign holdings of the Spanish holding company.

ETVEs can benefit from rights deriving from European Union Directives such as the Parent/Subsidiary Directive and the Merger Directive and they are regarded as a Spanish resident for tax purposes pursuant to Spain’s 80 bilateral tax treaties. Spain’s broad tax-treaty network with Latin America and the European character of the ETVE make it an attractive vehicle for channelling capital investments into Latin America as well as a tax-efficient exit route for European Union capital investments.

The main tax features of the ETVE are that (i) dividends obtained from qualified non-resident subsidiaries and (ii) capital gains obtained on the transfer of the shares held by the ETVE in qualified non-resident subsidiaries are exempt from Spanish CIT if the following requirements are met:

(i)       The ETVE holds a minimum 5% interest in the equity of the non-resident subsidiary (and any second-tier subsidiary) or, alternatively, the acquisition value of the interest in the non-resident subsidiary amounts to at least 6 million euro. The interest must be held directly or indirectly for more than one year.

(ii)     The non-resident subsidiary is subject to and not exempt from a tax similar in nature to the Spanish CIT and is not resident in a tax-haven country or jurisdiction; and

(iii)   The non-resident subsidiary is engaged in an active trade or business.

 Finally, Spain has ratified 18 BITs with Latin American countries (Argentina, Bolivia, Chile, Colombia, Costa Rica, Cuba, Ecuador, El Salvador, Mexico, Nicaragua, Panama, Peru, Uruguay, Honduras, Paraguay, Venezuela, the Dominican Republic and Guatemala).

The combination of the largest tax treaty network, the attractive holding regime and the BITs makes Spain an unmatched platform to channel FDI into Latin America.

In fact, the volume of Spanish and non-Spanish FDI in Latin America speaks for itself. According to the official statistics of the Spanish government, during the period 1993-2012 (Q1), Spanish FDI in Latin America accounted for more than €174 billion (of which more than €30 billion was invested by Spanish holding companies in Latin America owned by non-Spanish investors). In 2011, Spain was the second biggest investor in Latin America, after the U.S. Specifically, according to ECLA, out of the total FDI received in 2011 by Latin America, 18% was originated in the U.S., 14% in Spain and 8% in Japan.

Despite the appeal of the ETVE structures, traditionally, unlike other Asian multinationals, Chinese international groups have not invested in Latin America through ETVEs because, as mentioned, they usually hold their foreign subsidiaries through offshore territories (such as Hong Kong, the Cayman Islands and the British Virgin Islands) which are also considered tax havens for Spanish purposes. Direct investments from these jurisdictions into ETVEs are not tax efficient because of the anti-avoidance Spanish rules.

However, the entry into force in July this year of the recent Spain-Hong Kong tax treaty has paved the way for Chinese multinationals to invest in ETVEs through their Hong Kong tax resident holdings and some Chinese multinationals are starting to implement ETVE structures to hold their Latin American subsidiaries.

The tax treaty between Spain and Hong Kong

On 1 April 2011, Hong Kong signed a tax treaty with Spain. The tax treaty has just entered into force in July of this year. The new tax treaty represents the potential for new tax planning and investment structure opportunities that would reduce the overall tax-burden on Chinese investments in Latin America.

By virtue of the tax treaty, Hong Kong will cease to be considered a tax haven for Spanish tax purposes. Consequently, the tax treaty potentially opens the door to new tax structuring opportunities for Chinese investors that will be able to channel their outbound investments through Hong Kong to structure their investments into Latin America by using Spanish holding companies, provided the investment structure is based on appropriate business reasons. By doing so, Hong Kong investors may lawfully benefit from the Spanish tax treaty network in Latin America and also from the attractive Spanish holding regime. This will discernibly help reduce the overall tax-burden on repatriated Latin American source income.

Chinese investors should seriously consider the interposition of an intermediary Spanish ETVE in the overall structure of Chinese and Hong Kong investment into Latin America, provided that this investment structure is based on appropriate business reasons.


Chinese FDI in Latin America (either direct or indirect, through tax havens) does not benefit from a favourable tax regime.

Conversely, Spain is a tax efficient route for foreign investments in Latin America given its extensive tax treaty network in the region and the attractiveness of its domestic holding regime. Also, the large BIT network Spain has in the region provides a legal protection which foreign investors may not have when directly investing from their home country.

For these reasons, Chinese companies should consider making their outbound investments in Latin America through Spanish holding entities, the so-called ETVEs. Furthermore, the new tax treaty between Spain and Hong Kong makes it possible for Chinese companies that use Hong Kong offshore vehicles to invest overseas in order to channel their investments in Latin America through ETVEs.

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