On 10 January 2022, the Spanish Supreme Court issued a judgment with regard to the application of the Inheritance and Gift Tax benefits provided for family businesses in cases where financial investments are among the assets owned by the company. The discussion was to determine if financial assets could be considered as assets related to the economic activity of the family business.

Family business tax benefits

The Spanish Inheritance and Gift Tax provides for a reduction in the taxable base covering 95%7 of the family business's value if certain requirements are met. Among such requirements, the company must have been exempt for the purposes of Spanish Wealth Tax. Therefore, the tax benefit for Inheritance and Gift Tax purposes requires prior exemption under Wealth Tax provisions, which is established by reference to Spanish Personal Income Tax. The Spanish Personal Income Tax Act specifically refers to assets held for the purposes of a business activity in order to be considered exempt in the Wealth Tax. Therefore, to apply the exemption in the Wealth Tax and the reduction in the Inheritance and Gift Tax, the taxpayers have to prove the need for cash or financial assets for the purposes of the business activity and, in that regard, they need to prove whether such assets were held for the purpose of the activity carried out.

Precedents of the case

In that case, the tax audit considered that the 95% reduction in the Inheritance and Gift Tax Law was not applicable to the value of the family business referred to financial investments due to the fact that, in the opinion of the tax auditor, financial assets cannot be considered as held for the purpose of the activity of the family business. The Economic-Administrative Court and the High Court of Aragon (the family business was located in the Autonomous Region of Aragon) ruled in favor of the taxpayer on the ground that the conclusion reached by the tax authorities regarding the lack of involvement with the economic activity of the financial assets had not been sufficiently verified by the tax auditor, and due to the fact that, in this case, there were indications that the financial investments responded to the needs derived from the company's activity.

Judgment of the Supreme Court

The main conclusions of the Supreme Court can be summarized as follows:

• The fact that part of the family business's value is made up of cash or financial assets should not be an obstacle, per se, for the application of the Inheritance and Gift Tax reduction, provided that the requirement of the involvement of these assets to the company's business activity is accredited.

• The following indicators could contribute to prove that assets were held for the purposes of the business activity, and therefore these indicators could be considered relevant: the economic context and sector in which the entity carries out its activity; the average payment terms for both clients and suppliers; working capital ratios, business investment plans and any other circumstance, depending on each particular case, which could impact the need for the business to hold cash or cash equivalents.

The Supreme Court states that it is absolutely reasonable that the cash generated by the company's activity could be invested in financial assets within the scope of a reasonable financial management. In that regard, the burden of proof of the involvement of these assets to the economic activity of the family business could not be attributed to the taxpayer, because the tax authorities are the ones that required proof that there is no such involvement and that it is not total in case the cash equivalents or financial assets are higher than the needs of working capital or unnecessary for the development of the activity.

In conclusion, the Supreme Court reiterates the necessary final interpretation of the family business tax benefits intended precisely for its protection and continuity, and admits the effectiveness and involvement of financial assets in the company's activity. In particular, the Supreme Court affirms that "the necessity of capitalization, solvency, liquidity or access to credit, among others, are not opposed by themselves to this idea of involvement" of this type of assets to the economic activity of the family business.

This judgment will help the defense of the interests of taxpayers affected by numerous adjustments carried out by the Spanish tax authorities that restrict the scope of the tax benefits provided for the family business.