Executive summary

On 1 September 2022, the STA challenged the application of the US-Spain Tax Treaty¹ exemption on capital gains derived from the transfer of shares in a Spanish subsidiary in a binding report issued in the context of a tax audit procedure (the Report).² The challenge was based on the application of the GAAR, on the grounds that the overall transaction, consisting in a series of consecutive intra-group share transfers, was artificial and an improper form to achieve the intended result.

In order to substantiate a challenge based on the Spanish GAAR, the STA is required to follow a more onerous specific procedure which requires consultation with an Advisory Committee whose conclusion is binding for the tax audit teams.

Going forward (i.e., for transactions carried out from the date of publication of the Report), cases that are substantially equal to the one in the Report and successfully challenged by the STA based on GAAR could potentially entail penalties.

Detailed discussion

Case under analysis and approach followed by the STA

The instant case refers to a tax audit procedure related to the capital gains tax triggered on the transfer of shares in a Spanish subsidiary by its US sole shareholder and the subsequent intra-group transfers of the shares. As a result of these transactions, the Spanish subsidiary was ultimately transferred to a Dutch entity.

It is worth noting that in 2017, when the transfer took place, the applicable US-Spain Treaty included a “substantial participation” clause under which the transfer of shares in a Spanish entity by a shareholder owning more than 25% for more than a year, would be taxable in Spain.

The transactions audited by the STA were implemented through the following steps:

The US sole shareholder of the Spanish subsidiary (MCORP) contributed its interest in the Spanish subsidiary to other US entity (MXEI). MCORP took the position that the relevant capital gain was not subject to Spanish capital gains taxation under the application of the tax roll-over regime provided for in Section 10.c) of the Protocol of the US-Spain Tax Treaty applicable at the time.

Subsequently, on the same date, MXEI contributed the shares in the Spanish subsidiary to another US entity. MXEI considered that no capital gain was triggered (despite the roll-over in basis in the prior step) and/or claiming that the gain would not be taxable in Spain in accordance with the US-Spain Tax Treaty (since MXEI did not hold the shares for a year, as the Treaty requires for granting taxing rights to Spain, although the roll-over in the prior step would actually also apply to the holding period).

Each step was documented in a separate public deed, but all of them were granted on the same date and within minutes.

The Spanish tax auditors contended that the capital gain obtained by MCORP upon the first transaction should have been subject to capital tax in Spain on the grounds that the overall transaction and the series of consecutive intra-group share transfers were artificial (aiming solely to take advantage of treaty benefits) and an improper form to achieve the intended result (the transfer of the shares to the Dutch entity).

Upon realizing that the GAAR could be applicable, the STA initiated the specific procedure established in the law. The application of this anti-abuse rule requires a mandatory and favorable report, which is binding for the tax audit bodies, from an Advisory Committee composed by members of the Tax Agency and the General Directorate of Taxation.

Decision of the GAAR Advisory Committee

The GAAR Advisory Committee considered that the overall transaction (i.e., considering the series of subsequent transfers of shares) was unnatural and improper for the purpose of the transaction, since MCORP could have implemented the transaction by a direct transfer of the shares to the Dutch entity. However, such alternative would have resulted in the relevant capital gain being taxable under the US-Spain Tax Treaty under the referred “substantial participation” clause.

Therefore, the Advisory Committee concluded that MCORP artificially created the required conditions to qualify for the benefits of the US-Spain Tax Treaty, without MCORP having accredited any relevant legal or economic purpose (economic substance) to justify the artificial and unnatural steps taken to implement the restructuring.

Implications

The reports of the GAAR Advisory Committee constitute a roadmap for tax audit teams to assert the artificial nature of the transactions carried out by taxpayers in order to deny the application of tax treaty benefits based on the GAAR.

The application of GAAR may also have relevant implications on the applicability of penalties. Any arrangement or structure that is deemed as substantially equal to those which the STA has publicly designated as abusive could be subject to penalties (50% of that tax due), if the Spanish taxes are accrued and payment to the Spanish Treasury is due after the publication of the Report. Also, access to Mutual Agreement Procedures provided in tax treaties may be denied in certain cases if GAAR is applied.

The impact of the Report on transactions performed under the US-Spain Tax Treaty may be limited, since the new Protocol to the Treaty which came into force in November 2019 provides for a general exemption rule on capital gains derived from the transfer of shares in non-land-rich Spanish entities (although it may still affect non statute-barred transactions carried out before that date).

However, the approach followed by the Advisory Committee in the Report could also be used by the STA in similar transactions carried out within the framework of other tax treaties signed by Spain which include provisions configured in similar conditions.

Moreover, the Report keeps adding to the list of evidence or indicia that the Advisory Committee have considered in previous reports in order to characterize a transaction as artificial. Particularly remarkable is the relevance given to the fact that the transactions were implemented consecutively on the same date, even within minutes (a common practice universally and also in transactions based on sound business purposes and economic substance) and the debatable opinion by the Advisory Committee that the taxpayer should have transferred the shares directly to its final owner (neglecting the autonomy of taxpayers to choose how to structure their transactions and that the burden of proof of abuse is with the STA).

In this context, multinational groups seeking to carry out reorganizations that directly or indirectly involve a transfer of shares in Spanish entities should review their current corporate structure (in terms of economic substance) and plan the intended reorganization considering the current position of the GAAR Advisory Committee, and/or adopt a consistent “audit ready” approach to identify the good fact patterns and anticipate any weaknesses in relation to the business and legal purposes of the intended reorganization.

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

Ernst & Young Abogados, Madrid

• Tatiana de Cubas Buenaventura | tatianade.cubasbuenaventura@es.ey.com
• Isabel Hidalgo Galache | isabel.hidalgogalache@es.ey.com

Ernst & Young LLP, Spanish Tax Desk, New York

• Jose A. (Jano) Bustos | joseantonio.bustos@ey.com
• Andrés Carracedo | andres.carracedo.insua1@ey.com

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Endnotes

Convention between the United States of America and the Kingdom of Spain for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, signed on 22 February 1990 (version in force as of 2017).

Report No. 8/2022, of the GAAR Advisory Committee. Non-Residents’ Income Tax. Transfer of shares in subsidiary by mans of consecutive intra-group transfers.