October 11, 2022
Spanish Supreme Court rules on dynamic interpretation of tax treaties and “substance-over-form” characterization of cross-border transfer of client and operational data
Spain’s Supreme Court has ruled, through its judgment of 24 June 2022,1 recently published (the Judgment), that the remuneration agreed in consideration for a certain operation of "transfer" of customer and "operational" data between a Spanish entity and a related German entity must be characterized as a royalty within the meaning of article 12 of the 1966 –Germany-Spain tax treaty. As a result, the Spanish domestic provisions related to royalties (including withholding taxes) are applicable, subject to the reduced tax treaty rates set forth in the tax treaty.
SpanishCo and GermanCo, related companies and tax resident in Spain and Germany, respectively, entered into an agreement on 24 March 2009 whereby GermanCo "transferred" its Portuguese customer data and operational data (financial information and relevant data to provide distribution services in Portugal) to SpanishCo. The transaction was deemed as a transfer, giving rise to a capital gain, not subject to Spanish withholding taxes (WHT). The taxpayer treated the transaction as triggering a tax-exempt gain.
The Spanish tax audit challenged the tax treatment of payments made under this agreement, finding that the transaction did not trigger a capital gain but rather fell within the definition of royalty, subject to Spanish WHT.
Specifically, the transferred data consisted of certain Portuguese customer data (name, main business address, billing address, addresses of all retail stores, billing) and operational data (business experience of former distributor of products in Portugal with its customers in the development of its activity, experience and commercial knowledge) that are exclusive and that were not publicly available.
The Spanish tax courts and lower judicial courts confirmed the Spanish tax audit’s position. The case was appealed to the Spanish Supreme Court.
Cases may only access the Spanish Supreme Court in certain limited instances. The case was admitted to the Spanish Supreme Court to analyze and form case law around whether for the purposes of withholding Spanish taxes, payments by a Spanish company to a non-Spanish company in consideration for the “assignment” of customer and operational data, in the terms of the agreement in the instant case, trigger the taxable event as royalties.
Relevance of Judgment
The Judgment of the Supreme Court analyzes two relevant issues from the perspective of international taxation:
Dynamic interpretation of tax treaties
The Supreme Court holds the debatable view that the fact that the tax authorities use the Commentaries to article 12 of the 2008 OECD MTC to interpret the 1966 Germany-Spain tax treaty does not involve a prohibited “dynamic interpretation” of the tax treaty, since such Commentaries existed before the transaction (2009).
This conclusion lies on the fact that the tax treaty definition of royalties did include payments in consideration for know-how and that none of the parties have contended, verified or questioned that the evolution of the Commentaries entails a substantial or material change.
With the above nuance, this Judgment therefore supplements the Spanish Supreme Court case law,2 whereby dynamic interpretation of tax treaties or of the OECD MTC should only be allowed when there are no substantial or material changes, but rather a mere clarification of the provisions agreed by the parties.
Characterization of payments derived from transfer
The Supreme Court considers that the object of the agreement does not refer to a mere list of client data that may be extracted from a public database, but rather the assignment of operational data referred from commercial experience, notion included in the royalty definition under Spanish domestic tax law and the Germany-Spain tax treaty.
The Judgment, in line with previous case law, adopts a restrictive position regarding the recognition of transactions that determine a “full transfer” of certain rights over intangibles such as know-how or the transfer of technology, for the purposes of applying the tax treaties (art.12 vs. arts13 and 7 OECD MTC). The Supreme Court takes a “substance-based approach”: regardless of the denomination of the agreement, it is not proved that the transfer of ownership is definitive or that the transferor no longer has the right to dispose or use the transferred information, among other aspects.
This Judgment supplements the current case law. The Commentaries can be used as guidance as long as they refer to wording which has been expressly accepted by the signatories to the relevant tax treaty and to the extent that they are mere clarifications to the interpretation.
The conclusions of the Supreme Court have implications that affect those transactions in which the assignment or transfer of client and operational data, including from a client portfolio to experiences of a commercial nature or industry, defining such payments as royalties within a tax treaty, unless it is proved that there is a definitive transfer or sale of the rights over such know how.
The impact of this Judgment should also be considered in relation to certain highly digitalized business models involving a transfer or sale of data obtained through algorithms or sensors, or the access to databases, as well as potentially the transfer of data after aggregation/structuring or analysis (big data models).
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