Taxation of carried interest in Spain

In December 2021, the Spanish Government submitted for parliamentary approval a draft Bill to promote start-ups in Spain, also known as the Start-up Law. As part of a package of measures designed to make Spain a more attractive place for entrepreneurs, the draft Bill includes for the first time specific provision for the tax treatment for carried interest at Spanish state level (the Basque regions and Navarra had already put in place regulations for the taxation of carried interest). The draft Bill will establish a tax regime for carried interest in line with the provisions in the tax systems of neighbouring countries, as well as the Basque regions and Navarra.

Carried interest taxed as employment income

The draft Bill provides that income from carry shares realised by managers will be treated as employment income, subject to Spanish Personal Income Tax (at progressive rates, up to 45% to 54%). However, only 50% of this income will be subject to tax. The 50% reduction in the tax base means that carried interest will be taxed at an effective maximum tax rate between 22.5% to 27%, meaning that the taxation of carried interest is brought into line with the taxation of investment income and capital gains for individuals.

The draft Bill includes a number of conditions for the application of the 50% reduction of carried interest income:

• The 50% reduction only applies to carried interest from closed-ended Alternative Investment Funds as defined in Directive 2011/61/EU, including the following categories: i) entities regulated under Act 22/2014; ii) European venture capital funds; iii) European social entrepreneurship funds; iv) European long-term investment funds; and b) investment entities similar to these funds.

• The recipient must be a director, manager or employee of those entities, or of their management company or companies in their group.

• The special rights of the carry shares must be conditional on the investors obtaining a minimum guaranteed return defined in the regulations or bye-laws of the entity and (subject to certain exceptions, such as an early liquidation) they must be held for at least five years.

• These rights cannot derive directly or indirectly from an entity resident in a country or territory classified as a non-cooperative jurisdiction or with which there is no treaty on mutual assistance for the exchange of tax information in place.

The Bill has been submitted to Congress for debate and approval. Final approval is expected by mid-2022 and the new tax treatment of carried interest (as well as other amendments to Spanish Personal Income Tax Law) is scheduled to enter into force on 1 January 2023.

Comment

Until to the publication of the draft Bill, there was very little (and unclear) official guidance in Spain in relation to the tax treatment of carried interest - just a limited number of tax rulings issued by the Spanish General Directorate of Taxes (GDT). These had lead, in essence, to the view that, in case of employees, most carried interest schemes would most likely be considered as generating employment income to be taxed at the higher progressive rates for ordinary income, rather than at lower investment income rates, despite the fact that this income would be generated across a number of years.

The provisions in the draft Bill establishing a specific regime for the taxation of carried interest income is very welcome for venture capital and private equity firms in Spain as it provides a clear and attractive framework for the taxation of carried interest. It aligns with the rules in the Basque regions and Navarra and with the tax treatment of carried interest in a number of other European Union Member states. Taken together with other measures included in the draft Bill – see our article on Proposed improvements to the Beckham Law in Spain - this should enable Spain to attract private equity and venture capital businesses, as well as their investments.