Clarification of the taxation of carried interest in Spain

The General Directorate of Taxes (GDT) has issued the first tax ruling including interpretation of the brand new carried interest regime in Spain. This first piece of binding guidance provides some level of flexibility on the different aspects covered by the ruling, however there are still some grey areas in the regime that will require further clarification. Overall, however, the guidance is to be welcomed as a step in the right direction.

Background

Traditionally, the tax treatment of carried interest has been a highly controversial issue due to the lack of a specific tax rule and little or no interpretative guidance from the GDT. However, with the Law 28/2022, the tax treatment of carried interest was regulated and brought in line with the rest of the European countries (see our article on Taxation of carried interest in Spain) by treating carried interest income as employment income subject to a 50% reduction (i.e. 50% of gross carried interest is free of income tax), subject to the carried interest scheme meeting certain requirements.

However, the implementation of carried interest schemes in accordance with the new regulation has brought to light many different grey areas where the law is not entirely clear.

GDT guidance

The tax ruling was requested by the main association of Spanish private equity firms and it is focused on specific aspects of the regime which are not sufficiently clear in the law, including the following  highlights:

(i) the types of funds in respect of which carried interest is eligible for the 50% reduction,

(ii) the possibility to apply the regime to bonuses linked to carried interest schemes, and

(iii) the possibility to receive advance carried interest payments on account and treat them as eligible for the purposes of the 50% reduction, before the completion of the 5 year holding period.

Firstly, the GDT concludes that foreign entities analogous to Spanish private equity funds/companies (those meeting the requirements of article 14 of Private Equity Law) are eligible for the regime. This actually means that the relevant foreign private equity funds should be set up in an EU or treaty jurisdiction for Spanish tax purposes and be engaged in similar activities to those regulated for Spanish private equity funds. However, the GDT does not provide further guidance as to more specific comparability factors concerning the concept of "similar activities", and suggests that the analysis shall be made on a case-by-case basis.

Secondly, it confirms that bonus schemes, whose determination and settlement are linked to an eligible carried interest scheme, are also eligible for the tax benefit of the 50% reduction.

Finally, the GDT concludes that advance payments of carried interest income are also eligible for the regime to the extent that the five years of holding period for the carry shares is met in due course.

Comments

The guidance issued by the GDT is encouraging as it displays some flexibility in the interpretation of most of the specific questions raised. In particular, the flexibility accepted in relation to bonus schemes could boost the scope of beneficiaries of the regime as carried interest schemes based on shares are usually restricted to most senior managers.

Also, the possibility of applying the regime to anticipated payments of carried interest is very interesting because it will enable receipt of carried interest income in a shorter period than 5 years.. This is a step forward compared to other European tax regimes, such as France, which impose a five-year lock-up period before the tax benefits associated with the payment of carried interest can be enjoyed It also goes further than the beneficial tax treatment generally available to long-term employment income in Spain (a 30% reduction which requires that the income be generated over a period of at least 2 years and can only be claimed once in every five years).

Unfortunately, some aspects are yet to be clarified. It seems that the regime is still not available for real estate, infrastructure or debt funds unless the "other analogous entities" reference could end up being construed widely (which would require a further tax ruling from the GDT). The favourable interpretation of this reference in the tax ruling to the foreign private equity entities meeting the requirements of article 14 of the Private Equity Law requires a case by case analysis. ELTIFs could also represent a potentially eligible alternative to structure carried interest schemes for these kind of investments, but it is not currently a clear-cut issue.

Also, the anti-abuse provision impacting blacklisted jurisdictions will also need to be clarified, as it is not uncommon to find private equity entities with some indirect exposure to widely used jurisdictions in the industry, like the Cayman Islands (which is blacklisted for Spanish tax purposes but not for many other jurisdictions, including the European Union and the OECD).         

All in all, this ruling is a favourable and encouraging step forward which will help to promote the application of the new carried interest regime and the private equity industry in Spain.