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Favourable Judgement in Fraud Upon the Law Proceeding

6 Aug 2012

In the last years, the tax inspectors of the State Tax Agency have issued corporate income tax assessments to numerous multinational groups operating in Spain, contending that certain financing structures fall within the scope of the concept of "fraud upon the law" (or its equivalent since July 2004, "conflict in the application of the tax provision"). Taxand Spain investigates the development of this concept and its impact that this ruling may have on Spanish subsidiaries.

Specifically, the inspectors have questioned the tax deductibility of interest on intra-group loans obtained by a Spanish subsidiary to acquire holdings in other entities, resident or nonresident in Spain, already belonging to the same corporate group. The inspectors have considered that such purchase and financing transactions are carried out in fraud upon the law because they lack economic grounds other than tax and, thus, have an exclusive tax aim: to erode the tax base of the Spanish entity through the artificial creation of borrowing costs. In this type of structure, they have also challenged the tax deductibility of financial goodwill on the acquisition of nonresident entities of the group on the same grounds.

On 24 July, the National Appellate Court issued a favorable decision in which, while the Court does not evaluate the potential existence of valid economic reasons in the transactions questioned by the inspectors, it invokes the doctrine of estoppel to rule conclusively in favor of our client's submissions. The Court states that the tax authorities cannot disregard or contradict their own acts and, therefore, limits the inspectors' ability to make a finding of fraud in transactions carried out in fiscal years prior to those inspected.

In the case at hand, transactions that took place in 2005 had been reviewed in two previous general inspections which covered years 1996 to 2000, carried out from 2001 to 2003. In the context of those inspections, the inspectors did not consider it appropriate to initiate a special fraud proceeding, despite having specifically analysed the acquisition and financing transactions in question.

Taxand's Take

The National Appellate Court states that it would not be legitimate to make a finding of fraud in later inspections as that would be contrary to "various essential legal principles such as good faith, legal certainty and respect for legitimate expectations." Furthermore, the Court states that "it is not possible to consider acts, operations or transactions as fraudulent, for purposes of their tax treatment, where they have been carried out in different periods predating those to which the finding of fraud relates." Thus, we consider that if the transactions which the inspectors consider fraudulent have been carried out in statute-barred years, the finding of fraud might not be appropriate.

Where multinational groups with operations in Spain are facing any kind of tax audit or tax litigation, it may be worthwhile reviewing carefully the scope and content of previous tax audits in order to explore whether the doctrine of estoppel could be invoked, mainly if the Tax Agency has based the assessment on the existence of fraud upon the law.

Your Taxand contacts for further queries are:
Luis M. Vi?uales
T. + 34 91 5145200

Elena Mart?nez Pastor
T. + 34 91 5145200

Taxand's Take Author