Tax Newsletter - September 2020 | Judgments

State aid.- The European Commission may review correct application of transfer pricing rules and therefore identify the existence of types of tax aid, although within the limits of those assessment powers.

General Court of the European Union. Judgment of July 15, 2020. Cases T-778/16 and T-892/16

As we discussed in our Alert dated July 16, 2019, the General Court of the European Union supports the Commission using the prohibition on granting State aid to combat certain tax planning arrangements. In particular, it sees it as a valid tool for this task of reviewing correct application by taxpayers of the arm´s length principle (explicitly or implicitly recognized in their laws). The GCEU also acknowledges that the application of those rules is complex and subject to different though equally valid interpretations, so the Commission must be extremely diligent in providing evidence of the unlawfulness of the measure.

 

International taxation.- The commentaries accompanying the OECD Model Tax Convention cannot be applied retroactively

National Appellate Court. Judgment of March 13, 2020

The National Appellate Court concluded that it is not correct to interpret a tax treaty in light of an edition of the OECD Model Convention and the commentaries explaining it, which was issued later than the audited years. The interpretation of tax treaties must be evolving and dynamic, but a distinction is needed “between commentaries that simply seek to clarify interpretation issues, and those entailing a major change”.

In short, dynamic interpretation has an uncrossable boundary: it is not possible to apply the commentaries to the model convention retroactively where those commentaries are substantively different from those that were in force in the audited years.

This ruling by the National Appellate Court is in line with the view adopted by the Supreme Court on March 3, 2020, which is discussed in our alert dated June 2, 2020 (view here).

 

Corporate income tax.- Different timing of recognition rules cannot be applied to revenues and expenses from the same activity

Supreme Court. Judgment of June 17, 2020

The standard timing of recognition rule for revenues and expenses for corporate income tax purposes is based on the accrual method of accounting. Where revenues and expenses are recognized for accounting purposes in a different year from when they occur, (i) if in the accounts a revenue is recorded later or an expense is recorded earlier than the year in which they occurred, they must be reported for tax purposes in the period they occurred; and (ii) if an item of revenue is recorded earlier or an expense later, they must be reported for tax purposes in the period in which they are recorded in the accounts, unless this gives rise to less tax than would have been due by applying the rules for the accrual method.

In the case considered in this judgment, the taxpayer had recorded the revenues obtained from its real estate development activity in its accounts before they occurred; but had recognized expenses under the accrual method. According to rule (ii) above, the auditors concluded that both revenues and expenses had to be recognized for corporate income tax purposes in line with how they were recorded in the accounts, even if that meant revenues would be taxed before they occurred, and costs, when they occurred.

The Supreme Court concluded that, where the taxpayer only recognizes revenues wrongly (by doing so in a period before they occurred), the principle of following the accounting treatment cannot be accepted in relation to those revenues, while retaining the accrual method in relation to expenses. Acting in this way distorts the result to benefit the public purse and harms the ability-to-pay principle and the principle of objectivity that must prevail in all the tax authorities’ actions.

 

Corporate income tax.- Interest on loans provided for capital reduction to redeem own shares is not deductible, although it is deductible on loans obtained to pay dividends

National Appellate Court. Judgment of March 13, 2020

The National Appellate Court concluded in this judgment that finance costs in respect of a loan provided to repurchase own shares is not deductible because they are not associated with the company's revenues. Whereas interest on loans to pay dividends is deductible, because in this case the cost is associated with revenues.

 

Corporate income tax.- Late-filing of self-assessment does not prevent offset of net operating losses

Cantabria High Court and Valencia High Court. Judgments of May 11, 2020 and May 25, 2020

A company filed its corporate income tax return after the time limit. In that return it offset net operating losses carried forward from prior years. According to the auditors, the offset of net operating loses is an election that must be made in the voluntary period.

The Cantabria and Valencia high courts held in these judgments that the spontaneous late filing of a return already has the penalty consequences laid down in tax law, which do not include being prevented from offsetting net operating loss carryforwards, so their offset cannot be disallowed.

 

Personal income tax.- Senior managers are entitled to apply the exemption in cases of dismissal as well as for resignation. They do not forfeit their right to this exemption, even if they become members of the company's managing body after their dismissal

Valencia High Court, in a judgment delivered on June 30, 2020. Supreme Court, in a judgment delivered on July 23, 2020

The senior management royal decree states that senior managers are entitled to severance equal to twenty days’ pay per year capped at twelve monthly payments where their employment contract is terminated following unjustified dismissal (seven days’ pay per year capped at six monthly payments where termination is by unilateral decision of the employer). An agreement to the contrary is allowed in both cases, however.

The Supreme Court (Labor Chamber) in a judgment delivered on April 22, 2014 (appeal 1197/2013) held that it was not logical for the lawmakers to allow agreements that exclude any severance payments. On the basis of this principle the National Appellate Court (Judicial Review Chamber), in a judgment rendered on March 8, 2017 (appeal 242/2015), concluded in a case of termination by unilateral decision of the employer that the severance payment equal to seven days per year capped at six monthly payments amounted to a mandatory lower limit exempt from personal income tax. Later, in judgments delivered on November 5, 2019 (cassation appeal 2727/2017), July 23, 2020 (cassation appeal 910/2019), and September 4, 2020 (cassation appeal 3278/2019), the Supreme Court confirmed the National Appellate Court’s view.

Although in these judgments the Supreme Court refers to cases involving a unilateral decision, the view explained in them is transferable to cases involving unjustified dismissal, in light of the reasoning provided by the court. The same conclusion was reached again recently by Valencia High Court in a decision delivered on June 30, 2020, although referring to the judgment by the Supreme Court (Labor Chamber) on April 22, 2014 rather than to subsequent ones by the Judicial Review Chamber.

Moreover, article 1 of the Personal Income Tax Regulations states that the right to the relief for dismissal is forfeited if the employee does not actually sever ties with the employer. This failure to sever ties is presumed to exist (unless proof to the contrary is provided) if in the three years following dismissal the employee provides services to the company or a company related to it. In its judgment, Valencia High Court concluded that it cannot be presumed that the employee did not sever ties by reason of the fact that, following dismissal, the employee is appointed director at the company if, as may be inferred from the proven facts, (i) membership of the managing body does not coexist with an employment contract and (ii) the individual receives a retirement pension compatible with membership of the managing body.

 

Personal income tax.- A dismissal cannot be reclassified by mutual agreement without solid proof

National Appellate Court. Judgment of July 22, 2020

Tax auditors reclassified a few dismissals as employment contract terminations by mutual agreement on the basis of a number of items of proof. The reviewed period was before the 2012 labor law reform, in other words, when the so-called express dismissal still existed, which allowed employers to acknowledge unjustified dismissal without using a conciliation hearing.

The National Appellate Court examined each of those items of proof in turn and concluded as follows:

 

Personal income tax.- A taxpayer being taxed in the UK as a non-domiciled resident does not prevent the inbound expatriates regime applying when they return to Spain

National Appellate Court. Judgment of June 15, 2020

The UK income tax legislation allows a special scheme for resident taxpayers not having their permanent residence there (non-domiciled residents) if they meet certain requirements. Under this scheme, only income generated in or sent to the UK is taxed there.

In Spain, the inbound expatriates regime allows workers sent to Spain who acquire residence there to continue being taxed as nonresidents for several years if specific requirements are met. In particular, taxpayers cannot claim this regime if they have been resident in Spain in the ten years before the new period spent in Spain.

The question at issue in this judgment related to determining whether a taxpayer that had traveled to Spain for work reasons could claim the inbound expatriates regime, even though in the previous ten years they had been a non-domiciled resident in the United Kingdom and, therefore, had had to be taxed as a resident in Spain to report certain types of income that were not taxed in the United Kingdom; to which the National Appellate Court replied that they could.

 

Inheritance and transfer and stamp tax.- The attribution to a spouse of property under absolute ownership in respect of payment for a usufruct right in a testate succession implies an exchange subject to transfer and stamp tax (Catalonia)

Supreme Court. Judgments of July 23, 2020 (appeals numbers 3947/2018, 7380/2018 and 2391/2019)

In his will the deceased had bequeathed to his wife a universal and lifelong usufruct right and the offspring were named as universal heirs. In the deed of statement and acceptance of the inheritance absolute ownership of certain items was conveyed to the spouse in respect of payment for the usufruct right, and to the heirs, absolute ownership of the other items of property.

The Supreme Court recalled that, for the purposes of inheritance and gift tax, acquisition of the inheritance takes place at the time of death of the deceased. This means that the lifelong usufruct right bequeathed to the spouse on a universal basis in all the items of property in the inheritance takes place at the time of death, which is when the coheirs obtain naked ownership of all the items of property in the inheritance. In other words, it is in the later deed of statement and acceptance of inheritance that it is decided to exchange the lifelong usufruct right in all the items of property for absolute ownership of certain items, which causes the existence of a new conveyance that must be taxed separately.

Although article 57 of the Inheritance and Gift Tax Regulations state that, for tax purposes, the exchange of a lifelong usufruct right for absolute ownership of items of property is not treated as a separate legal transaction from the inheritance itself, the Civil Code only allows the exchange of a universal usufruct right in intestate successions. Therefore, because the case involved testate succession, the exchange of the usufruct right by decision of the parties implies that, (i) for the widow, there is an exchange subject to transfer and stamp tax and, (ii) for the coheirs, there is a consolidation of legal title subject to inheritance and gift tax (all of which is separate from the inheritance and gift tax associated with the inheritance that took place when the death occurred).

 

Inheritance and gift tax.- The rectification of a return filed in voluntary period does not interrupt the statute of limitations if tax authorities fail to review that correction within time limit

Supreme Court. Judgment of June 18, 2020

The deceased from whom the property had been inherited had died in May 2007. The person liable for inheritance and gift tax filed their tax return within the time limit and later (in 2008 and 2009) filed two supplementary returns. In November 2012 the tax authorities initiated a limited review procedure which ended with the relevant assessment.

The tax authorities found that the two supplementary returns tolled the statute of limitations and that therefore the period had not ended when the assessment decision was issued. The Supreme Court concluded, however, that those returns each gave rise to the commencement of a separate tax management procedure which the tax authorities had not settled within the six month period and therefore they expired. As a result, the actions performed within those procedures, including the returns that had initiated them did not toll the statue of limitations for the tax authorities’ right to make an assessment.

The court underlined that, otherwise, (i) a breach by the tax authorities of their obligation to complete within a specific time period the procedure initiated by the return would have no consequences, and (ii) would allow the tax authorities to keep the statute of limitations tolled indefinitely.

 

Inheritance and gift tax.- Only income from directly held investments is taken into account for the purposes of the family business reduction

Supreme Court. Judgment of June 18, 2020

In share transfers, the family business reduction to inheritance and gift tax requires certain requirements to be met, including that one of the members of the family group must carry out management activities at the company and receive in respect of those activities compensation representing more than 50% of all their income from business or professional activities and from personal work.

The Supreme Court concluded that, to be able to claim the reduction, only income from directly held investments may be taken into account (which clashes with the view taken by the DGT in various resolutions).

 

Cadastral valuations.- Taxes calculated by reference to value in the cadaster that the tax authorities have acknowledged to be incorrect must be refunded

Supreme Court. Judgment of June 3, 2020

The legislation on the cadaster states that, where the cadaster corrects discrepancies between a property description in the cadaster and the property’s actual characteristics, any new appraisal will be effective from the date following that of the decision to correct it. The Supreme Court concluded in this judgment, however, that the time limit for the effects of the correction is only valid with respect to the cadaster; because a tax assessment calculated by reference to a value in the cadaster that has been acknowledged to be incorrect by the authorities themselves cannot be accepted. This means the taxpayer can recover any amounts paid incorrectly in the past.

 

Real estate tax.- Tax authorities must provide proper reasoning for separate tax rates

Seville Judicial Review Court no 3. Judgment of May 18, 2020

The real estate tax law recognizes the authorities’ power to establish separate tax rates for urban properties with the highest values in the cadaster, in light of the uses determined in the legislation on the cadaster. These separate rates could be applied to up to 10% of the properties in a municipality with the highest values in the cadaster for each use, not including residential.

In this judgment, the Seville court concluded that, in all cases, reasoning must be provided for setting these separate rates and they must have economic support; otherwise, any real estate tax assessments using these rates will be null and void.

 

Tax on construction, installation projects and works.- The statute of limitations for the right to audit the taxable amount starts on physical completion of the work

Supreme Court. Judgment of June 22, 2020

The Supreme Court clarified that the four-year statute of limitations that the tax authorities have to audit the taxable amount for the tax on installation projects and works self-assessed by the taxpayer starts to run on the date of completion of the work. And this is regardless of the validation date of the certificate for the completion of building work and of whether the authorities have received formal notification of that completion.

 

Expiry of the statute of limitations and 'actio nata'.- Where an incorrect revenue is found as a result of an adjustment made to another taxpayer, the right to apply for a refund arises when the taxpayer has notice of that adjustment

Supreme Court. Judgment of June 11, 2020

In an audit it was found that items of commission paid by one company to another were not deductible because they really related to return on equity. This classification means that the recipient company should not have been taxed on the items of commission (if they were dividends, they would have been exempt). Therefore, when this company became aware of the adjustment to the payer, it applied for a refund of incorrect payments (four years after it had reported the items of commission).

The Supreme Court held that, under the actio nata theory, together with the principles of good management and of prohibition of unfair enrichment, the recipient company is entitled to a refund. In these cases, the time limit for applying for a refund starts when the individual has knowledge of the adjustment made to the payer because it is this adjustment that discloses the incorrect nature of the payments made. Besides, the tax authorities themselves could have adjusted both items at the same time.

 

Collection procedure.- Denial by silence does not allow the tax authorities to initiate enforced collection proceedings

Supreme Court. Judgment of May 28, 2020

A taxpayer appealed against a tax assessment without requesting a stay. After the maximum time limit for settling the appeal had ended the tax authorities deemed that the appeal had been dismissed and initiated enforced collection proceedings for the debt. Despite the taxpayer having been able to request a stay of the debt and not doing so, the court concluded as follows:

The court underlined that it is reprehensible to enforce collection of a tax debt before expressly deciding on the appeal lodged against that debt, which, if the taxpayer’s claims are upheld, could lead to the assessment being overturned; since the same amount of effort needed to issue the order initiating enforced collection proceedings could have been employed to decide on the appeal in the proper time and form.

 

Shifting of liability.- A “double shot” is allowed in decisions determining tax liability

Supreme Court. Judgment of June 03, 2020

The authorities held the director secondarily liable for a company's debts. The director appealed against that decision by arguing that the tax debts assessed for the company (principal debtor), and for which liability had been shifted, had been calculated incorrectly. The Valencia Regional Economic-Administrative Tribunal (TEAR) upheld the claim, overturned the decision determining liability and ordered the tax authorities to issue another decision shifting liability changing the amount of the tax debts of the principal debtor. The appellant, however, objected to that second shifting of liability by arguing that the decision by Valencia TEAR rendered the principal debtor ‘s debt null and void. Therefore there was no debt for which to shift liability.

The Supreme Court concluded that the liable person’s debt is separate (distinct from that of the principal debtor) and only arises if the legal requirements for shifting liability are met. Therefore, the effects of an appeal lodged by the liable person cannot be extended to the principal debtor. Under that reasoning, if an economic-administrative body partially upholds the claim against the decision determining liability, in enforcement of that decision a new decision determining liability may be delivered which changes the original decision (as long as the right to demand payment of the debt has not expired and the reformatio in peius principle is observed).

 

Audit procedure.- If certain elements have been audited in a management procedure they cannot be audited again by the tax authorities in a later procedure

Supreme Court. Judgments of July 23, 2020 (appeals numbers 1216/2018, 877/2018 and 158/2018)

The Supreme Court examined whether the auditors may issue a separate assessment from that made earlier by a management office, where the examined facts are the same and the only difference is their legal classification.

The court concluded that, where the management body has all the information needed to issue the assessment, that assessment cannot be modified in a later audit, unless in this later audit new facts or circumstances are discovered which require different activities from those performed to make the first assessment.

 

Audit procedure.- The tax activity program appearing in the specifications does not necessarily restrict the scope of audit and examination work

Supreme Court. Judgment of July 23, 2020

A general personal income tax audit was carried out on a taxpayer who carried on a professional activity and conducted a real estate development business. The audit program’s specifications stated that the program for auditing taxpayers was on “professionals”, whereas the revenues of the individual’s real estate business were also adjusted.

The Supreme Court held that the program behind the selection of taxpayers to be audited and which appears in the audit program’s specifications does not predetermine the scope of the audit work, which must be decided by the competent bodies of the tax authorities and appear in the notice of commencement of audit activities.

 

Penalty procedure.- A penalty procedure may be commenced before the assessment is issued

Supreme Court. Judgment of July 23, 2020

It was raised whether the legal system generally and article 209.2.2 LGT in particular authorize the tax authorities to initiate a tax penalty procedure before issuing and notifying the assessment decision, determining the event legally defined as a tax infringement.

The court concluded that infringements causing a loss of tax revenue are governed by the “no assessment no penalty” principle, although this does not prevent a tax penalty procedure being commenced before an assessment exists.

 

Penalty procedure.- The 25% reduction is allowed for penalties imposed to replace others that have been voided

Supreme Court. Judgment of July 8, 2020

Article 188.3 LGT states that the penalty amount may be reduced by 25% where the taxpayer does not appeal against the assessment or the penalty and pays in the voluntary payment period.

In the case examined in this judgment, the taxpayer appealed against the assessment and the penalty issued by the authorities. The court partly upheld the appeal on the penalty, and ordered for a new penalty to be imposed to replace the one that had been voided. The Supreme Court confirmed that, in these cases, the taxpayer must be granted a new voluntary payment period and the 25% reduction must be allowed if they do not appeal against the new penalty and pay it in that period.

 

Penalty procedure.- A penalty lapses if the infringer dies before it becomes final

Supreme Court. Judgment of June 03, 2020

This judgment stemmed from a penalty decision which was appealed by the person held responsible for the tax infringement. The taxpayer died before the penalty became final.

The Supreme Court ruled that, under article 190.1 LGT, the death of the infringer after the imposition of a penalty, but before it has become final, causes it to lapse, so it cannot be sought from the heirs.

 

Review procedure.- A final and consented assessment may be held null and void

Supreme Court. Judgment of July 16, 2020

A nonresident taxable person for inheritance and gift tax purposes was taxed under the central government legislation instead of the autonomous community legislation that would have applied to them if they had been resident in Spain. The Court of Justice of the European Union (CJEU) later concluded in a judgment delivered on September 3, 2014 (case C-127/12), that Spanish law was discriminatory and precluded the principle of the free movement of capital by establishing differences between residents and nonresidents in Spain. The assessment on the taxable person had already become final when this judgment was delivered, although it was issued after the appeal had been lodged with the CJEU, a fact that the authorities did not notify to the taxpayer.

The Supreme Court concluded that the CJEU’s case law contained in that judgment does not per se provide sufficient reason for holding all the authorities’ actions null and void, although it does require, even in the presence of final actions, the petition to be considered without the need to invoke for this purpose a ground for them being null and void as a matter of law, the only option for satisfying the principle of effectiveness.

In this case the requirements for rendering an action null and void as a matter of law under article 127.1 LGT were met (actions “a) harming rights and freedoms protected by the Constitution”), and therefore it involved an assessment issued under a law that was held not to be in conformity with EU law due to being discriminatory, with a breach of article 14 of the Constitution. The fact of it being a final assessment is not an obstacle to this.

 

Enforcement procedure.- It is not necessary to complete the administrative jurisdiction to apply for extension of the effects of a final judgment

Supreme Court. Judgment of June 18, 2020

The Supreme Court held in a judgment on October 3, 2018 that social security maternity benefits were exempt from personal income tax. A taxpayer applied to Madrid High Court for the effects of that final judgment to be extended, an application that the court rejected because it considered that the interested party should first have completed the administrative jurisdiction (starting with an application for correction of their personal income tax self-assessment).

Against this, the Supreme Court concluded that requiring the interested party to submit their request first to the authorities means making a useless step, causing unnecessary delays and contradicting the purpose of the law allowing the option of requesting extension of the effects of final judgments.