Overseas Spanish investments, whether these are done on a private or business basis, constitute an increasingly common practice. These require knowing the tax burden in each country in order to obtain the maximum return on the investment.
To this end, the existence of Double Tax Conventions (DTC) that take precedence over domestic law is essential. These are intended to provide legal certainty to taxpayers who decide to operate with other States, inasmuch as they will be able to reduce the taxation of their operations and avoid international double taxation.
Spain currently has 94 DTC in force, including the DTC with Chile, which is the subject of this post. All the agreements signed by Spain follow the same scheme of the Model Agreement of the Organization for Economic Cooperation and Development (OECD), hence they all have practically the same structure.
✔ The DTC signed between Spain and Chile provides two systems of taxation for the income obtained in one State by a resident of the other Contracting State: exclusive and shared taxation.
Through the exclusive taxation system, the DTC grants taxing power on the income only to one of the two States that have ratified the agreement.
✔ In contrast to this method, the system of shared taxation empowers the two States, the source State and the State of residence, to claim the taxation on the same income. The DTC also limits the taxation in the State of source of dividends, interests and royalties, so that if the domestic law of such State establishes a higher taxation rate than that resulting from applying the limit, it will only be taxed on the amount obtained by applying the limit.
✔ This is the case, for example, of the income obtained by entertainers and sportspersons or the taxation from real estate. In relation to the former, the DTC provides that income may be taxed in the State in which the individual performs his personal activities as such, regardless of whether it is obtained directly by the entertainer / the sportsperson or by a third party. Likewise, in relation to the real estate income, the DTC regulates that it may be subject to taxation in the State where this real estate is located.
In such cases, the applicable tax rate will be the one provided for in the domestic law, which is generally higher than the average rates established by the DTCs. In this sense, the tax rate established by Spain for the previous income is 24% when the non-resident is from a non-EU country. This tax rate is higher than the average rate of the DTCs, when the State of source is also granted the right to tax a relevant income but under the Treaty rates.
In order to reduce taxes in international cross border transactions and to provide legal certainty to taxpayers, Double Tax Conventions (DTC), establish specific taxation rules between the Contracting States.
For these purposes, exclusive and shared taxation distribution rules are provided and, in this latter case, limiting the capacity to tax in the source State for certain types of income.
The system of shared taxation applicable in the case of dividends, interests and royalties, permits foreign investors limiting the taxation in the country of source, at the rate established in the DTC, which is of particular importance when the source country is a high tax jurisdiction.
✔ The system of shared taxation with limitation in the State of source that the DTC between Spain and Chile provides for dividends, interests and royalties, is the following:
- Dividends: the taxation in the source State is limited to 10% of the gross dividends, as a general rule, and 5%, in the case of a parent and subsidiary relationship, when there is a minimum 20% interest in the share capital.
- Interest: the DTC establishes the general rule that the tax may not exceed 15% of the interest earned. A reduced 5% applies to interest deriving from loans granted by banks or insurance companies, bonds and securities regularly and substantially traded in a recognized stock exchange, or the sale granted to the buyer of machinery and equipment by the beneficial owner.
- Royalties: as a general rule, the tax at source may not exceed 10% of the gross royalty amount. A reduced 5% applies when these are paid for the use or for the right to use industrial, commercial or scientific equipments.
✔ This means that if, for example, your company obtains interest deriving from a loan granted to a Chilean company, your company maybe taxed in Chile at a maximum rate of 15% rate.
✔ It is worth taking into account that the Treaty includes the provision that if Chile, on a later date to the entry into force of the DTC, signs an agreement with a Member State of the Organization for Economic Cooperation and Development (OECD) in which Chile exempts or limits the payable tax rate to a lower rate than the one applicable according to the DTC with Spain, such rate or exemption shall be applied automatically in case that the effective beneficiary of such income is resident in Spain.
Consequently and for the purposes of taxation of interests and royalties, it will be relevant to recurrently check whether Chile has signed an agreement on a later date with a member state of the OECD, foreseeing lower rates than those of the Spanish DTC, as they would automatically apply to the Spanish beneficiary of the Chilean source income.
Double Tax Conventions (DTC) permit the Contracting States sharing the right to tax certain types of income.
In these cases, income is subject to international double taxation, since it can be taxed in two different States.
In order to reduce the tax burden that may result for the taxpayer from this situation, the DTC between Spain and Chile provides for double tax relief, as it is further developed below.
✔ The DTC signed between Spain and Chile stipulates that international double taxation shall be avoided with the so – called ordinary imputation method. An individual or entity resident in Spain obtaining income in Chile may deduct it in Spain, with the limit of the Spanish income tax or wealth tax on the same income, as the case may be:
- the income tax paid in Chile, (net of the “First Category Tax”).
- the wealth tax paid in Chile.
- in the event of a company distributing dividends, the income tax effectively paid corresponding to the benefits from which such dividends are paid, (“First Category Tax”).
The DTC also regulates that when income obtained in Chile is exempt from taxation in Spain, this State may also take into account the exempt income to calculate the tax on the rest of the resident’s income or wealth, (the so – called, “Exemption with progressivity method”).
✔ Finally, let us remind you of the impact of the Multilateral Agreement against the erosion of negative tax bases and the transfer of profits, within the framework of the BEPS Action Plan, on the Double Tax Conventions signed by Spain. The Multilateral Agreement aims at eliminating the gaps and discrepancies that exist in international regulations and that facilitate the “concealment” or artificial transfer of companies profits to low tax jurisdictions or with nil taxation, where companies carry out little or no economic activity.
Once the Multilateral Agreement enters into force, due to the ratification by each of the Contracting States, some of the articles of the DTC may be automatically modified whenever the other State adopts the same article. That is why it will be of the utmost interest to follow the consolidated text of the Agreement which, to that end, will be made available to taxpayers and which we will monitor on a daily basis.