The Spanish Government approved a Draft Bill on 1 August 2014 which includes significant amendments to Spanish Income Tax and Corporate Income Tax Laws. It has been submitted to the Spanish Parliament for discussion and approval before 31 December 2014 and is planned to come into force as of 1 January 2015.
This Draft Bill includes significant tax changes to the Spanish Corporate Income Tax Law ("Spanish CIT Law") which will impact leveraged buy-outs and generally the tax position of Spanish borrowers, as discussed below.
We note that this Draft Bill includes several changes with respect to the pre-draft bill that was released by the Spanish Government on 23 June 2014 for a period of public consultation.
"Anti-LBOs" tax provision restricting tax deduction of acquisition debt
Currently, Spanish CIT Law provides that net financial expenses (that is, the excess of financial expenses over interest income), either withrelated or unrelated lenders, shall be tax deductible, up to a limit of 30% of the EBITDA (as defined in this tax provision) of the tax period. Net financial expenses exceeding this 30% EBITDA limit can be carried-forward and deducted in the following 18 years (subject to the same 30% EBITDA limit). If the entity forms part of a Spanish tax group, the limit shall be applicable at the level of the tax group (certain particular rules are applicable for companies joining and leaving the tax group).
The Draft Bill keeps this 30% EBITDA deductibility limit, but includes an additional limitation for LBO transactions restricting the tax deductibility of acquisition debt against the taxable profits of the acquired target entities through tax consolidation or a merger (being an "anti-LBO" tax provision).
In particular, this new provision states that, when calculating the 30% EBITDA limit to deduct the interest accrued by a Spanish BidCo on the debt borrowed to acquire the target entities, the EBITDA of the target entities that have joined the BidCo´s tax group or that have been merged into BidCo should be excluded.
However, compared with the initial drafting of this anti-LBO tax provision in the pre-draft bill of 23 June 2014, the Draft Bill includes some amendments that may soften the impact of the change, namely:
- This additional limitation would only apply during the four years after the LBO acquisition; and
- This additional limitation would not apply when (i) the amount of the purchase price financed with debt does not exceed 70% of the total purchase price, and (ii) in the fiscal years following the acquisition the borrower repays debt principal every year, at least in an amount of 5% of the total debt, until the debt principal is reduced to 30% of the initial purchase price.
The Draft Bill provides that this anti-LBO provision will not apply to acquisitions where the target entities have joined the BidCo's tax group in tax periods commencing before 20 June 2014, or where the target entities have been merged into BidCo before 20 June 2014. Also, this limitation would not apply when the merger takes place after 20 June 2014 but the target entities already belonged to the BidCo's tax group in a tax period commencing before 20 June 2014.
Finally, the Draft Bill also provides that interest accrued on financial instruments with related parties shall not be tax deductible for the Spanish borrower if this interest is characterized as a dividend in the lender's jurisdiction and as a consequence of this tax characterization in the lender's jurisdiction the income is tax exempt or subject to a nominal tax rate below 10%.
New tax deductible "capitalization reserve"
In order to incentive the strengthening of the net equity of Spanish entities by keeping retained earnings undistributed, the Draft Bill also introduces a so-called tax deductible "capitalization reserve".
Basically this "capitalization reserve" enables a tax deduction in the company's annual taxable income amounting to up to 10% of the increase in its net equity during the year (i.e. comparing the net equity at year end (excluding profits of the year), with the net equity at the beginning of the year (excluding profits of the previous year), and without taking into account any shareholder contributions and other specific items). This tax deduction is capped at a 10% of the taxable income of the year.
To utilize this tax relief the amount of the net equity increase would need to be maintained during the following five years after the tax deduction is applied (except in case of accounting losses), and the company should recognize a specific reserve in its statutory accounts for the amount of the tax deduction (this capitalization reserve cannot be distributed during the following 5 years, except in certain situations).
In the case of a tax group, the tax deduction of the capitalization reserve would need to be calculated on a tax group basis, although the accounting reserve can be recognized by any of the tax group's entities.
Other relevant proposed tax changes with impact for Spanish borrowers
There are other changes in the Spanish tax regime contained in the Draft Bill. These include:
- a reduction of CIT rate and withholding tax rate:
- existing standard 30% CIT rate for Spanish entities will be reduced to 28% in 2015 and to 25% in 2016.
- existing standard 21% withholding tax rate on dividends and interest being reduced to 20% in 2015 and to 19% in 2016 (without prejudice of applicable domestic and tax treaty exemptions and reduced rates).
- Changes in participation exemption for domestic/foreign dividends and gains
- Limitations to the use of carry-forward tax losses being softened
- Changes in tax depreciation of intangibles
- Changes to the tax deductibility of asset accounting impairments.