Is the debate on the indebtedness of Spanish companies over?

The corporate tax treatment of interest earned on financing obtained to carry out certain types of corporate transactions – including the distribution of dividends, the payment of share premiums or the purchase of own shares – has been a point of contention with the Spanish tax authorities in the past. According to them, if there was no direct and immediate relationship between these borrowing costs and the income of the entity, they should be treated as gratuities and were therefore not deductible.

The interpretation supported by the Spanish tax authorities had been confirmed, with identical arguments, by the National Court of Appeal and by various high regional courts.

The above view was overturned by a judgment of the Supreme Court dated March 30, 2021. The court found that borrowing costs are paid as a result of a loan agreement for value. Therefore, they can in no way be qualified as free and it does not matter whether they had a more or less direct relationship with the entity’s income.

The Court of Cassation confirmed the principle determined in its judgment of March 30 in a judgment delivered on July 21 in an appeal in cassation, led by the tax litigation lawyers of Les Garrigues, and adopting a principle which was reiterated in two judgments delivered July 26. The Supreme Court added that borrowing costs paid under a loan agreement generally do not qualify as equity compensation.

Consequently, according to the judgment of July 21, if the cost of borrowing is duly accounted for and justified, it will be deductible, subject in all cases to the limits provided for by the law relating to corporation tax for expenses of this nature (the general ceiling on financial charges). This is regardless of whether the funds received are used to distribute a dividend, pay an issue premium or buy own shares.

It didn’t stop there. In the judgment of July 21, the Supreme Court admitted that it is up to the freedom of assessment of companies to choose financing structures with more or less debt, and that they cannot be called into question simply because of the impact they may have on the corporate tax base (in the case examined in the judgment, the foreign parent company of the Spanish subsidiary granted a loan so that the subsidiary could distribute a dividend).

The Supreme Court has recognized that the decision to go into debt is “a decision of the governing bodies of the company, and the conditions for deducting costs cannot in any case be subject to the value judgment that the tax administration seeks to impose” .

However, despite recognizing the business owner’s freedom of choice, the Supreme Court left open the possibility of challenging transactions of this type when the transaction is considered to be fraudulent or contrived.

It should be recalled that in September 2022, in the context of a tax audit of a Spanish company, a report was published by the Advisory Commission on the conflict in the application of tax provisions (Conflict no. 9) declaring the existence a dispute over a number of transactions that resulted in the use of third-party financing for the distribution of a share premium amount from a Spanish entity. This finding was used to disallow the deduction of borrowing costs incurred by this Spanish entity.

The debate therefore does not seem to be completely closed, even if it is likely that future disputes of this type with tax auditors will be more limited. They can be expected to focus on the types of transactions that drive borrowing costs and their potential artificial nature. This means that careful analysis of these types of transactions is required before they are made.