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Sometimes the Tax Agency carries out inspections because it suspects that some legal figure is being used with the sole intention of reducing taxation, in which case it usually resorts to article 16 of Law 58/2003, of December 17, General Tax Law (hereinafter, LGT), to justify the “simulation” of a legal transaction and apply a higher taxation than that declared by the taxpayer.
These types of cases, where the Tax Office uses simulation as justification, are common when an individual forms a Company to invoice for work that the individual actually performs personally, without the Company having the means to carry out said work, so that the Company pays 25% tax instead of perhaps reaching 45% in the Personal Income Tax.
Tax simulation is defined as the declaration of intent of a non-real content issued consciously and, in agreement between the parties, to produce, for the purpose of deception, the appearance of a legal transaction that does not exist (absolute simulation) or is different from the one that has actually been carried out (relative simulation).
The Supreme Court Judgment, Administrative Litigation Chamber, of October 29, 2012, considers that there is simulation when “a series of transactions are carried out that do not correspond to the typical reality that justifies them”, or when “the cause nominally expressed in the contract does not exist, because it responds to a different legal purpose”.
In any case, to establish the existence of a simulated transaction, the simulation must be sufficiently proven. That is, the elements comprising its concept, to declare it inconsistent with the true will of the parties and the purpose of concealment from third parties, would be the following:
- SERIOUSNESS: That there is a genuine link or relationship between the known fact and the consequence drawn, which allows this to be considered in a logical order as extremely probable.
- ACCURACY: that the known fact or facts are fully and completely proven and are clearly revealing of the unknown fact that is intended to be demonstrated.
- CONCORDANCE: between all known facts that should lead to the same conclusion.
In simulations, the burden of proof lies with the party alleging them, so the Tax Agency, throughout the inspection, must demonstrate and justify that such simulation exists, sufficiently justifying it in the Conclusions and Settlement Report.
What happens if we are faced with an inspection procedure of a Company where it is accused of simulation?
The administration must prove the cause of the simulation. Who is the one invoking it. This accreditation must be sufficiently proven. The Court, Administrative Litigation Chamber, in judgment of September 29, 2005, indicates that: “for these purposes it must be taken into account that the aforementioned type of circumstantial evidence or presumptions are not only suitable, but are even necessary and, sometimes, essential when it comes to proving simulation,” especially with regard to the subjective element that comprises it.
It is known that simulation is not characterized by its evidence, since it operates within the realm of the parties’ intentions, so it will generally be necessary to resort to indications and presumptions to reach the conviction that a simulation has occurred.
Simulation has a factual component subject to the assessment or evaluation of the lower Courts and the result of that assessment is a question of fact, and its verification is the prerogative of the lower Courts.
Furthermore, according to Article 16.2 of the General Tax Law, the classification of an act or transaction as simulated by the Tax Administration will have no effects other than those related to taxation. This means that declaring an act or transaction simulated does not entail its nullity in Civil or Commercial Law. However, this does not mean that the Tax Administration considers simulated transactions null and void for tax purposes.
In summary Therefore, in an inspection procedure where the Tax Agency indicates that there is a simulation of a Company or that it is a shell Company, it is the administration that must prove that this simulation exists, providing circumstantial evidence, since, due to the intuitive nature of this type of inspection, it will be the Courts of first instance that assess the facts.
