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TaxationWeb by Jonathan Miller

Many Britons own property in Spain. Some also have business interests and investments in Spanish territory. This article takes a quick look at the effects for them of Spanish Inheritance and Gifts Tax (ISD).

BACKGROUND

Many Britons own property in Spain. Some also have business interests and investments in Spanish territory. This article takes a quick look at the effects for them of Spanish Inheritance and Gifts Tax (ISD).

Before getting into any detail, it is well to point out two particular features of ISD which can surprise the average Briton.

1. The taxable person is the recipient.
   ISD is a tax on acquisitions, not on transfers. In the UK equivalent (IHT), it is the estate of the deceased which is subject to tax. In Spain, the recipient of the lifetime gift or inheritance is the taxpayer.
2. Spouses are not exempt.
   In IHT, a spouse is generally an exempt beneficiary. In ISD, that is not the case. Spouses are treated in no way differently from adult children. It is worth repeating - spouses are not exempt from Spanish Inheritance Tax.

WHO IS LIABLE TO ISD?

An individual resident in Spain is liable (by way of obligación personal) to ISD on receipts by him of assets (etc) sited anywhere in the world.

An individual not resident in Spain is liable (by way of obligación real) on receipts of assets (etc) sited in Spain.

Note that nationality has no effect whatever. The only two questions are: where are you resident? ... and where are the assets sited?

So, if you are a married couple who jointly own a property in Spain (whether or not you are resident there), on the death on one spouse, the survivor will be liable to ISD on the deceased spouse's half (assuming that's the way your wills are written).

HOW MUCH TAX IS PAYABLE?

All rates, percentages, band thresholds, and so forth given in this article are those which apply to taxable events falling in the year 2005 (note that Spain's tax year runs concurrently with the calendar year).

Calculation of tax due is done in five stages:

First: Value the asset. Whilst all sorts of valuation bases may be used for different purposes and reasons in Spain, the basis required for ISD is that known as "real value". In practice, this means that the starting point is a full, open-market valuation. If there is a mortgage on the property (which is registered in the Spanish land registry) the appropriate portion of that may be deducted from the market value.

Second: Remembering always that the taxable person is the recipient, work out the relationship between the taxpayer and the person making the gift or leaving the inheritance. That relationship falls into a group. It goes like this:

Group I consists of natural and adopted children, grandchildren and so forth in direct (ie not collateral) line of descent who are under the age of 21

Group II consists of the same descendants listed above in Group 1 but of the age of 21(+), ascendants in direct line, and spouses. As mentioned earlier, spouses are not favoured beneficiaries and are treated in no way differently from adult children or, indeed, parents and grandparents.

Group III consists of those in the next degrees of kinship out to first cousins. (For the technically inclined, that is to say including the collateral third grade).

Group IV consists of the rest of the family (collateral fourth grade and beyond) and unrelated persons. This latter category (unrelated persons) would include not only unadopted stepchildren, but also the so-called common-law spouse. This latter is a common (neither pun nor social comment intended) condition amongst, say, joint property owners. As will later become apparent, marriage can be a vastly successful tax-planning manoeuvre (I say nothing of other consequences).

Third: work out the personal allowance available (remember, this is per recipient). Note that no allowance is available on lifetime gifts - only on inheritances. The table is as follows:

Kinship Group	those included	allowance (DEATH ONLY)
I	direct descendants under 21 yrs	Euro 15,956.87 plus Euro 3,990.72 for each year under 21 yrs of age maximum allowance of Euro 47,858.59
II	direct descendants over 21 yrs, spouse, ascendants	Euro 15,956.87
III	Other relatives, out to collateral second and third degree (eg: brother, uncle, nephew)	Euro 7,993.46
IV	more remote family, unrelated persons (including "common-law spouses")	nil

Fourth: having deducted any personal allowance available from the value arrived at in stage 1 above, calculate the "raw" tax figure from the following table:

Band up to.... Euro	Tax rate on band %	Cumulative tax Euro
7,993.4	7.65	611.50
15,980.91	8.50	1,290.43
23,968.36	9.35	2,037.26
31,955.81	10.20	2,851.98
39,943.26	11.05	3,734.59
47,930.72	11.90	4,685.10
55,918.17	12.75	5,703.50
63,905.62	13.60	6,789.79
71,893.07	14.45	7,943.98
79,880.52	15.30	9,166.06
119,757.67	16.15	15,606.22
159,634.83	18.70	23,063.25
239,389.13	21.25	40,011.04
398,777.54	25.50	80,665.08
797,555.08	29.75	199,291.40
excess	34.00	-

Fifth: apply the relevant co-efficient. This is derived from the table below which takes into account the degree of kinship (stage 2 above) and the taxpayer's pre-existing net wealth (for non-residents, pre-existing net wealth is calculated with reference to Spanish sited wealth only):

Pre-existing net wealth (Euro)	Group
	I and II	III	IV
0 - 402,678.11	1.0000	1.5882	2.0000
402,678.11 - 2,007,380.43	1.0500	1.6676	2.1000
2,007,380.43 - 4,020,770.98	1.1000	1.7471	2.2000
4,020,770.98 (+)	1.2000	1.9059	2.4000

An example:

Mr and Mrs Averagely-Well-Off (AWO) are resident for tax purposes in the UK. They own Casa Quite Pretty in the outskirts of Marbella in Spain. They keep no other assets in Spain. They own all their assets jointly. Their wills leave everything to each other.

Mr AWO gets a hole-in-one at his golf club in Spain. He is over the moon. Then he remembers that he has to buy everyone in the club a drink. He has a heart attack and dies.

In due course, their wills are proved, and their Fiscal Representative in Spain gets to work on the ISD calculation.

Casa Quite Pretty is valued at 400,000 Euros. The Fiscal Rep knows a thing or two, so he checks this with a couple of other valuers. Mr AWO's share to be passed to Mrs AWO is therefore 200,000 Euros.

There is no mortgage charge on Casa QP, even though they borrowed in the UK to make some of the purchase price. So the net real value is also 200,000 Euros.

They were lawfully married (and it can be proved) so the kinship group applicable is Group II. Mrs AWO's personal allowance is therefore 15,956.87 Euros. This leaves 184,043.13 Euros to tax through the bands (fourth stage above). This results in a "raw" tax figure of 28,250.01 Euros

Inspection of the table of co-efficients reveals (a) that Mrs AWO has Group II kinship with the deceased and (b) that her pre-existing net wealth (only that sited in Spain, in this case) is 200,000 Euros (her half of the property), and that therefore she must apply a co-efficient of 1.0000 to the raw tax figure. The tax due on her inheritance from her husband is therefore (28,250.01 x 1) = 28,250.01 Euros (an average tax rate on the inheritance of a smidgen over 14%).

Of course, had they not been married, her tax would have been double that amount (Group IV kinship, and therefore a co-efficient of 2.0000).

AN INTERMEDIATE SUMMARY

It may be helpful to summarise the bare bones so far:

• Value the asset received
• Deduct any allowable deductions or reliefs
• Determine the degree of kinship between donor and donee (the taxpayer)
• Establish into which kinship Group the taxpayer falls
• Deduct any available personal allowance
• Tax the resultant figure through the bands
• Calculate the taxpayer's pre-existing net wealth
• Determine which co-efficient is applicable
• Apply the co-efficient to the tax figure obtained earlier

WHEN DO I HAVE TO PAY?

It is the taxpayer's duty to present in the due form all the documents reporting the taxable transaction and necessary to the calculation of the tax due. He may opt himself to calculate the tax due and present his declaration (which includes the calculation) together with the money (a procedure called autoliquidación). This must be done as follows:

1. The liability to tax arises:
   • Death: on the date of death of the transferor; or when this is not known, the date on which declaration of death is duly signed in accordance with the Civil Code Art 196.
   • Lifetime gifts: The date on which the gift is made (in whatever way is lawful for the asset in question)
2. Declarations must be made:
   • Death: within six months of the date of death of the transferor. There are some provisions allowing the tax office to agree to a deferral if requested within five months of the date of death.
   • All other cases: within 30 calendar days of the day following the conveyance of the gift

CAN I DEFER PAYMENT?

This is possible, but mostly only in the case of inheritances. In general, it is necessary to demonstrate that the taxpayer has insufficient liquidity to meet the tax in cash. Any deferment granted will require interest at the official rate to be added to the tax bill, and the provision of adequate guarantees for both the tax and interest.

There are some limited circumstances where deferred payment is possible on lifetime gifts. This is limited to interests in a family trading or professional business.

HOW FAR BACK CAN THEY GO?

The tax administration is prohibited from seeking payment, or applying sanctions for non-payment of tax once a period of four years has passed counting from, in the one case the date for final presentation by the taxpayer of all the required documents, or in the other case the date of any tax offence. This four-year (formerly five years) proscription period is a general one in Spanish tax law. There are various opportunities for the tax authorities to "stop the clock" and so keep the case within the 4 year window.

HOW WILL THEY KNOW?

This is an interesting area of the legislation and regulations, which clearly demonstrates the reliance placed in the Spanish legal system upon bureaucratic control. The emphasis is upon anti-evasion. The general intention of the law is to weave a web of reports around the taxable event, such that the taxpayer is effectively enmeshed by the system.

Most institutions (eg banks and insurance companies), authorities and other people likely to be involved (eg Notaries and Registries) in a transfer of value are obliged to make reports to the tax authority. This duty is reinforced by making them "subsidiarily liable" for payment of the tax.

In short, they will seek clearance from the tax authority before making any payment or transfer which might be liable to ISD.

As I observed earlier, most of this is aimed at evasion. Such small neo-anti-avoidance measures as there are tend to aim at intra family manoeuvres, such as renunciation of rights under the forced heirship rules. They are, in general, designed to ensure that a lower co-efficient is not thereby achieved. The Deed of Family Arrangement has no place, and could give rise to a double charge to ISD; practitioners considering such variations where there Spanish sited property is involved would be well to check the effect for ISD.

SOME OTHER MATTERS

Life Assurance. Spanish life assurance is nearly always written on an own-life, own-benefit, basis. Naturally there is no opportunity to write policies in trust for a beneficiary. It is always possible to nominate a beneficiary, but this is a purely administrative annotation, and has no effect upon title. The proceeds of a life assurance policy are therefore assessable to ISD when the recipient is anyone other than the policyholder (usually the life assured), and are treated as any other asset passing to that recipient. A life assurance policy written in trust (say, a UK policy) for a spouse stands the risk of attracting twice the rate of tax: trustees will be unrelated to the recipient, and hence Group IV transferors, where the spouse would have been Group II. It is good planning for a policy to be held on a life-of-another basis, since the recipient of the proceeds will also be the policyholder hence there is no transfer to be taxed (though if there is a savings element, there may be a charge to income tax on the policy gain).

Cumulation. Lifetime gifts from the same donor to the same donee are cumulated over a rolling three year period. Upon death, lifetime gifts made by the deceased within five years of his death are accumulated with transfers at death to the same recipient.

Double Taxation Relief. There is no treaty with the UK concerning inheritances and gifts tax. ISD Art 23 provides a unilateral relief for "similar taxes paid abroad" to those liable by way of obligación personal (ie those resident in Spain). The lesser of two sums may be deducted from the Spanish tax: a) the amount of foreign tax paid or b) the result of applying the average rate of ISD on the gift/inheritance in question to those foreign assets on which foreign tax has been paid.

Patently, no relief is available where no foreign tax has been paid. The prime example of this would probably be the death of one of an English domiciled couple resident in Spain. There is no UK IHT to be relieved against the ISD on any transfer between those spouses.

HOW CAN I PLAN FOR THIS TAX?

First of all ... do a quick calculation. It may be that the amount of tax is small enough not to matter; or that the cost of a solution is equal to or greater than the tax.

General. It should be remembered firstly that Spain's is an acquisitions tax, and that there may be some mismatch with the UK's transfer tax (IHT); secondly that a spouse is not an exempt beneficiary and that therefore first death planning is crucial.

Spouses. As signalled above, inter-spouse planning is quintessential. This is particularly true of residents and the family home. The problem is exacerbated if the "spouses" are not married. Often, the most practical solution (where health, age, and so forth permit) is to write cross-held life assurance policies on a life-of-another basis to provide the cash necessary to fund the tax.

"Common law spouses" Get married? (It can halve the charge to ISD!)

Children. As the reader will have deduced, ISD draws no distinction between adult children and spouses, both being Group II recipients. The common "second death" approach to planning for IHT is therefore generally inappropriate as an approach to ISD. Provision for the surviving spouse is usually much more important.

Trusts. There are no general guidelines for the tax treatment of interests in trusts. A case by case basis is the only practical way of looking at them. It should be remembered by planners that the trigger for consideration of a charge to ISD is an increase in an individual's wealth. Receipts from trustees can fall with a resounding thud into this definition; the thud is due to the facts that (a) transfers from trustees will be inter vivos, so no personal allowance is available and (b) the body of persons composed by trustees is by definition (even if the trustees themselves are blood relatives) unrelated to the recipient, and that therefore the tax can be double that of a direct receipt from a close relative (spouse or parent, for example).

Use of offshore companies. In considering the use of offshore entities to hold Spanish sited assets, there are many factors to be taken into account. Where real property is concerned, not the least of these is the annual 3% Special Levy. Also to be given serious consideration is the effect of Spain's Corporation Tax law, which deems a rental income to arise in consequence of use of a company's property. This is subject to withholding tax (at 25%) on the gross rental in the hands of a non-resident company.

In general a resident taxpayer will gain no ISD advantage from the simple interposition of a company. Those resident in the UK should consult their advisors about such matters as the shadow director and benefit-in-kind rules.

It is probably safe to say that, in most circumstances, the use of an offshore company is probably not advisable. The complex reasons why that is so are outside the scope of this short article.

Mortgage the property? A debt secured against the property will reduce its taxable ("real") net value for both ISD and, indeed, for Wealth Tax (IP). For ISD purposes, it is necessary that the heir assume the debt attaching to the transferred property. The commonest mechanism is to mortgage the property. It doesn't matter if the lending institution is resident in Spain or not, but it is essential that the mortgage charge be registered in the appropriate Spanish property registry. Don't forget, however, that the mortgage charge is a mechanism by which the lender may take over the property if the payments aren't fully kept up.

Life assurance. One of the most convenient and efficient methods of funding any form of inheritance tax is via a life assurance policy. Note the observations above under "Some Other Matters". If you are not resident in Spain, and not intending to become resident, then a UK policy written in trust in the normal way for the benefit of the heir is an excellent way of dealing with it. In other circumstances, the life-of-another approach (or own life and then a free assignment) is likely to be more appropriate. For a non-resident married couple a "joint-life, first-death" policy may worth considering. Check with your broker or IFA for appropriate policies and ways of writing them.

A FINAL WORD

Although ISD is a national tax, the state devolves responsibility and competence to the autonomous regional governments (eg Andalucia, Baleares, Catalunya, Canaries). They in turn may modify some of the detail and, in particular, set different exemption limits. It is important, therefore, to check for local variations, depending on where you live or on where your property is sited.

CONCLUSION

This has been something of a dash over the key features of an important tax. Inevitably it has left much unsaid; and much of that is to do with the interrelationships between this and other taxes. This is a tax the unplanned, or poorly planned, consequences of which can result, inter alia, in much sadness and financial worry, especially for a surviving spouse. In less emotional terms, and in larger estates, it can produce an unwanted and unexpected erosion of value and worth. Informed planning is crucial.

© Jonathan Miller - June 2005

Windram Miller & Company SL
Jacinto Benavente 17 - 2A
29600 Marbella, Malaga
Spain

Tel: (+34) 95 282 0779/4910
Fax: (+34) 95 277 8468
Email: wmiller@readysoft.es