Tax consolidation regime. Limitation on the elimination of dividends.

The General State Budget Law for 2021 introduces an amendment to the exemption for dividends received from entities in which more than 5% is held (Article 21 of the Corporate Income Tax Law (LIS)). This amendment reduces the full exemption to 95% of the amount of the dividends received or of the gains obtained on the transfer of the holdings, with 5% of the amount obtained having to be included as taxable income in respect of management expenses relating to the holding.

In short, if the tax base of the company receiving the dividends, before those dividends, is positive, the tax burden increases by 1.25% on the dividends in question (25% applied to 5% of the dividend). If that prior tax base is negative, the effect is a smaller negative tax base available for offset or a positive tax base, depending on the resulting algebraic sum.

In corporate groups with a significant vertical or cascading structure, this gives rise to excessive double taxation, with a greater direct and indirect impact on the companies forming a tax group taxed under the tax consolidation regime, and may even give rise to the paradox that income already taxed within the group at the time would be taxed again within the group when the dividend is paid out of reserves from prior years.

Turning to the substance, Article 65 of the General State Budget Law for 2021 has amended the wording of Article 64 of the Corporate Income Tax LawPDF, adding the paragraph highlighted in blue:

Article 64. Eliminations.
Eliminations shall be made in accordance with the criteria established in the Rules for the Preparation of Consolidated Annual Accounts, approved by Royal Decree 1159/2010, of September 17PDF, provided that they affect the individual tax bases and subject to the specific features provided for in this Law.

Amounts that must be included in the individual tax bases pursuant to paragraph 10 of Article 21 of this Law shall not be eliminated.

Likewise, the reference to the Rules for the Preparation of Consolidated Annual Accounts (NFCAC), Royal Decree 1159/2010, highlights that intragroup dividends, that is, dividends distributed by group companies and received by other group companies, form part of the consolidation eliminations. In this regard, Article 49 of the NFCAC provides:

Article 49. Elimination of internal dividends.

1. Internal dividends shall be those recorded as income for the year of a group company that have been distributed by another company belonging to the same group.

2. These dividends shall be eliminated and treated as reserves of the recipient company.

3. In the case of interim dividends, they shall be eliminated against the equity item representing them in the company that distributed them.

In short, the amendment to the tax limits the elimination to 95% of the dividends, so that the remaining 5%, which must be included in the individual tax base of each group company, is not eliminated, thereby creating, in our opinion, inconsistencies with the very concept of a tax group or with the prohibition of double taxation:

a) The tax group shall be treated as the taxpayer (contribuyente). Impact on the tax group as a unit subject to taxation.

The Corporate Income Tax Law classifies the tax group as the taxpayer, and it is the Law itself that provides that the companies forming the tax group are not to be taxed individually under the tax. Furthermore, it should be borne in mind that the group lacks legal personality and that it is the tax legislation that establishes it as the (taxable person) taxpayer, on which the income obtained is measured and on which the principal obligation to pay the tax is imposed.

Consequently, the limitation on intragroup dividends received by the companies, for elimination purposes, directly affects the concept of a single unit subject to taxation, which constructs a new taxable event from the income obtained by all the companies forming the group as a whole. Each of the parts (the companies forming the group) acquires a significant position which, at odds with the very notion of an economic unit, affects the concept of income obtained by the group. The group obtains income vis-à-vis third parties outside the group, but internal income/expenses, which are eliminated, do not constitute actual income; the amendment concerning dividends breaks with this basic concept.

b) Internal integration in Corporate Income Tax (IS).

Under the 2014 Law, the model of internal integration in Corporate Income Tax (tax on tax) is based on two factors:

1) full integration, where a company holds more than 5% in another company, subject to exceptions; and,

2) no integration, in the case of profits distributed by companies in which the holding does not exceed 5%, and in the exceptions referred to above. The legislative amendment adjusts the first method, so that integration is almost full, except for the 5% for management expenses relating to the holding.

Tax consolidation rests precisely on the concept of full integration, tax on tax, by subjecting the entire income of the tax group to tax at once. The amendment introduced by the General State Budget Law (LPGE) for 2021 inevitably affects the full integration model that tax consolidation, or consolidated taxation, has historically represented.

The breach of the model, albeit a limited one, raises a series of tax-accumulation issues not necessarily addressed in the legislative amendment. In simple groups, consisting of a parent company and one or more subsidiaries at the same level, the accumulation within the group will mainly affect the tax impact on the parent company of the dividends it receives from each of the subsidiaries.

In complex groups, in which a parent company may hold interests in investee companies that in turn form subgroups, corporate chains arise that begin with the dividends distributed by the lower-tier subsidiaries, continue with the dividends applied by higher-tier companies, and end with the dividends ultimately obtained by the parent company. It may well happen that the same profit moves up the chain as a dividend applied through the succession of higher-tier companies: a tax-accumulation effect then arises within the group that is no longer limited to 1.25% but may add up cumulatively to correspondingly higher percentages.

c) Dividends paid out of reserves from prior-year profits

Another aspect to consider—for the purposes of tax-on-tax integration—may arise where an investee company distributes dividends not out of the profit for the year but out of reserves, that is, out of profits from prior years. This would create the paradox that income already taxed within the group at the time would, when the dividend is paid out of reserves, be taxed again within the group through the mechanism introduced by the LPGE.