HR managers filling placements in Spain can include in the package the good news, at least for the time being, that loopholes exist for reducing personal income tax. Elisa Martín del Yerro and Gonzalo Alvarez-Yuste report from Deloitte's offices in Madrid.

Until 31 December 2003, expats in Spain were subject to Spanish taxation on a general basis, depending on their status as tax- or non-tax residents in Spain.

However, as of 1 January 2004, the 'Spanish personal income tax act' introduced new regulations with regards to Spanish tax residence that might be of great interest to those employees who are posted to work in Spain for certain periods of time.

Introduced essentially to attract executives — who often earn high salaries — to work in Spain this new regulation has something to do with football, as the editor of Expatica Spain reported, "It is no accident that this law will help the highly-influential and affluent bosses of most of Spain's biggest football clubs, who are close to Aznar and his party [Prime minister Jose Maria Aznar's conservative government altered the tax law to make it more attractive for foreigners live here and to help companies that employ many workers from abroad to recruit successfully.]."

According to the new regulations, those persons considered to be tax residents in Spain as a result of their assignment to Spain, and therefore subject to Spanish personal income tax, may choose to be taxed in Spain as non-tax residents during the year of the assignment and the following five fiscal years, provided the following requirements are met:

The taxpayers have not been tax residents in

• Spain in the previous ten years before their assignment to Spain.
• The assignment to Spain arises from an employment contract.
• The work is performed in Spain.
• The work is performed for a Spanish tax resident company or for a permanent establishment of a foreign tax resident company in Spain.
• The salary derived from that labour relationship should not be tax-exempt in Spain pursuant to the Spanish non-resident income tax law. [If the taxpayer chooses this option, it will also apply for wealth tax purposes.]

The system is designed for executives who expect to be in Spain for a medium term, hence the potential six-year duration of the regime.

Should the employee wish to have this tax regime applied, they must apply beforehand — following a procedure still awaiting further regulations — to the Spanish tax authorities, stating that they would like to be taxed according to the Spanish non-resident income tax act. However, given that the Spanish tax authorities have yet to approve the form in which the employee must opt for this tax regime, at this stage it is not possible to apply it.

For example, an employee transferred to Spain at the end of the current year will not, in principle, be a Spanish tax resident until 2005. Therefore, the application of the new regulation would apply for 2005 and the next five years.

The application of this new regulation will reduce Spanish taxation for employees assigned to Spain. They would be taxed at a flat tax rate of 25 percent (Spanish non-resident tax rate) on their gross salary income instead of on the progressive tax scale ranging between 15 to 45 percent applicable to Spanish tax residents (individuals).

This matter is not sufficiently straightforward to conclude, in advance, the criteria determining whether it would be more tax advantageous to be subject to the 'Spanish personal income tax' or the 'Non-resident income tax', since several aspects must be taken into account, such as the nature and amount of income, family situation, spouse's earnings, taxpayer's wealth or if he/she expects to acquire a private residence in Spain.

In any case, we could consider an average threshold of EUR 50,000 to carry out a further analysis for determining the application of this new regulation.

The most important effects of applying this tax regime can be summarized as follows:

1. The Spanish non-resident income tax will be applicable on the individual's gross salary income, which relates to Spanish duties. Additionally, any other Spanish-source income will be subject to Spanish taxation.
2. Gross salary income will be taxed at a 25 percent flat tax rate. Therefore, the reductions/deductions foreseen on the 'Spanish personal income tax act' will not be applicable.
3. As a general rule, capital gains obtained in Spain will be taxed at a 35 percent tax rate regardless of the length of time the asset has formed part of the taxpayer's wealth. On the contrary, if the taxpayer is considered a Spanish tax resident, his/her capital gains will be taxable in Spain regardless of the country in which they were obtained. In this case, a 15 percent tax rate may be applicable if the asset had formed part of the taxpayer's wealth for at least one year.
4. No tax credits may be claimed to reduce the individual's net tax payable.
5. For Spanish wealth tax purposes, the individual will be taxed as a non-resident in Spain. Therefore, the individual will be liable to Spanish wealth tax, albeit only on the assets or rights located in Spain. The personal allowances foreseen for Spanish tax residents will not be applicable.

Finally, it is necessary to stress that, although the amendment is effective as of 1 January 2004, it has yet to be implemented in the Spanish personal income tax regulations. Therefore, there are still some technical and practical issues that need to be clarified. Furthermore, the Spanish tax authorities must approve the form in which the employee must opt for this tax regime.

The recent changes in the Spanish government can delay or alter these regulations, and at this stage the final scope of this regime has yet to be made known.

May 2004

Elisa Martín del Yerro is an IAS Senior Manager, and Gonzalo Alvarez-Yuste is an IAS Consultant in the Madrid office of Deloitte & Touche. They can be reached by telephone at: +34.91.582.0900 or by email at:
emartindelyerro@deloitte.es
galvarezyuste@deloitte.es