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What Do You Call Shareholder Income?
For Spanish legal commentators, the income a shareholder receives as a result of capital reductions or distributions of share premiums (and which exceeds the acquisition cost of the shareholding), has been long debated. The various characterisations that have been defended for this type of income are dividends, capital gains and other income. This characterisation is highly relevant given that, in principle and always according to the specific tax treaty in question, if the income is treated as a dividend, the source State can tax it. Whereas if the income is characterised as a capital gain or as other income, the taxation normally differs. Taxand Spain investigates this new characterisation and its impact on multinationals with subsidiaries in Spain.
The Directorate-General of Taxes (DGT) of Spain (the highest interpretative body in the Spanish Tax Administration) has recently published two rulings in which it concluded that the income received by a shareholder from a capital reduction, which exceeds the acquisition cost of the shareholder's holding, should be characterised as a dividend. Although the DGT did not specifically say anything about the excess amount over the acquisition cost where a share premium is distributed, the analysis reaches the same conclusion.
Having analysed Mexico and Luxembourg's tax treaties, the DGT's argument is that the definition of dividends in article 10.3 includes a catch-all clause which refers to the domestic legislation, specifically indicating that income from corporate holdings other than in the State is subject to the same tax treatment as income from shares by the legislation of the State - where the company distributing it resides. The DGT refers to the Nonresident Income Tax Law, which in turn refers to the Personal Income Tax Law, to indicate that according to article 33.3 of that law these excess amounts have the character of income from movable capital within the article that regulates the taxation of dividends. Accordingly, the excess should be characterised as such in tax treaties.
The DGT also ruled on an additional case, namely the obligation to withhold. Although the Spanish legislation generally excludes the obligation to withhold tax on this type of income, there is anexception to this rule for cases where a capital reduction on repayment of contributions is made out of retained earnings. This implies that the income in question will be subject to the withholding obligation. The DGT also pointed out that, even though there is no withholding obligation in cases where the repayment of contributions is not made out of retained earnings, the nonresident taxpayer will be required to assess its tax by way of a self-assessment.
Although we consider these rulings merit some constructive criticism, depending on the specific case in question, (for example, in the Luxembourg case the DGT does not consider application for exemption under the parent-subsidiary directive), it seems clear that the Spanish tax authorities' position is that these excess amounts are characterised as dividends for tax treaty purposes and that, in general, they are therefore taxable in Spain as the source country.
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