I recently received a question from the owner of a UK company questioning the imposition of Spanish withholding tax on payments his company received from a Spanish subsidiary.

He thought that the EU Parent-Subsidiary Directive exempted the tax. In fact it would do for dividends but not for royalty payments, which these payments were for and which are covered by a different directive. This is the EC Interest and Royalties Directive (2003/49/EC), which subject to a few conditions outlawed any taxation on royalties (or interest) between EU companies as from 1st January 2004.

However Spain was granted a transitional exemption, which totally exempted it from the Directive until 1st July 2005 and then partially exempted it but still allowing it to levy a 10% withholding tax between “associated” EU companies for a further 6 years; until July 2011.

So the current position is that whilst the full withholding tax rate on Spanish source royalties is 24% payments made by Spanish companies to “associated companies” resident in other EU Member States (apart from Cyprus and Gibraltar) are charged at the lower 10% rate.

For Spanish purposes two companies are “associated” if:

(a) one of them directly holds at least 25% of the shares of the other; or
(b) a third EU company directly holds directly at least 25% of the shares of the two companies.

This means that if Company “X” owns 25% of the shares in Company “Y” no tax is charged, as they are associated.

Alternatively if company “A” holds 10% of company “B” and 15% of company “C” then B & C are associated companies. That means that if “C” makes a royalty payment to “A” tax is payable because “A” is not associated with the others but a payment from “A” to “B” or “B” to “A” attracts no tax.

There is a qualifying condition that the shares must have been held continuously for at least 12 months. So you can’t buy today, receive the royalty tax-free tomorrow, and sell back the day after.

A further condition is that the associated companies all have to have a legal form listed in the Annex of the Directive. However this condition has recently been challenged in the European Court of Justice and may soon be ruled illegal.

Indeed some other conditions are also being challenged, as is the Spanish legislation that imposes the full 24% rate on payments to Cyprus and Gibraltar, both of which are EU member states.

I am currently involved in a case which is challenging the imposition of withholding taxes generally as being against Article 56 of the EU Treaty (Freedom of Capital). This case, and others, could mean the end to withholding taxes generally both inside and outside the EU.

If withholding tax is something you would like to discuss do contact me via my other website www.jamesgreenandco.co.uk

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