The tax treaty Protocol signed between Spain and the United States

convenio de doble imposicionFinally, almost six years after its negotiation, the tax treaty for the avoidance of double taxation between the United States (U.S.) and Spain (tax treaty) will be modified.

 

The protocol amending the tax treaty (the protocol) was signed by both States at the end of 2013 and has finally been ratified by the U.S. Senate on July 28, 2019. Spain concluded its internal ratification process in 2014.

 

 

Once completed by the U.S. its internal approval process, the protocol will enter into force on November 27.

 

The protocol implies, in many aspects, a clear improvement over the current tax treaty.

 

Main relevant provisions: 

The amendments of the protocol include long-time requested changes to the existing Spain-U.S. income tax treaty.

 

Key provisions of the protocol include:

  • Reduction of dividend, interest and royalty withholding taxes and capital gain taxation.

 

  • Dividends: dividends are exempt from withholding tax in the source country in the case of substantial shareholdings (if the parent company owns shares representing 80 percent or more of the voting stock in the company paying the dividends for a 12-month period ending on the date on which the dividends are due).

 

If these conditions are not met, the withholding tax rate is reduced from 10% to 5% to the extent that are dividends paid to a company that owns at least 10 percent of the paying company are subject to a 5 percent withholding tax.

 

All other dividends continue to be subject to a 15 percent withholding tax.

 

  • Interests: there is a new general exemption from source country withholding tax on cross-border interests. This measure is extremely important, as it facilitates equal conditions between financing with the U.S. and financing with EU companies. It should be noted that, under the existing treaty, interest payments are currently subject to a 10% withholding tax (except in certain and limited situations).

 

  • Royalties: the new protocol exempts all royalties from source country withholding tax with the result that such income would be subject to tax only in the country of residence of the recipient of the royalties with certain limits. Under the existing treaty, royalty payments are subject to source country tax of 5, 8, or 10 percent, depending on the nature of the royalty. This provision gave rise to endless discussions about the nature of the taxable income.

 

  • Capital gains: the protocol eliminates the taxation on capital gains, by removing a provision from the capital gains article (article 13) of the existing treaty that permits one country to tax a resident of the other country on gains from the sale or exchange of stock or other rights in a company or other entity that is resident in the first country, if the recipient of the gain had a 25 percent or greater participation right in the company or other entity. This provision of the treaty enabled Spain to impose tax on gains from the sale of stock in a Spanish entity by a nonresident investor. (The U.S. generally does not impose tax on Spanish resident investors selling stock in U.S. companies unless the company is a U.S. real property holding company or the investor is otherwise engaged in a U.S. trade or business).

 

In addition, Spain could also tax capital gains on the transfer of land rich entities. The revised wording of Article 13 maintains the capital gains tax on the transfer of land rich entities but eliminates it in all other cases.

 

  • Branch tax: the treaty currently in force imposes a 10% additional branch tax on the remittance of profits by branches to their head offices. The protocol eliminates the branch tax but retains the provision authorizing the branch profits tax, but it specifically subjects such tax to the rate imposed on dividends.

 

  • The protocol adds specific rules concerning Spanish REITs (Sociedades Anónimas Cotizadas de Inversión Inmobiliaria -SOCIMIs-) and US Real Estate Investment Trusts (REITs). In addition, dividends distributed to pension funds may benefit from certain exceptions.

 

  • As regards pension funds, the protocol includes a provision to the pensions article of the tax treaty setting forth that income earned by a pension fund is taxable to the individuals participating in that fund only when, and to the extent that, it is actually paid to or for the benefit of such individuals. As discussed above in relation to dividends, the protocol includes detailed definitions of which plans in each country meet the definition of a pension plan for purposes of the treaty.

 

  • Transparent entities: the protocol substitutes the rules currently applicable, under the new provision, an item of income derived through an entity that is fiscally transparent under the laws of either the US or Spain, and that is formed or organized (a) in either the US or Spain or (b) in a State with a tax information exchange agreement in force with the Contracting State from which the income is derived, will be considered to be derived by a resident of the U.S. or Spain (as the case may be) to the extent that the item is treated for purposes of the taxation law of the U.S. or Spain (as the case may be) as the income of a resident. This is a relevant provision given the number of transparent entities, or that may elect to be treated as fiscally transparent, existing in the U.S.

 

It is clarified the requirements to be met in order to benefit from the benefits of treaty. Furthermore, the protocol has also updated the exchange of information provisions to conform to the 2006 US Model Treaty and to the standards developed by the Organisation for Economic Co-operation and Development (OECD).

 

  • The general definition of permanent establishment currently in force is maintained but the protocol extends the minimum threshold for a building site or construction or installation project to constitute a permanent establishment from six to twelve months.

 

  • The protocol provides for mandatory and binding arbitration in order to resolved double taxation issues between both countries. This measure ensures that double taxation cases are effectively addressed.

 

  • The protocol introduces an updated, comprehensive and complex limitation on benefits (LOB) article with some significant changes, and an updated exchange of information article. These changes include a new discretionary grant of benefits provision within the LOB article that departs from the standard that has been applied in previous treaties. The standard commonly applied is that the competent authority of the source country may provide a discretionary grant of treaty benefits if the taxpayer demonstrates that the establishment, acquisition, or maintenance of the taxpayer and the conduct of its operations did not have as one of its principal purposes the obtaining of treaty benefits.

 

However, the protocol imposes a significantly more restrictive standard that requires an evaluation of the extent to which the resident satisfies the requirements of the qualified person tests (which include the publicly traded company, subsidiary of a publicly traded company, and ownership-base erosion tests), the derivative benefits test, the active trade or business test, and the headquarters company test.

 

Entry into force

 

  • For dividends, interests, royalties’ withholdings and capital gains taxes, the protocol generally will apply to amounts paid or credited on or after November 27, 2019.

 

  • For taxes determined by reference to a tax period, the protocol will apply for tax years beginning on or after November 27, 2019 (e.g., January 1, 2020, for calendar-year taxpayers).

 

  • In all other cases, the protocol will apply on or after November 27, 2019.

 

Conclusion

The amendments of the protocol include long-time requested changes to the existing Spain-U.S. income tax treaty.

 

The entry into force of the protocol is a welcome development. The new lower withholding taxes, improvement of the tax treatment of certain entities and income, as well as the improvement of other measures under the protocol will take effect on or after November 27, 2019. This development is essential for U.S. resident entities with investments and/or operations in Spain and vice versa.

 

Under these new provisions and in the current context of competition for attracting foreign investments, an increase in U.S. investment in Spain can be expected as the comparative disadvantage with respect to other European countries that have a more favourable tax treaty disappears.

 

Moreover, it could be expected an increase of investments by Spanish small and medium-sized enterprises (SMEs) in the U.S. The stringent rules of the tax treaty applicable before the protocol, prompted the need for multinationals enterprises (MNEs) to channel their investments in the U.S. through entities resident in other European countries with a more favourable tax treaty. In the case of SMEs, this kind of investment was excessively costly. The new provisions under the protocol would likely allow Spanish SMEs to increase their presence in the U.S.

 

All in all, the tax treatment of the income derived by both countries upon the entry into force of the protocol will favour the economic relationships between the U.S. and Spain