Mallorca Property Investment – Mallorca is a good investment?
This article provides an overview of the Spanish taxation applicable to the ownership of Spanish real estate by Non-Resident investors and to the sale of real estate. A comparison is made between tax consequences of holding the property directly or by a company.
In this article it is not analyzed situations where there is an income derive from the renting of the real estate.
1. – TAXATION ON OWNERSHIP AND CAPITAL GAINS ON THE PROPERTY HELD DIRECTLY BY FOREIGN INVESTORS:
1.A. -Taxation on Ownership:
Property owners in Spain, both individuals and companies, are subject to a Property Tax. This tax is levied annually by local authorities on the ownership of urban and rural property. The tax base is the value of the property as recorded in the Municipal records, the so-called cadastral value, which is composed of the value of the land and the buildings. It should be observed that the cadastral value is normally far below market value even if recently revised.
The rate of tax amounts to 0.4% for urban zones and 0.3% for rural areas. Local Councils may increase the applicable tax rates up to a ceiling determined by law, depending on local circumstances such as population density.
In addition to the local Property Tax, other Taxes on ownership are levied, the nature of which varies depending on whether the owner is an individual or an entity.
a). -Individual Ownership:
If the owner is an individual, both Wealth tax and Non-Resident income tax will be levied on the mere ownership of real estate property:
• Wealth Tax:
Wealth Tax is levied on the value of assets situated in Spain unless exempted by a tax treaty. The tax rate is progressive and varies from 0.2% on the first Euros 167.129’45 up to 2.5%. Property assets must be valued at the greater of their acquisition value, their cadastral value or the value estimated by the Tax Administration in other taxes.
• Non-Resident Income Tax:
When the property is for the private benefit of the individual owner, the Tax Administration establishes a taxable deemed income. Deemed Income does not apply to dwelling house, rural real estate not built land, real estate under construction, and real estate that cannot be used because of urbanization planning. As a general rule the tax amounts to 25% of 2% of the cadastral value of the real estate. If the cadastral value applicable has been revised by the administration, the 25% tax will be applied over 1.1% of this new cadastral value.
b). – Companies Ownership:
If the owner of the property is a non-resident entity, it may be liable to a Special Property Tax for non-resident entities. Non resident entities that own or possess real estate in Spain, or otherwise enjoy or benefit from Spanish real estate, are liable to an annual tax of 3% on the cadastral value of such property. This special tax shall not apply to:
• States, public institutions and international organizations;
• Entities resident in countries having concluded a tax treaty with Spain which contains an information exchange clause, whenever the ultimate owners of the share capital are individuals resident in Spain or in a country that has a tax treaty with Spain containing also an information exchange clause;
• This exemption is available upon submission of the certificate of residency of the entity and the ultimate owners issued by the competent tax authorities;
• Entities carrying out business activities on a regular basis other than the lease of real estate;
• Entities quoted on officially recognized stock exchanges;
• Non profit entities of countries with a tax treaty with Spain containing an information exchange clause whenever the real estate is used for the activities carried out by these entities.
The Special Property Tax for non-resident entities is rather controversial and many scholars are of the opinion that its applicability is doubtful in cases where the relevant tax treaty contains a non-discrimination clause.
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1.B. Taxation on Capital Gains:
The capital gain in principle consists of the difference between the acquisition value and the sales value.
The acquisition value is composed of the purchase price paid to which costs of improvements and expenses and taxes paid by the buyer upon acquisition are added, less the minimum depreciation allowed. This acquisition value will be updated in order to eliminate inflation. The sales value is composed of the actual sales price minus expenses and taxes paid by the seller.
Capital gains realized upon the sale are taxable at the general rate of 18%.
If the foreign investor is an individual, it is important to mention that there exist transitional rules for capital gains derived from the sale of real estate that has been held at 31/12/96 for more than two years in order to benefit the investors of the gradual reduction applicable. As a consequence no tax on capital gains will be due if at 31/12/96 the investor has held the real estate for more than 10 years.
However, if the foreign investor is a company, the transitional rules are not applied.
In order to secure the payment of tax on capital gains obtained by non residents not having a permanent establishment in Spain, the buyer is obliged to withhold 5% of the purchase price and remit it to the Spanish Tax Authorities unless:
• The property was transferred by an individual that at 31 Dec 1996 has held the property ten years.
• The seller proves that is subject to the Spanish Corporate or Personal Income Tax.
• When transfer was caused by a contribution in kind, increase in capital or incorporation of a Spanish Company.
If the buyer fails to retain the withholding tax, the tax claim remains on the real estate. The withholding tax is a pre payment on the actual tax payable by the seller upon filing his capital tax return. A refund is made to the seller in case the actual tax liability proves to be lower than the withholding tax.
1.C. – Indirect Taxation on Property Transfer:
A transfer of Spanish real property is liable to either Value Added Tax (VAT) or Transfer Tax. Also a local tax is levied on the increase in value of urban land.
a). – VAT:
The transfer of real estate is, in principle, subject to VAT at the rate of 7% for first transferring of new dwellings houses and 16% for other properties, in the case the transferor is an entrepreneur or a legal entity. Certain transfers are, however, exempt from VAT and thus subject to Transfer Tax. A main exemption is the second and every subsequent transfer of buildings, including the land on which they are built after construction or restoration. This exemption may be waived by the transferor if the buyer is an entrepreneur for VAT purposes and can offset the VAT paid. The buyer supports the VAT.
Property transfers subject to VAT also carry an additional stamp duty of 0.5% payable upon registration of the public deed of transfer in the Public Property Register.
b). – Transfer Tax:
All real property transfers not subject to VAT are subject to Transfer Tax this is the case of sales realised by private individuals. The general rate is 6% of the actual value of the real property. The different Spanish regions can modified it, i.e. in Madrid the tax rate is of 7%. This tax is payable by the transferee and cannot be recovered.
It is important to emphasize that the Tax Administration may verify that the recorded purchase price corresponds to the actual value of the property. In case the actual value exceeds the declared value by over 20% and such excess exceeds Ptas. 2 million, the transferee will become liable to Gift Tax on the excess value, and the transferor will be liable to tax on a deemed capital gain.
c). – Municipal Tax on a Deemed Increase of Value of Land:
Finally, a transfer of urban land gives rise to a Municipal Tax on a Deemed Increase of Value of Land. The deemed increase depends on the cadastral value of the land at the time of the disposal, the number of years that the property has been held and the size of the municipality in which the land is located. This tax is as a general rule of relatively minor importance. The taxpayer is the seller.
2. TAXATION ON OWNERSHIP AND CAPITAL GAINS ON THE PROPERTY HELD BY FOREIGN INVESTORS PROPERTY THROUGH A SPANISH COMPANY:
2.A. -Taxation on Ownership:
When the real property is owned by a Spanish company, the company will be liable only to Property Tax in the same way as outlined above for foreign owners.
2.B. – Taxation on Capital Gains:
Generally, spanish companies are liable to Corporate Income Tax at a rate of 35% on their profit.
However, if the gains coming from the sale of the real estate, are reinvested there is a 20% tax credit, which means an effective taxation of 15%. The company may choose to reinvest one year before the delivery or three years after this date.
The reinvestment must remain in the possession of the company for 5 years or the time of the depreciation of the asset.
Depreciation on real estate is limited to buildings as land is considered not to decrease in value. As a general rule, a loss sustained in any tax year can be carried forward against taxable profits in the following fifteen years.
A new tax regime has been introduced in January 1, 2003. In accordance with it if the Spanish company is considered a holding passive investment company (known as “Sociedad Patrimonial”) the capital gain derived from the sale of real estate after a one-year holding period would be taxed at a 15% rate. However, if the real estate is sold within less than one year holding period, the capital gain would be taxed at a 40% rate.
2.C. – Transfer of Shares:
It is common practice to transfer the real estate property indirectly through a transfer of shares of a property holding company. In this respect Spanish legislation prevents the evasion of capital gains from the transfer of real estate by means of the sale of the shares of the company owning it, because it expressly determines that the capital gains derived from the sale of shares of a Spanish or foreign company will be subject to tax in Spain if its main assets consist of real estate located in Spain or if they give the owner the right to use real estate in Spain.
A Non-Resident shareholder of such a company will be liable to tax on capital gains, unless he is resident in a country that has concluded a tax treaty with Spain, which is favorable in this issue. Only few tax treaties provide that capital gains from the sale of shares which main asset is real estate in Spain will be subject to tax exclusively in the country of which the shareholder is a resident (The Netherlands, Germany, U.K., Austria, Hungary, Cuba).
Due to the above, many investments in Spain are made through a Dutch company owning a Spanish company which in terms owns real estate. In this situation, when an indirect property transfer, is realized via disposal of the shares, the capital gain will not be subject to tax in Spain, but only if any in the country of residence of the seller, The Netherlands.
3. – CONCLUSION:
From a fiscal point of view many factors have to be considered when investing in real estate in Spain.
The most tax efficient way of Investment depends on the circumstances of each particular case.
However, it should be pointed out that the incorporation by the foreign individual of a Spanish company could reduce the taxation substantially. In addition, if the shareholder is a company resident in a country which has concluded a Tax Treaty with Spain which does not contain special rules for the alienation of shares or other rights in a company whose assets consist mainly of real estate located in Spain, as in the case of The Netherlands the capital gain will not be taxed in Spain.
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