The European Commission has referred Spain to the EU’s Court of Justice over its succession tax rules. The Commission argues that the rules are discriminatory because they require non-residents to pay higher taxes than residents, even if they live elsewhere in the EU.
It remains to be seen how Spain responds – it does not appear to have paid much attention so far. Back in May 2010 the Commission had sent Spain a ‘reasoned opinion’, requesting Spain to take action to comply with EU rules in regard to inheritance and gift tax provisions. While Spain did tweak its laws it was not enough to make them fully compliant with EU law, so in February this year the Commission sent Spain a ‘complementary reasoned opinion’ on the matter, giving Spain two months to respond. However no further amendments were made to the Spanish legislation so the EC has decided to refer Spain to the Court of Justice.
So, what is the issue with the Spanish succession tax?
In Spain, inheritance and gift tax (‘succession tax’) is governed by both the state and the Autonomous Communities. There are 17 Autonomous Communities in Spain, and each has the right to amend the State rules to make them more beneficial (they cannot make them more punitive).
Over recent years, several Autonomous Communities (in particular those governed by the Partido Popular) have made significant reforms to their succession tax rules. There has been a general trend towards substantial reliefs and increased allowances, resulting in almost total exemption from inheritance tax in certain cases. For example, in Murcia, Islas Baleares, Islas Canarias, Castilla y León, Madrid and Comunidad Valenciana up to 99% of the deceased’s assets can be exempt from succession tax where the beneficiaries are children and/or a spouse. Andalucía has also reformed its rules, where inheritances of up to €175,000 passing to a spouse or children can be tax free, and more recently Cataluña has significantly increased the allowances up to a maximum of €650,000 for a spouse and €400,000 for a child.
Such generous exemptions are in stark contrast to the state rules, where the allowances are very much reduced. For example, under the state rules, the general allowance is only €16,000 for inheriting spouses or children.
The system is complex, since the rules within each Autonomous Community vary, and different allowances and different rates can apply. However, one thing is certain: for the rules of a particular Autonomous Community to apply, the deceased must have been habitually resident there for the preceding five years. If the deceased does not meet this condition, then the state rules apply by default.
Currently, non-residents cannot take advantage of the favourable Community rules, since they will fail the habitual residence condition. So, for example, individuals not resident in Spain who have holiday homes or investment properties in Spain are most affected. Even though the property may be situated in a Community with favourable inheritance tax rules, these rules are of no benefit. As a consequence, higher taxes will be payable than if the individual had been living in Spain.
Press release IP/11/1278 issued by the European Commission on 27th October and announcing the referral to the Court of Justice states:
“The Commission considers that this discriminatory tax treatment constitutes an obstacle to the free movement of people and capital, fundamental principles of the EU’s Single Market, and is in breach of the Treaty on the Functioning of the European Union.”
It remains to be seen whether Spain will change its succession tax laws so they no longer discriminate between residents and non-residents.
The problem for Spain is that it certainly cannot afford to lose any tax revenue at the moment – it has only just reinstated wealth tax specifically to increase the tax take. We will have to wait and see how it reacts to this latest EC move.
There was a similar situation with capital gains tax prior to 2007 when residents were charged 15% and non-residents 35% (2006 rates). The EU succeeded in getting Spain to end the discrimination, and while it did begin charging everyone the same rate, residents suffered as their rate increased to 18% (now 19% or 21% for total savings income and gains over €6,000). Could the government take a similar approach here?
Also remember that, if you are a non-resident who owns property or other assets in Spain, while you may end up paying less tax in Spain in relation to your Spanish assets if Spain changes its laws, you will need to consider the inheritance tax implications in your country of residence, since you may still have a liability to inheritance tax in that country.
For example, if you are resident and domiciled in the UK and you own a holiday home in Spain, the property may be exempt from UK inheritance tax if it passes to a spouse or if your total assets are below the UK Nil Rate Band of £325,000. In these instances, the Spanish inheritance tax payable under current laws on the first death represents a true cost that cannot be offset against any future UK inheritance tax on that property.
If, however, the beneficiary is not your spouse, and your total estate exceeds £325,000, then the Spanish tax can be offset against the UK inheritance tax liability on your Spanish property. In this instance, mitigation of the Spanish taxes may be academic since you will still have the UK tax to pay.
When considering inheritance tax planning, you should seek advice from an expert who knows the systems of both countries, such as Blevins Franks who specialise in Spanish and UK tax planning.
The tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; an individual must take personalised advice.