On 7 March 2023, it was once again confirmed by the Spanish National Court (SAN 773/2023) that a United States (US) Regulated Investment Company (“RIC”) qualifies for the reduced Spanish withholding tax rate of 1% applicable to Spanish and EU/EEA undertakings for collective investments in transferable securities (“UCITS”) investment funds. What makes this ruling noteworthy is that the Court clarified that it is irrelevant under EU law whether a US fund or its investors can claim a tax credit of the Spanish withholding tax in the US. The case addressed the so-called “neutralisation argument” which has often been cited by the Spanish Tax Authorities (“STA”) as a basis for rejecting claims.
The recent ruling further echoes the decision of the Spanish Supreme Court made on 13 November 2019 (STS 3675/2019) in which the Court concluded that a US RIC has a right to a refund of Spanish withholding tax on dividends charged in excess of 1%.
Exploring Spain’s Discrimination against Foreign Investment Funds: The Background
In Spain, investment funds are taxed at a rate of 1% on dividends declared by Spanish companies, compared to foreign funds that suffer tax at 19% on the same dividends (if applicable, this rate can be reduced under a relevant double tax treaty). During 2010 the favourable 1% rate on dividends was extended to collective investment institutions regulated by Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009, thus “UCITS” established in other Member States. Third-country and non-UCITS funds however are not entitled to benefit from the favourable 1% rate on dividends. As such, this constituted discrimination and an infringement of Article 63 of the TFEU.
Progress Since 2019: How the Spanish Supreme Court Ruling Impacts US Investment Companies
In 2019, the Spanish Supreme Court confirmed that the Spanish legislation represents a restriction on the free movement of capital under Article 63 of the TFEU which cannot be justified. Furthermore, the Court clarified that it is sufficient for a US RIC to be comparable to a UCITS and nonconformity with Spanish internal regulation does not warrant the different treatment imposed on the US RIC. The tax information exchange agreement (“TIEA”) contained in the Spain-US tax treaty was also analysed and the Supreme Court was satisfied that it enabled the STA to obtain adequate information exchange regarding US funds. The Court favourably concluded that the US RIC was eligible for a refund of tax withheld in excess of 1% on Spanish source dividends.
In our experience, despite this favourable decision, the STA has since been consistently rejecting Spanish ECJ reclaims submitted by US RICs. One of the most significant points raised by the STA in their rejections is that (in their view) US RICs can pass through a foreign tax credit to their investors which means that the discriminatory treatment of the US RIC is neutralised in the US and as such, no refund is due to the US RIC. The recent 2023 judgement passed by the Spanish National Court is welcomed as it provides some clarity on the neutralisation argument put forth by the STA.
Key Takeaways from the 2023 Spanish National Court Ruling on US RIC’s Withholding Tax Refunds
In SAN 773/2023, the STA had the view that a US RIC was not comparable to a Spanish investment fund and that the TIEA under the treaty is not comprehensive enough for the STA to obtain the required information.
The Spanish National Court did not accept the STA’s arguments and referred to previous decisions taken by the Spanish Courts to strengthen its case. It reiterated the Spanish Supreme Court’s view on a US RIC’s eligibility to reclaim Spanish withholding tax. It further emphasised that the US fund should be compared to a UCITS under the Directive instead of a fund regulated under Spanish law and that the US RIC, in turn, provided adequate support to prove that it is comparable to a UCITS.
The STA argued that the Spanish withholding tax is neutralised, as the US RIC passes through a tax credit to its investors. The Spanish National Court clarified that the burden of proving that the tax is completely neutralised in the US falls on the STA and not on the US RIC. It went on to state that the creditability of the Spanish tax could be affected by the personal tax situation and residence of each unitholder and it would be difficult to impossible to prove that the Spanish withholding tax was fully creditable against a unitholder’s tax liability. The Court also clarified that imposing the burden of proving neutralisation on non-resident funds is contrary to EU law since non-resident funds are then required to prove a requirement that is not imposed on Spanish funds.
Looking Forward: Implications of Recent Spanish Tax Rulings on Foreign Third-Country Investment Funds
The latest ruling strengthens the argument that US RICs and other third-country investment funds are eligible for refunds of Spanish withholding tax. It is critical to ensure that claims and/or appeals are filed with sufficient documentary evidence to prove the comparability of those funds to UCITS under Directive 2009/65/EC. WTax actively tracks and handles any queries or rejections received from the STA on behalf of clients and we remain optimistic that our arguments in respect of these Spanish ECJ reclaims for US and third-country funds should ultimately result in successful refunds.
For detailed information on the impact of the recent ruling we encourage you to promptly get in touch with WTax’s regional specialists.