The new protocol to the US-Spain tax treaty will be in force soon

On 14 January 2013, the United States of America (US) and the Kingdom of Spain (Spain) signed a Protocol (the Protocol) amending the Convention Between the United States of America and the Kingdom of Spain for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion (the Tax Treaty) with the aim of aligning the Tax Treaty with the current tax treaty policies of both countries. As an example of this, the Protocol provides exclusive taxation for the country of residence for interest, royalties, certain dividends and capital gains.

This Protocol was ratified by Spain in December 2014. However, since then, its ratification in the US has been blocked by a republican senator such that both US and Spanish taxpayers have been bearing higher tax burdens on their cross-border trading and investment activities during this period.

However, on 16 July 2019, the US Senate approved a set of tax treaty protocols which were negotiated during the Obama administration and had been blocked since then including the Protocol with Spain.

This article sets out a high-level summary of the main tax implications of the amendments to the Tax Treaty between the US and Spain made by the Protocol.

Main changes introduced by the Protocol:

Tax transparent entities

The Protocol includes within the scope of the beneficiaries of the Tax Treaty tax transparent entities (i.e. these entities will be entitled to the Tax Treaty benefits) provided that the income earned by the entity is taxed as income, profit or gain of a tax resident of the relevant territory.

Permanent Establishments (PE)

The period provided by article 5.3 of the Tax Treaty for construction, installation projects, installations, drilling rig or ship activity to be considered as a PE has been extended from six to twelve months.

Dividends

Dividends are taxed as follows:

• 0% withholding tax on dividends arising from a direct participation of at least 10%; 

•  0% withholding tax on dividends arising from a participation which represents 80% or more of the voting stock in the company paying the dividends provided that it is held for a minimum 12-month period ending on the date on which entitlement to the dividends is determined and provided the Limitation on Benefits clause is satisfied; 

•  0% for dividends distributed to pension funds;

• 15% withholding tax in all other cases.

  Spanish dividends paid by Spanish REITs (SOCIMIs) and Collective Investment Institutions will generally be subject to 15% withholding tax or, if the dividend is distributed to a qualifying pension, fund 0% withholding tax

Interest

Interest will generally benefit from a full exemption (only taxable in the residence of the beneficiary).

Royalties

Royalties will be taxable only in the State of residence of the beneficial owner.

Capital gains

A new provision is established for the taxation of capital gains made on the sale of shares which, directly or indirectly, entitle the owner to the enjoyment of immovable property located in a State, whereby such gains may be taxed in the State where the property is located. This provision allows the State where the property is located to tax such capital gains even if the value of the property is less than 50% of the share value (it should be noted that the OECD standard includes a 50% threshold of property value to apply this rule).

The significant shareholding clause has been eliminated, so there is no longer any need to have a substantial participation to benefit from exemption on the sale of non-property rich company shares.

Limitation of benefits clause (LOB)

The Protocol includes a new LOB clause which ensures that only qualified persons (i.e. in general terms these persons must be US or Spanish tax residents, with a connection with the state of residence or valid economic reasons to obtain the income from the source) will benefit from the application of the Tax Treaty. This clause has also been included as specific condition for the application for some of the Tax Treaty benefits.

Arbitration proceeding Exchange of Information

This clause has been further developed in line with the latest US tax treaties. Where the mutual agreement procedure between the authorities of both States is unable to resolve the discrepancies in relation to the application of the Tax Treaty within a period of two years, the dispute must be resolved through binding arbitration.
The Protocol introduces a number of other modifications such as a new definition of pension funds and a broader clause for the exchange of information and administrative assistance.

Entry into force

The process for entry into force must now be completed through the exchange of instruments of ratification. Once this exchange occurs, the Protocol will enter into force three months after the date of exchange of the final note. At this time, the Protocol will enter into force, except in relation to those taxes that operate by reference to a tax period. For those taxes, the Protocol will have effect in relation to the fiscal year starting after the entry into force of the Protocol.

Comment

After more than six years of waiting, the entry into force of this Protocol will be welcomed by a wide-range of US and Spanish investors who will benefit from broader exemptions as well as a more certain and detailed Treaty better aligned with the OECD standard and the requirements of the modern economy.

Of particular note are the enhanced treaty benefits for all categories of lenders benefiting from full interest withholding tax exemption and the broader range of dividend and capital gains exemptions. Furthermore, progress has been made in extending the opportunities for members of tax transparent entities to obtain treaty benefits.