New tax measures affecting holdings in subsidiaries

The Spanish Parliament has just enact new tax measures, which will have a significant impact on the way Spanish companies have traditionally structured their investments via holdings in domestic or foreign subsidiaries. We have often had occasion to recall that for many years Spain has been one of the few OECD jurisdictions that allows companies to take a tax deduction for the impairment of their shareholdings in subsidiaries. Although historically the deduction required the impairment of the holding to be recorded in the investor’s books, this requirement was eliminated in 2008 for holdings in companies qualifying as group entities, jointly controlled entities or affiliates. In these cases the deduction, in the form of a book-to-tax adjustment, was tied to the mere reduction of the amount of equity in the subsidiary, as adjusted by (1) those expenses which were not regarded as tax deductible under the Spanish CIT Law, and by (2) in the case of holdings in foreign companies, the result of re-computing the reduction in equity in accordance with Spanish GAAP.

The complexity of the two adjustments, particularly in groups with operations in multiple jurisdictions and sophisticated corporate structures, has converted this deduction into one of the most contentious areas between the Tax Administration and taxpayers. In addition, the deduction has also enabled Spanish businesses to significantly reduce their corporate income tax payments. Possibly with a view to curbing these two effects, the Government has proposed and the Parliament has approved the elimination of this deduction. Logically, in the interest of neutrality, it has also established that losses incurred by foreign PEs will not be deductible either.

The removal of this deduction is going to affect the valuation of projects where there are multiple investors none of whom holds a stake of more than 75% in the venture. This is the minimum threshold generally required to qualify for tax group consolidation and, where it is possible, it is certainly the most straight-forward way to enjoy the tax shelter that net operating losses naturally provide.

Where that threshold is not present, which is usually the case in joint ventures, the challenge is how to optimize the use of tax losses. In other jurisdictions, this is traditionally achieved through the use of tax transparent vehicles, or entities that can be disregarded for tax purposes, in which the losses flow proportionally to the investors.

We do not currently enjoy such look-through entities in Spain, other than a form of unlimited liability partnership known as a sociedad civil which, on the other hand, is not legally designed to carry on a trade (indeed, there is some controversy about whether the sociedad civil can maintain its tax look-through status when it engages in a trade) or some special forms of agreements suitable for certain limited activities for the benefit of their members or for businesses the come together to carry out a certain project, typically of a temporary nature, such as a construction work.

Where the project is located outside Spain, the challenge is even bigger, almost insurmountable, where the trade would create a permanent establishment abroad since the losses attributable to the PE will not be deductible under the new regulations. This is, undoubtedly, a matter to be carefully reviewed.