Tax Treatment of Management Services in Spanish Corporate Tax

    Article 16 of Spain’s Corporate Income Tax Law (Law 43/1995) regulates transactions between related entities. It also establishes rules for valuing those transactions and sets deductibility requirements for expenses derived from those transactions. Under article 16.1, tax authorities may revalue transactions between related entities at normal market values. This is permitted in cases where the agreed value leads to lower taxation in Spain for the related entities as a whole than that which would have resulted from application of normal market value. Revaluation is also permitted where the agreed value leads to a deferral of taxation for the related entities. However, in no event can the revaluation by the tax authorities lead to taxation of income higher than is actually generated in the transaction. In practice, this means that if a transaction is performed between two companies resident in Spain, and the value agreed is amended giving rise to an increase in the tax base of one of the entities (through higher income or lower costs), the tax authorities are obligated to reduce the tax base of the other related party. The corresponding adjustment is mandatory.

    This rule is deemed to apply to expenses for management support services between related entities, so that the adjustments arising from the application of article 16 in relation to these expenses must be of a bilateral nature. Those services are regulated by article 16.5, which sets forth the necessary requirements for the corresponding expenses to be deductible. The rule states that related parties should execute a written agreement prior to the provision of the management support services, which specifies the nature of the service to be provided and establishes the rules for allocation of the expenses incurred in respect of the relevant entities and the related margin. Article 16.5 should also require that expense allocation methods be established with regard to principles of continuity and reasonableness.

    Spain’s tax authorities are now classifying management support services expenses as (nondeductible) gratuities where they do not meet all the requirements mentioned above, and especially where there is no written contract. The government’s view — which these authors do not share — is that the lack of a written contract means the payment cannot be demanded by the entity rendering the services. Accordingly, it can be considered as a gratuity.

    Another problem is the lack of appropriate justification for services effectively rendered, even when requirements of article 16.5 are satisfied. We are facing an increasing number of assessments in which the authorities are rejecting the deductibility of all management support services expenses based on the fact that it was not justified that all services covered by the contract were effectively rendered in the year subject to review. In those cases, the authorities now take the view that all payments made under the contract (not just those related to unrendered services) should be considered gratuities and treated as nondeductible.

    It should be highlighted that if an expense is included among the gratuities regulated in article 14.1(e) of the Corporate Income Tax Law, in no event should correlative adjustments be made to the tax base of the other contracting party, since this type of bilateral adjustments is only foreseen for valuations derived from the application of the special rules on related-party transactions.

    Contrary to the stance adopted by tax authorities, we must refer first to the principle of specific rules, whereby the application of specific regulations (article 16) must have preference over general regulations (article 14). If the management support services are rendered to a related party, the expenses and revenues derived from those services should be valued in accordance with the special rules on related-party transactions (article 16). Consequently, as established in said rules, if the valuation leads to a positive or negative adjustment by the tax authorities with respect to one of the contracting entities, the tax authorities must make the related negative or positive adjustment to the tax base of the other related entity (when both parties are resident in Spain).

    Second, in addition to the foregoing, it should be analyzed whether those expenses can be classed as gratuities. The Central Economic-Administrative Tribunal established in several decisions (for example, those dated 10 September 1986 and 18 July 1990) that:

    . . . in internal relations of national or multinational groups of companies, the reason for transfer pricing may lie in various causes . . . but in no way to specifically remunerate capital or give a gratuity to a company of the group, since it is characterized by the intention to obtain maximum benefit for all of them, by using an economic strategy whereby each company, despite having its own legal personality, is part of a large enterprise or multinational and the strategy of these groups takes into account the tax legislation of each country or region, the wage levels, public policy, political stability, inflation levels, exchange rate control, the advantages and drawbacks of the industrial positioning, transport and distribution problems, financing facilities, communities, existence of certain simple and flexible commercial and banking institutions, etc., thereby establishing, in accordance with highly complex management models, the intergroup transfer prices, and therefore, it does not seem appropriate to consider that the economic relations in these groups of companies are inspired by the specific remuneration of capital of one of its components or by reasons of gratuity.

    Therefore, the idea that management support services expenses are not deductible because they are gratuities pursuant to article 14.1(e) is not valid. On the contrary, those services result in an actual expense generated by a transaction between related entities to which the special regulation for that type of transaction must be applied.

    Finally, we understand that if the legislature wished to exclude nondeductible management support services from the scope of the special rule for related-party transactions, it would not have included subarticle 5 in article 16, but rather in article 14 (in which case the general rules for the deductibility of expenses would apply to management support services). Because that is not the case, the special rules on related-party transactions must be deemed to be applicable to the expenses and revenues derived from management support services, even where those expenses are not deductible.

    In short, the rules established in article 16 are of a mandatory nature, so they are applicable whenever we are dealing with a related-party transaction. When tax authorities reduce the amount of the expenses derived from management support services rendered by a related party, the receiving company must necessarily be able to correlatively adjust its tax base by way of computing in the same amount lower revenue. A contrary method would result in the generation of fictitious income for the group of companies and double taxation — which would directly clash with article 16 and the constitutional principles of payment capacity and interdiction of confiscatory effects.

    Having made these observations, we understand it is of the utmost importance to meet all the requirements mentioned in article 16.5, as this should limit any discussion with the tax authorities to the sufficiency of the proof that the services were effectively rendered.

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