The new Spanish tax regime on carried interest income earned by Spanish residents

Guillermo Canalejo Lasarte

Uría Menéndez, Madrid

guillermo.canalejo@uria.com

Spanish Law 28/2022 of 21 December 2022, the so-called ‘Start-up Law[1]’ includes, for the first time in Spanish tax history, a special tax regime applicable to the so-called carried interest income earned by directors, employees and/or managers of eligible closed-end alternative investment funds.

Is it truly the first time in history? This is half true. A few years ago, the Spanish provinces of Guipuzcoa, Vizcaya, Alava and Navarra, which have certain autonomy to enact their own tax laws, and behaving to some extent like the village of indomitable Gaulish warriors in the Asterix comic book series, passed rules on the taxation of carried interest income. However, like the Gaulish warriors, they could not agree amongst each other, so carried interest income is taxed as employment income (benefitting from a 50 per cent allowance) or as a capital gain (taxed at low tax rates), depending on the rules applicable in the specific province of residence of the carried interest holder.  

So, the other half truth is that, for the first time, the (federal) Spanish personal income tax (PIT) includes a special tax regime applicable to carried interest income. Unfortunately, and consistent with the position taken by the Spanish tax authorities in the past (by way of tax rulings and, more alarmingly, tax assessments), carried interest income will be deemed to constitute employment income, which is subject to marginal PIT rates of, currently, up to 54 per cent. However, subject to certain requirements, the taxpayer will be entitled to apply an unlimited 50 per cent allowance!

The special tax regime applies to Spanish tax resident individuals subject to the (federal) PIT law who are employed or act as a director, employee and/or manager of an eligible closed-end alternative investment fund, or of their management entities, or other group entities, and which hold shares or other rights, including success fees, which grant special rights over the return of eligible closed-end alternative investment entities.

We are now facing the first hurdle, or limitation of the special tax regime, as eligible closed-end alternative investment entities are limited to:

1.  Spanish venture capital entities;
2.  European venture capital funds;
3.  European social entrepreneurship funds;
4.  European long-term investment funds; as well as
5.  other entities analogous to the above.

The latter would be the back door for accessing the special tax regime outside of the ‘safe harbour’ use of one of the four regulated types of entities listed above. However, for the time being, guidance on which relevant factors should be taken into account to verify whether a closed-end alternative investment entity is ‘analogous’ is certainly missing.  

Additional requirements also apply:

1.  a given in this type of scheme: the special economic rights of the carried interest holder are conditional on the ‘true’ fund’s investors reaching a guaranteed rate of return on their investments;
2.  a long-term commitment, meaning that the carried interest right must be held for a minimum of five years, unless it is redeemed or becomes ‘ineffective’ or is totally or partially forfeited as a consequence of a change in the managing entity, or if the holder passes away before the end of such period; and
3.  an anti-abuse restriction, meaning that the special economic rights linked to the carried interest cannot be connected directly or indirectly with a non-cooperative jurisdiction (ie, a tax haven) for Spanish tax purposes, or in a country or territory with which Spain has not entered into a tax information exchange agreement. That is: bye bye Cayman Islands, Guernsey and Jersey funds.

Although some questions remain, and hopefully the Spanish tax authorities will provide clear guidance on the most relevant ones, it must be said that the new special tax regime not only provides for an attractive effective tax rate on carried interest income but, more relevantly, it provides much needed legal certainty on the tax rules applicable to such income.