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December 1, 2021

Spainís amendments to CFC rules and participation regime may require action by multi-tier international structures under Spanish holdings

Executive summary

Spain published rules amending the existing Spanish controlled foreign companies (CFC) regime in July 2021 (For background, see EY Global Tax Alert, Spain approves Anti-Tax Fraud Law, dated 16 July 2021); among other changes introduced, the scope of application of CFC provisions were broadened to include dividend income and capital gains derived by intermediate non-Spanish holding companies which qualify as CFCs.

In addition, the Spanish State Budget Bill introduced a limitation to the Spanish participation exemption regime so that the exemption was effectively reduced to 95% of the relevant income (For background, see EY Global Tax Alert, Spain approves State Budget Bill for 2021, dated 6 January 2021).

The combination of these provisions could impact multi-tier international structures under Spanish holding companies, as the latter could be required to include in their taxable income the dividend and capital gains derived by the intermediate non-Spanish holding companies which comply with the rest of the CFC requirements.

Detailed discussion

Legal framework and recent amendments

The Anti-Tax Fraud Law (Law 11/2021, dated 9 July 2021) introduced, among others, several amendments to the Spanish CFC regime which were aimed at aligning the Spanish rules with the European Union (EU) Anti-Tax Avoidance Directive (ATAD I) provisions. The amendments to the CFC rules are applicable to fiscal years beginning on or after 1 January 2021.

In particular, the Anti-Tax Fraud Law eliminated the safe harbor clause for holding companies applicable until 2021, under which dividends and capital gains obtained by foreign holding companies owning at least a 5% participation in foreign operating subsidiaries during more than one year would not fall under the scope of the CFC rules. The application of this safe harbor required that the foreign holding company had human and material resources to manage the participation.

Also for fiscal years beginning on or after 1 January 2021, Spain’s State Budget Bill for Fiscal Year 2021 amended the Spanish participation exemption to introduce a limitation in the amount of the qualifying income which can benefit from the exemption. While the exemption remains in principle available to 100% of the qualifying income, an amount equal to 5% of the same shall be treated as non-deductible expenses, effectively limiting the exemption to 95% of the qualifying income. Given that the standard Corporate Income Tax (CIT) rate in Spain is set at 25%, the effective tax rate on dividends and capital gains derived by Spanish companies will be 1.25% (1.50% for financial entities which have a standard CIT rate of 30%).

The combination of these two amendments could lead to a CFC inclusion in the taxable base of the Spanish holding company of dividends and gains obtained by non-Spanish intermediate holding companies benefitting from a full participation exemption, as such income: (i) would be regarded as passive with no specific substance safe-harbor being available; and (ii) would be subject to a tax lower than 75% of the tax which would have been paid in Spain (generally, 1.25% as per the above).

Further, the safe harbor for EU entities/permanent establishments (which has been extended to European Economic Area taxpayers as well) now is only applicable if the taxpayer can evidence that “it carries out an economic activity.”1 The specific safe harbor will likely be strictly interpreted by the Spanish tax authorities that have taken the view that holding companies are not deemed to perform a business activity; however, such interpretation could be seen as an infringement of the EU freedom of establishment.

Practical implications

As anticipated, the recent amendments to the Spanish CFC and participation exemption rules could have a significant impact on multi-tier structures under Spanish holding companies.

In particular, the new rules would not only target sub-holding international structures, where a sub-holding company is used to hold investments in one or more other jurisdictions, but also fact patterns where a foreign company holds participations in entities resident in the same jurisdiction and is entitled to a full exemption/tax credit on domestic-source income.

To determine and manage the potential impact that these new rules could have on existing structures, the following actions should be taken:

  • Identify the entities within the structure which could entail a CFC exposure: sub-holding entities which would be entitled to a full exemption/tax credit on dividend income or capital gains.
  • Put in place additional monitoring to identify distributions or other transactions (e.g., mergers, liquidations, etc.) within the structure that could potentially result in the need of them being disclosed in the CIT return of the Spanish parent company and that until the enactment of this rule were commonly left out as per the holding company safe harbor. This monitoring exercise should be carried out at least on an annual basis for provision purposes.
  • Determining the CFC position on an annual basis is also key with respect of a potential future divestment. Due to the interaction between CFC rules and the participation exemption regime, a capital gain arising in connection with the transfer of shares in a foreign holding company which has derived CFC income representing more than 15% of that company’s annual income could be tainted (i.e., would not be exempt in the portion corresponding to that given year in which the CFC rules applied).

The above being said, positions can be taken to support the lack of CFC inclusion for dividends and gain from lower tiered sub-holding entities. These assertions may include, among others: incompatibilities with EU Law; the non-existence of lower taxation on the basis that technically the Spanish participation exemption is still 100% of the relevant income; business or regulatory purposes for the structure; lack of abusive behavior or effective income deferral; or existence of double taxation that is expressly forbidden under ATAD I. These or other assertions cannot be widely applied and rather need to be tailored to the specific factual circumstances of the investment structure.

In addition, mitigation of the Spanish additional taxation by crediting the foreign taxes which have applied to the foreign-source income, if any, could also be available.

Next steps

The interaction of these new rules might have a significant impact on multi-tier structures under a Spanish holding company. For this reason, multinational groups should carefully review their holding structures to assess the practical implications on their corporate structure as well as potential exposure mitigation considerations.


For additional information with respect to this Alert, please contact the following:

Ernst & Young Abogados, Madrid

Ernst & Young LLP (United States), Spanish Tax Desk, New York



  1. Alternatively, this safe harbor may be met if the EU entity is a UCITS fund (Undertakings for the collective investment in transferable securities, governed by Directive 2009/65/EC.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ernst & Young LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her Ernst & Young LLP or other tax professional prior to taking any action based upon this information. Ernst & Young LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.


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