The Protocol and its Memorandum of Understanding, signed in Madrid on 14 January 2013, amending the Convention between The United States of America and The Kingdom of Spain for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, and its Protocol, made at Madrid on 22 February 1990, was finally published in the Official State Gazette on 23 October 2019. Although it is not a new tax treaty but the amendment of the one existing since 1990, the changes included in it are very important, so we will refer to it hereinafter as the “new tax treaty”.
In general, the new tax treaty substantially reduces the taxation in the source State, placing the taxation in Spain of dividends, interest, royalties and capital gains obtained by US residents on a par with those which would, in many cases, be borne by residents of the European Union (EU).
The new tax treaty will take effect on 27 November 2019 with the following particularities:
- That date is the relevant one for purposes of taxes withheld at source; thus, for example, the dividends, interest and royalties which are claimable as of 27 November 2019 will benefit from the new, lower withholding rates. The new tax treaty will also apply to capital gains generated as of that date, even if taxes are not withheld in this case.
- In relation to the taxes calculated by reference to a fiscal year, the new tax treaty will apply to fiscal years commencing on or after 27 November 2019. That could be the case, for example, of the taxation of permanent establishments.
- Regarding mutual agreement procedures, the new arbitration clause will not apply to procedures requested prior to 27 November 2019. It will be necessary for the contracting States to agree previously in writing on the periods and procedures for carrying out this conflict resolution through arbitration.
There follows a brief summary of the main changes.
1. Dividends and supplementary taxation of branches
The withholding rates applicable to dividends will be the following:
- 0%, if received by a pension fund or by a company that has owned at least 80% of the capital stock of the entity that distributes them for a period of 12 months prior to the date on which the right to receive the dividends arises, and that is not adversely affected by the new limitation on benefits (“LOB”) clause.
- 5%, if received by a company that holds at least 10% of the capital stock of the entity that distributes them.
- 15% in the rest of cases.
In any case, in order to be able to apply those withholding rates, the recipient of the dividends must be their beneficial owner.
The new tax treaty maintains the supplementary taxation of branches (branch tax) in certain cases only, including the case of income from real property (in specific cases), limiting that additional taxation to 5% (down from the previous 10% rate).
2. Interest and royalties
Interest and royalties will not, in general, bear withholdings at source, except in very particular cases in which the interest derived from the United States could be subject to a 10% withholding in that country.
Just as in the case of dividends, the recipient of the interest and royalties must be their beneficial owner in order to be able to apply the exemption or, as the case may be, the reduced withholding rate.
3. Capital gains
As a general rule, capital gains on the transfer of holdings in companies may be taxed exclusively in the country of residence.
Only in the case of alienation of stock or participations which confer on the owner the right to enjoy real property situated in the other State, can that State tax the capital gains arising on that alienation. Neither the new tax treaty nor the Memorandum of understanding refers to whether the real property must constitute the main assets of the entity whose shares are alienated.
4. Permanent establishment
The only relevant change is the extension, from six to twelve months, of the minimum period necessary for a building site or construction or installation project to constitute a permanent establishment.
Other than that, the definition of permanent establishment has not changed. In this regard, it should be borne in mind that the United States has not signed the Multi-Lateral Instrument (MLI) whereas Spain has acceded to the amendments introduced by the MLI which amplify the traditional definition of permanent establishment in the OECD Model Tax Convention (the Spanish authorities have already been interpreting the concept of permanent establishment broadly and the Spanish courts have accepted that administrative interpretation in a number of judgments).
Thus, at least in theory, the existence or not of permanent establishments of US and Spanish companies in Spain and in the US, respectively, should continue to be resolved according to the definition of permanent establishment contained in the original wording of the tax treaty of 1990.
5. Listed Corporations for Investment in the Real Estate Market (SOCIMI)
The new tax treaty establishes in its Protocol a special treatment for dividends which a US resident receives from a Spanish SOCIMI:
- If the holding in the SOCIMI does not exceed 10%, the withholding will be 15% (0% if the recipient is a pension fund).
- If the holding in the SOCIMI exceeds 10%, the general withholding rate established in Spanish law (currently, 19%) will apply.
In this way, it is considered that a substantial holding (over 10%) in a real estate investment vehicle not subject to taxation should grant the source State the power to levy higher taxation when the profits are distributed to the shareholders.
6. Limitation on Benefits
Following the tradition of the tax treaties signed by the US, the new LOB is much more detailed than before and, thus, entails greater complexity in its wording and interpretation.
Despite this complexity, the absence of a Principal Purpose Test – PPT – clause in the new tax treaty and the existence of this detailed LOB clause should minimize the use of the general anti-abuse provisions of the General Taxation Law for challenging the application of the benefits of the new tax treaty.
7. Mutual agreement procedure and arbitration
An arbitration clause is included for the case where the tax authorities of Spain and the US do not reach an agreement within the period of two years to resolve on a mutual agreement procedure requested by a taxpayer. This procedure and its resolution through arbitration are not aimed exclusively at preventing cases of double taxation but at resolving situations in which the taxpayer considers that there has been taxation that does not comply with the provisions of the new tax treaty.
As stated previously, this new regulation of the mutual agreement procedure will apply to cases submitted to the States after 27 November 2019.
8. Exchange of information and administrative assistance
The exchange of information provision has been the reason for the blocking of the new tax treaty in the US senate since its signature in January 2013, almost seven years ago, mainly due to the concerns of senator Rand Paul regarding confidentiality in the exchange of data relating to US citizens.
It may be noted, however, that the new clause fully respects the domestic legislation, administrative practices of the Contracting States, and business, industrial, commercial or professional secrecy pursuant to the national legislation of each State.
9. Memorandum of Understanding
The new tax treaty is supplemented by a Memorandum of Understanding which covers, among other issues, its application to the payments made to fiscally transparent entities, a declaration of intent for the conclusion of an agreement to prevent double taxation of investments between Puerto Rico and Spain, and the scope of the term “pension funds” and rules for determining their residence.