The law that introduced the new taxes on banks, energy companies and large fortunes, in force for the last two months, came with an unexpected change in the Wealth Tax that fully affects non-resident foreigners who own property in Spain.
A modification that, according to the experts consulted by idealista/news, has a very broad scope, could scare off new foreign investment in the real estate sector and lead to discriminatory situations between non-residents and residents. And it even generates doubts of interpretation.
Despite the importance of the change, it was included as a provision in Law 38/2022, of 27th December, which provides for the implementation of temporary levies on the energy and financial sectors, as well as the Solidarity Tax, better known as the tax on large fortunes. And it has gone unnoticed.
The regulation, published in the Official State Gazette on 27th December 2022 and in force since 28th December, includes in the third final provision the modification of "section one of article 5 of Law 19/1991, of 6th June, on Wealth Tax", which includes non-residents who own property in Spain, both directly and indirectly, as taxpayers of this tax. A change which, by extension, also affects the tax on large fortunes and which, in practice, will mean the disbursement of the tax for estates of more than 3 million euros, which will have to pay up to 3.5%.
As stated in point b of the provision, "By real obligation, any other natural person for the assets and rights of which he or she is the owner when these are located, can be exercised or must be fulfilled in Spanish territory. For these purposes, securities representing equity interests in any type of entity, not traded on organised markets, at least 50% of the assets of which consist, directly or indirectly, of real estate situated in Spanish territory, shall be deemed to be situated in Spanish territory. For the purpose of calculating the assets, the net book values of all the assets entered in the accounts are replaced by their respective market values as determined on the date on which the tax becomes chargeable. In the case of immovable property, the net book values shall be replaced by the values to be used as the tax base in each case".
Thus, all non-residents who own real estate in Spain, either directly or indirectly (through a company or any type of entity, whether resident or not), and at least half of the assets of said legal entity are real estate and are located in the domestic market, will have to pay Wealth Tax (whose schedule coincides with that of Personal Income Tax). And, by extension, they will also be subject to wealth tax.
We review the implications, how it will affect the sector and what doubts it is generating among taxpayers, advisers, economists and law firms.
A change with many effects
According to experts consulted by idealista/news, the origin of the tax change responds to the Treasury's objective of equalising the taxation of non-residents who own property directly and indirectly in Spain, as until now foreigners who owned property directly were subject to "Patrimonio", while if the property was owned indirectly, through a company, they did not have to pay the tax. However, as the amendment is drafted, its implications go beyond that.
Antonio Sánchez Recio, partner at PwC Tax & Legal, recalls that "the Directorate General of Taxes had been thinking for some time about how to apply the Wealth Tax to those who created a company and escaped having to pay Wealth Tax. With a certain amount of sense, they wanted to attack this, but the legislator has gone too far and the wording contemplates more cases than they wanted to solve. It has more scope than we believe the legislator intended".
For example, the amendment speaks of real estate in general, without differentiating between homes and other assets used for economic activity (commercial premises, logistics warehouses, shopping centres, land, etc.), nor does it distinguish between property holders in Spain and investors (i.e. between those who have a property for their use and enjoyment and those who seek economic profitability through investment).
Thus, insists Sánchez Recio, "the investor who buys shares or stocks in an investment fund whose portfolio is mainly composed of real estate located in Spain is also within the taxable event". For example, this would be the case of a German individual who has shares in a German entity whose main assets are properties located in Mallorca.
The Spanish Association of Tax Advisers (AEDAF) also considers that the amendment "could have the laudable aim of providing fair tax treatment for properties located in Spain owned by non-residents through companies (which were previously not taxed)", but they warn of the legislator's lack of precision when drafting the change, given the urgency with which the legislation was processed so that the tax on banks, energy companies and large fortunes would enter into force in 2022, and in which amendments presented by other political parties were not accepted.
"The amendment is intended to correct this lack of taxation. However, the rule applies regardless of the non-resident taxpayer's percentage shareholding in the non-resident entity, whether or not it has control over it (for example, investment funds that invest most of their value in real estate assets in our country), which should undoubtedly be corrected by the legislator. Likewise, the subjection rule determines that, once the rule has been complied with, the value attributable to assets located in Spain is 100% of the value of the investment", clarify Alfredo Garcia Prats, member of the AEDAF Expert Group on Taxpayers' Rights and Guarantees; and Leonardo Neri, member of the AEDAF Expert Group on Personal Income Tax.
"It is the strongest BOE there has been in recent years, because what it is saying is that non-residents must pay Wealth Tax (and/or that of large fortunes, therefore) for 100% of the investment as long as at least half of it is in Spain and even if the rest is in other countries. And that appears in a final provision of a law that establishes other taxes," stresses Antonio Fernández, president of Armanext, a company specialising in helping SOCIMIs (real estate investment trusts) and SMEs to list on the stock markets.
Furthermore, the experts from the Spanish Association of Tax Advisers point out that the new regulation in force "may ultimately prove to be discriminatory, as it could result in the case that the taxation of the non-resident shareholder is much higher than that of the resident shareholder who also participates in the same company, simply because of the rule for valuing shares that has been included in this amendment".
Alicia de Carlos, a partner at the Cuatrecasas law firm, recalls that, although it came into force two months ago, "this regulation has gone unnoticed and is obviously very important, given that many property purchase transactions by non-residents are instrumented through a company".
In addition, the Cuatrecasas partner recalls that "there is a lot of concern given that the tax change was approved at the end of the year and has an impact on both the Wealth tax return and the Large Fortune Tax for the 2022 tax year". And, above all, because "the approved rule was possibly intended for situations of abuse of rights (instead of acquiring an asset for personal use directly, I do it through a company to avoid taxation), but the wording, as it does not contemplate any exception, has a very generalised application and affects multiple situations".
The law firm Pérez-Llorca also criticises the scope of the change, and warns in an opinion article published in FundsPeople that "with the current rule in force, non-resident individuals who have invested in investment funds or any other type of vehicle over which they have no control and who, voluntarily or even unexpectedly, have invested the majority of their value in real estate assets in our country, could be taxed under Patrimonio (and/or the tax on large fortunes). In the same way, non-residents who invest through family offices in listed vehicles or entities, but who would not be subject to the tax if they invested directly, could also be taxed. In our opinion, it is disproportionate for the rule to equate the case of a foreign investor, who only expects profitability and not to encounter bureaucratic and tax problems, to the case of another person who, enjoying the underlying real estate, actually 'interposes' a legal entity and 'evades' taxes".
A hindrance to new real estate investments
Experts say the change could have a direct impact on future real estate investments in Spain.
AEDAF, the Spanish Association of Tax Advisers recognises that "the regulatory modification is rethinking foreign investments in Spain", and states that its offices have already dealt with "various queries arising from the concern generated by the approval of the aforementioned regulation and the International Taxation departments are advising them to adapt the particular asset situation of each one of them to the various legal-tax consequences that may arise from the variety of international and regional regulations applicable".
Meanwhile, the partner of the Tax & Legal area of the consultancy firm PwC maintains that "more than the alarm that non-residents may disinvest what they have, what worries us is that the tax change is a disincentive to invest here. It is a disincentive for foreign investors. In a 'due diligence', for example, we now have to warn that the ultimate investor has to pay Patrimonio, because it directly affects the individual investor. And this undoubtedly discourages investment, not only because of the tax itself, but also because it is removed quickly, overnight, and on the back.
Along the same lines, Gregorio Izquierdo, director general of the Institute of Economic Studies (IEE), warns that the tax change could trigger a "distorting effect and a contraction of investment flows. What the legislator does not realise is that international investment is more sensitive to tax changes than national investment, because it has no attachment or link to the country, which leads to a loss of relative interest in Spanish real estate. Foreign investment is being penalised and this may mean that it will look for alternatives in other markets. According to the director of the CEOE (Confederación Española de Organizaciones Empresariales) think tank, the greatest impact will be felt by the luxury real estate market.
What the president of Armanext has no doubt about is that there will be a delay in new real estate investments due to this change, added to "interest rate rises, an election ahead and a war scenario that does not see an end in the short term". A scenario that will cause "many investment decisions to be postponed or to look for other alternatives", emphasises Antonio Fernández.
On the other hand, the experts point out that the alarm generated by the recent modification of Patrimonio will not only have an impact on new investments, but will also have negative effects in terms of tax collection and lead to less being collected than expected by the Treasury.
And they also criticise the inconsistency that Spain, on the one hand, has encouraged foreign investment in recent years through the so-called 'Golden Visa', which allows visas to be granted to foreigners who buy homes worth at least 500,000 euros and which amount to almost 5,000 units since 2013: and that, on the other hand, the current Government is toughening taxation. "International investment is treated with different criteria," they stress.
Exceptions and doubts of interpretation
What the experts also point out is that not all non-residents who meet the general criteria will become taxable persons for Patrimonio. There are exceptions, for example, if the country in which the foreigner resides has signed a double taxation agreement with Spain, if the company in which they have their property or investments is listed or where the property is located.
Double taxation agreements
"In order to determine whether the entity has a primarily real estate substrate, the market value of all assets held by the entity at the date of accrual of wealth tax and, for real estate, the value of the real estate for wealth tax purposes should be taken into account. However, it should be borne in mind that the taxation of non-resident taxpayers in the IP is subject to the provisions of Double Taxation Conventions (DTC). It will therefore be necessary to analyse, on a case-by-case basis, how the application affects", the AEDAF explains.
For example, there are agreements that do not apply to Wealth Tax, such as those signed with the USA, Italy, Portugal and Mexico, while there are others that expressly allow Spain to tax the assets of shares in companies whose main substrate is real estate, such as those in force with Germany, France, Luxembourg, Panama, the United Kingdom, Belgium, Israel and South Africa. Non-residents of any of these countries would, in principle, be affected by the new tax rules. And it is worth remembering that these are some of the nationalities that are investing the most in Spain.
On the other hand, taxpayers from countries such as Canada, Argentina, Austria, Switzerland, Sweden, the Netherlands and Bulgaria, whose "conventions only allow Spain to tax the direct ownership of real estate" and, therefore, "the application of this rule would be prevented as a consequence of the provisions of the Convention", would not be subject to the new rules.
Listed companies
In addition to the country of origin, another of the exceptions contemplated by the regulation is that the company through which the non-resident holds the property, either as an investment or for its use and enjoyment, must be listed on a market, as the provision literally states, it applies to "securities representing the participation in the equity of any type of entity, not traded on organised markets".
Armanext, a company specialised in accompanying companies in the process of going public, explains that this term includes official or regulated markets (such as the continuous market) and Multilateral Trading Systems (BME Growth, Euronext, Portfolio Stock Exchange...). For this reason, they believe that the tax change could encourage the creation of new listed investment vehicles to avoid paying the tax, especially for assets of at least 18-20 million euros. "In our experience, that is when it pays to go public," says Antonio Fernández.
The problem is that listing on a market has a cost, as you have to pay a registered adviser (such as Armanext) and audit the accounts every year, among other things. "We have to see if the tax savings are worth it or not," says the PwC partner.
Application by the Autonomous Regions
The last case that would allow non-residents to avoid paying Wealth Tax is that, as it is a tax ceded to the Autonomous Communities, it would not be applied in those situations in which the majority of the properties are located in regions that establish allowances, such as the Community of Madrid or Andalusia.
In this respect, the Spanish Association of Tax Advisers adds that "although the Law on the transfer of taxes only transfers to the Autonomous Communities the Wealth Tax corresponding to individuals resident in that Autonomous Community, the Wealth Tax Law allows non-resident taxpayers to apply their own regulations approved by the Autonomous Community where the highest value of the assets and rights they own is located. This rule should make it possible to regulate the real estate assets of non-residents in Spain, although it may generate situations of conflict of competence between different Autonomous Communities, which the approved rule does not clarify".
However, there are doubts as to whether this exemption should apply to where the majority of the real estate is located or where the Spanish headquarters of the company is located. "We believe it is where the company is located. And many of them are based in Madrid, a region where wealth tax is subsidised, as is the case in Andalusia," says the PwC partner.
Cuatrecasas adds to the dilemma and states that "the rule subject to taxation is the shares in an entity whose main assets are, directly or indirectly, real estate located in Spain, but none of the rules that establish the possibility of being able to apply the autonomous region's rules have been modified. In this respect, the fourth additional provision of the Wealth Tax Law recognises the right to apply the rules of the Community where the assets for which the tax is levied have the greatest value. However, in the cases under analysis, the question arises as to whether the criterion for determining the applicable regional legislation will be based on the location of the entity owning the properties or on the location of the properties".
Partner Alicia de Carlos also warns that the modification has an impact on the tax on large fortunes and that, therefore, there will be cases in which there will be no tax shelter. The change "is relevant for the purposes of the tax on large fortunes, given that in the latter there is a referral to the rules of PatrImonio. This means that for the purposes of the IGF this rule will also be applicable and, therefore, holdings in non-resident entities that meet the aforementioned requirement may also be taxed under this tax. It should be remembered that the IGF regulations are exclusively state regulations and that the Autonomous Regions do not have regulatory powers in this respect".
The Pérez-Llorca law firm is also unclear about the situation and acknowledges that "in the absence of express administrative criteria, it seems logical to think that, if the property is located in a Spanish company, the regulations of the Autonomous Community where its registered office is located will apply (as it is there that its rights can be exercised). However, if the property is located in a non-resident company, it could be understood that the law where the majority of the underlying property is located applies. Notwithstanding the above, the rule certainly does not clarify this point and we will have to wait for the interpretation of case law and doctrine on this matter".
Under the Treasury's scrutiny
Finally, experts have doubts about how the Treasury will be able to apply this tax and how it will be able to carry out the necessary checks, especially considering that the larger the assets and portfolio of a company, the more sophisticated its modus operandi.
"It is difficult. There are companies that have anchor funds, for example, but in some situations it is going to be much more complicated," says the PwC partner.
Despite this, Cuatrecasas insists that "the general guidelines of the Annual Tax and Customs Control Plan for 2023 have recently been published in the Official State Gazette, and there is a reference to the verification of non-resident companies that own real estate, especially after the modification of Patrimonio". Therefore, he states, "it is very likely that there will be a campaign to check the taxation of this type of holdings for the purposes of Patrimonio in the 2022 financial year".
This is also recalled by José María Mollinedo, secretary general of the Tax Technicians' Union (Gestha), who argues that "precisely the general guidelines of the Annual Tax Control Plan for 2023 cites the use of information on the real owners of opaque companies resident in Spain that are owners of high-end residential real estate assets, as well as information on the indirect ownership of real estate by non-residents".
According to Mollinedo, "the investigation will not be simple in the event that this taxation is concealed, but not impossible, as it will be possible to cross-reference the information on the properties in our country with the highest cadastral value and which are not owned by a resident natural or legal person, and then investigate each non-resident natural person who may be behind each of these large properties, and once their real ownership has been determined, it will be verified whether they meet the two aforementioned requirements for the taxation of these values in the Wealth Tax".
He adds that "the verification of large fortunes and business conglomerates is not the core of the activities carried out by 80% of the AEAT staff, but there are a number of people assigned to the verification of discrepancies in this type of relevant wealth". Mollinedo recalls that "a research project on opaque companies allows the automated identification of the users of high-value homes (over one million euros) located in Spain whose formal ownership corresponds to foreign companies whose real owners are unknown", and insists that "the OECD's Global Forum on Transparency and Exchange of Information for Tax Purposes continues to make progress in improving transparency and the exchange of information".
With regard to any doubts that may arise about the regulations, the secretary general of Gestha reminds us that "there is always the possibility of consulting the Directorate General for Taxes to clarify any doubts about a taxation before the end of the deadlines established for the exercise of the right, for the filing of the tax return or self-assessment".