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The term Asset Entity is not defined in a single way for the entire Tax field and often leads to confusion.
It is generally understood to be an Entity that does not carry out any activity and, since it has not been liquidated and dissolved, is obligated to file periodic Tax Returns. Or, it can be understood as one that only owns Properties.
However, the concept of a Patrimonial Entity is different depending on the tax we are referring to, and therefore the consequences are also different.
In fact, it can happen, for example, that an entity is considered a Holding Company for the purposes of Corporation Tax and not for the purposes of Wealth Tax, and vice versa.
In upcoming posts we will discuss the concept of asset Entity for the purposes of Wealth Tax, focusing this time on the concept of assets in the field of Corporate Tax.
Asset-Holding Entity for the purposes of Corporation Tax
Article 5 of the Corporate Income Tax Law defines the concept of economic activity as “the organization on one’s own account of the means of production and human resources or one of both with the purpose of intervening in the production or distribution of goods or services.”
And this same precept indicates that Patrimonial Entity, and therefore an entity that does NOT carry out economic activity, is understood to be one in which more than half of its assets are made up of securities or goods not related to an economic activity.
This definition has historically raised the complexity of knowing which goods are considered not related to an economic activity.
Specific case of Real Estate leasing activity
For the activity of leasing Real Estate, the Corporate Income Tax Law defines that, in order for it to be considered an economic activity, it must use “at least one person employed with a full-time employment contract.”
This definition, which had historically been required for the purposes of Personal Income Tax, was added by Law 27/2014 on Corporate Income Tax and has given rise to various interpretations, case law and many problems, for the reason that we explain below.
In general, the jurisprudence and doctrine of taxes are unanimous that, although the employed person is an essential requirement, it will not be sufficient if the workload generated by the leasing activity does not justify having an employee, and it may be a mere unreal appearance of the existence of economic activity.
However, case law has not addressed the existence of a minimum number of properties or their complexity, in a way that would automatically and objectively justify the need for a full-time employee, leaving it to the discretion and assessment of the Administration’s verification bodies, which creates a situation of legal uncertainty and implies having to analyze each specific case separately.
The Directorate General of Taxes has consistently acknowledged, within the framework of Corporate Income Tax, that in the case of complex leased properties, the management of resources can be subcontracted to a specialized company (for example, a property manager or a Real Estate Agency) in order to be considered as an economic activity.
Similarly, in the case of groups of companies under Article 42 of the Commercial Code, the requirement of an employee with a full-time employment contract may be met by a person employed by another of the companies in the group.
What is meant by an Asset related to an Economic Activity?
Since Corporate Tax regulations do not expressly regulate this concept, to know what is considered an asset used in an economic activity it is necessary to refer to Personal Income Tax regulations, which list them as follows:
- The Real Estate where the taxpayer’s activity is carried out.
To do this, it will be necessary to analyze the activity carried out by the Company to know if it is considered affected, with the special complexity posed by the particular cases of the activity of buying and selling real estate or real estate development that usually require an individualized analysis of each case.
- The goods are intended for the economic and sociocultural services of the personnel serving the activity.
- And, on the contrary, Leisure and Recreation Assets or assets for the private use of the owner of the economic activity are NOT considered to be affected (example of the partner’s private house, boats, villas, chalets).
- Any other assets that may be necessary to obtain the respective returns.
This very small number raises the question of what happens to the money, treasury and various credit rights that the Company may have in its assets.
What happens to a Company’s Treasury and accounts receivable?
In this regard, the Corporate Income Tax regulations allow the money and credits derived from transfers of elements related to economic activity to be considered as an asset for 3 years, that is, the year in which it is transferred and the two subsequent tax periods.
However, it is clear how complex it is for the taxpayer to distinguish which part of the money they have in cash comes from an “affected” transfer and which does not.
In summary, we could understand that (i) money from transfers of affected assets, (ii) money from the ordinary activity of providing goods and services, (iii) cash corresponding to dividends from affected shares and (iv) customer credit rights; could be considered as affected assets in general terms.
And what about stakes in other Companies and loans granted?
In the case of shares, stocks and transfers of capital to third parties (deposits, loans, etc.), the regulations expressly state that they will not be considered as affected assets.
However, the Corporate Income Tax regulations expressly stipulate that the following are not considered as non-taxable Assets:
- Those possessed to comply with legal and regulatory obligations.
- Credit rights arising from commercial relationships inherent to the Company’s economic activity.
- Those owned by the company as a consequence of its own social purpose (stock).
- And those that represent a participation of at least 5% in the subsidiary and are held for a minimum period of 1 year, with the purpose of directing and managing said participation in an entity that, in turn, is not considered to be asset-based.
This regulation leads us to consider as non-affected assets all other shares/holdings that the Company may have (for example, in investment funds or stock market shares), as well as deposits and loans granted of any kind.
Once it has been determined which elements of the balance sheet are related to economic activity and which are not, the average of the quarterly balance sheets must be calculated in order to determine if the related assets exceed 50% of the total assets of the Company.
As you can see, in some cases it can be extremely complex to determine whether a Company is a Holding Company or not. And whether or not it is a Holding Company can be extremely important for the tax reasons we will explain below.
What are the consequences of my Company being considered a Patrimonial Entity?
The Corporate Income Tax Law excludes some tax incentives for Companies that are considered Asset-Holding Companies:
- The Entity will not be entitled to apply the 15% tax rate provided for newly created companies during the first two years in which they generate profits.
- There will be no right to apply the regime for holding companies of foreign securities (ETVE), which is normally used in cases where the holding entity invests in foreign companies that carry out economic activity.
- In the event of a change in the Company’s shareholding, the new partners will not be able to apply the negative bases pending compensation that the acquired entity may have, in order to prevent the purchase of inactive entities solely for that purpose.
- The Company will not be able to apply any of the tax incentives provided for small businesses, namely:
- Freedom of depreciation of new tangible fixed assets and new real estate investments.
- Accelerated (double) depreciation of new asset items.
- Overall deterioration of 1% of outstanding credit rights at year-end.
- Leveling reserve.
- If an Entity is a Holding Company, its partner will not be able to apply the exemption of article 21 of the Corporate Income Tax Law for the capital gain generated in the event of the transfer of its shares or in the event of the liquidation of the investee entity.
Finally, it is necessary to mention that in those cases where, in addition to half of the assets not being used for an economic activity, the Company does not carry out any economic activity and therefore does not issue invoices, the non-deductibility of the expenses incurred could be considered as they are not correlated with the generation of income.
These assumptions usually arise in cases of Entities whose only asset is the housing of their members, without carrying out any economic activity, since they are charged an estimated monthly rental amount that is never actually paid by them.
Therefore, and given the negative consequences of being considered a Holding Company, it is highly recommended to carry out prior Tax planning that allows for a detailed analysis of the specific circumstances of each Company and, even in the case of an Entity that carries out an economic activity, but also possesses a series of assets not related to it (or even for the personal use of the partners and administrators), to consider whether it is advisable to restructure in order to separate the economic activity and related assets from the non-related assets into different entities.
Finally, other consequences would arise regarding the personal taxes of the partners in this Asset-Holding Company; that is, beyond Corporate Tax, we are referring to the implications for Wealth Tax and Inheritance and Gift Tax. While we will address these implications in our next article on Asset-Holding Entities, we provide some details below:
It could happen that the Company’s shares are valued in a way that requires them to be included as non-exempt in the Wealth Tax return, with the consequent increase in personal taxation, which would depend on said valuation, but which can have a tremendous impact to go from being considered non-wealth to wealth, especially when the Tax Agency can settle the last four years of all these taxes.
