Spanish Supreme Court to rule in hedge fund withholding tax cases

The Spanish Supreme Court is to rule on the application of withholding taxes on Spanish source dividends paid to EU alternative investment funds. At least four decisions are expected to clarify the basis on which EU based alternative investment funds may rely on the free movement of capital to claim refunds of Spanish withholding taxes levied on dividends from their Spanish investments. In particular, the ultimate decisions should explain the basis on which EU based alternative investment funds are to be treated as comparable to Spanish alternative investment funds for the purposes of the non-discrimination principle.

Whilst these specific decisions will deal with the position of EU based funds, it is also expected to be highly significant for the position of non-EU funds which may also rely, in principle, on the free movement of capital to claim refunds of withholding taxes on Spanish dividend withholding taxes.

Background

On 30 July 2021, the Audiencia Nacional released a decision extending the application of the non-discrimination principle under EU law to withholding taxes applied to Spanish source dividends obtained by EU hedge funds. For more details of this decision, see our earlier article “Recovery of Spanish withholding taxes by foreign hedge funds”. This judgment was appealed to the Supreme Court by the Spanish tax authorities, as it included dissenting judgments from two of the judges, creating some level of uncertainty as to the specific comparability requirements which may be required for foreign alternative investment funds to qualify for dividend withholding tax refunds.

In addition, at least another three decisions issued by the Regional High Court of Madrid were simultaneously appealed to the Spanish Supreme Court (in these cases by French and German hedge funds). The Spanish Supreme Court has now accepted these applications to review the four appeals.

Scope of the expected Supreme Court judgment

The matters on which the Supreme Court will decide will include the following important issues:

• If the comparability analysis between non-resident hedge funds and the Spanish funds should be carried out in accordance with Spanish domestic legislation applicable to hedge funds, in accordance with UCITS Directive, or in accordance with the legislation applicable to this type of hedge funds in their home state.

• What parameters should be taken into consideration for the purposes of the comparability analysis between the non-resident hedge fund and Spanish fund (e.g. the authorisation, the number of unit-holders, minimum assets or share capital, open-ended nature of the fund, etc.).

• Who bears the evidential burden in relation to the comparability requirements and the question whether the discriminatory treatment has been counteracted by the relevant tax treaty (under which the fund may be able to deduct in its country of residence the taxation borne in Spain, thereby neutralising the effects of the restriction on the free movement of capital).

Comment

The appealed cases will be a priority for the Court and it is expected that the final decision should be released by the end of the year.

It should be noted that the matters on which the Supreme Court will rule will be relevant not only for hedge fund cases but also for other alternative collective investment funds, depending on the outcome of the Court judgment. In particular, the decision is likely to extend to non-EU based hedge funds provided that they can show that they are comparable to Spanish hedge funds and that they are based in a treaty jurisdiction with an appropriate exchange of information provision with Spain.

During the last five years the Spanish Supreme Court has ruled in favour of UCIT funds, insurance companies, sovereign funds, US investment funds and Canadian pension funds. Withholding tax cases on Spanish source dividends could amount to EUR 1bn based on the estimations of the Court Auditors, though some experts suggest higher figures (particularly bearing in mind US, Canadian, Swiss, and Chinese investments). Yet again, the fund industry has a new opportunity to obtain significant tax refunds.

If your alternative investment funds have suffered Spanish withholding tax on portfolio dividends then you should consider whether they may be entitled to a refund. Our Spanish tax team, which has been involved in a number of these developments at the highest levels (including landmark cases at the Spanish Supreme Court) and has advised a number of AMIF clients on the recovery of withholding taxes, can advise you on the position.