Editor’s note: This article was first published in November 2014. It describes the Spanish tax reform approved by Congress on 20 November 2014 and in force from 1 January 2015, with rates for 2015 and 2016. Tax brackets, rates and limits have changed since, so it should be read as a 2014 snapshot, not current tax guidance.
Article provided by the financial department of Aspain11.com, Asesores Financieros EAFI (an independent financial advisory firm).
Last Thursday, 20 November, Spain’s Congress passed the new law reforming the country’s tax system, which will come into force on 1 January 2015.
The government had hoped to pass an ambitious law overhauling the entire tax system, both the taxes themselves and how powers are shared out, but the difficulties of changing the system for financing the autonomous regions meant that the law, although very significant in content, “only” covers personal income tax (IRPF) and corporate tax (Impuesto de Sociedades) for the most part, with smaller effects on other taxes. This tax reform introduces numerous changes concentrated in five key areas:
- Reform of employment income
- Wealth tax
- Taxes on homes (sale, rental, dación en pago)
- Reform of the taxation of investment products
- Reform of business taxation
1) Reform of employment income
The main change to personal income tax is the new distribution of tax brackets and the reduction in tax rates.
The first difference is the smaller number of brackets: we go from seven to five next year. This is mainly because the top brackets of the previous model have been merged; in fact, from €60,000 a year upwards a single rate of 47% will apply in 2015, and 45% in 2016. In the lower brackets, on the other hand, the bands become finer.
What we do see is a general reduction in tax rates. At first glance it might seem that the highest incomes will save the most, but in percentage terms the lowest incomes will save 9.4% in 2015 compared with 2014, while the highest will cut their tax bill by 5%.
Middle incomes, although they do get a reduction, benefit the least: for a worker earning €35,000, the saving compared with 2014 would be 3% of the amount paid to the Spanish state. Finally, it’s worth stressing that the autonomous regions control 50% of income tax. We can already anticipate that regions such as Madrid, Castilla y León, Castilla-La Mancha, Cantabria and Aragón will generally set lower rates than the state, while the regions with higher taxation will be Andalusia, Catalonia and the Valencian Community.
2) Wealth tax
This extraordinary tax was not included in the tax reform; however, the Spanish government decided to approve an amendment so that it continues to apply for one more year. The tax applies to net wealth above €700,000, except in Catalonia, where the threshold is €500,000, and in the Community of Madrid, where the tax has a 100% rebate. It does, however, come with various exemptions.
The first general exemption is €300,000 for your main home. Another limit on the tax is that the combined amount of wealth tax and income tax can never exceed 60% of the total income tax bases. Finally, it’s worth noting how assets will be valued:
- Real estate: the highest of the cadastral value, the purchase price or the value assessed by the tax authorities.
- Bank deposits: the higher of the balance at 31 December or the average balance for the last quarter.
- Investment funds: net asset value at 31 December.
- Other listed securities: average market price in the fourth quarter.
- Household contents: market value.
3) Taxes on homes (sale, rental, dación en pago)
First, let’s look at how the tax reform deals with home sales. The key change here is the removal of the inflation adjustment coefficient, which let you deduct the part of the capital gain on a property sale that was due to inflation. So now, if you sell a property for €250,000 that cost you €200,000 in 2000, you’ll be taxed on the full €50,000 gain.
On the other hand, the abatement coefficients for those who bought their property before 1995 have been kept, but with a cap of €400,000 in sale value. This means that a property or asset worth more than that can only apply these coefficients, and the reduction they bring, to the gain corresponding to the first €400,000 of value, and must pay tax in full on the rest of the gain.
What’s more, this can’t be used for each property or asset separately: the tax authorities cap the overall total of capital gain transactions at €400,000. So if we sell one property for €250,000 and another for €250,000, we won’t be able to apply the abatement coefficient to the full gains from the sale of both. We’ll have to apply it to the gains corresponding to €250,000 of value of one property and €150,000 of the other, and pay tax in full on the gain corresponding to the remaining €100,000 of the second property’s value.
Since the older the property, the higher the coefficient, it will pay to sell the oldest asset first to get the maximum tax saving.
As for rentals, the main changes are the end of the deduction for tenants renting their main home with incomes below €24,107, and the end of the 100% exemption for landlords who rented to people under 35.
Finally, for dación en pago (handing a property over to the bank to settle the mortgage), the capital gain arising from the transaction will be exempt from tax.
4) Reform of the taxation of investment products
For investment products, this tax reform brings some improvements over the current law. First, the tax rate applied to capital gains and savings income is reduced.
However, there’s bad news for small investors: the first €1,500 received in dividends, which until now were tax-exempt, will be taxed in full at 20% once this law comes into force.
But the big change in this area concerns short-term stock market investments.
Until now, stock market gains generated in less than a year were treated as employment income, taxed at high rates that could reach 52%, or even 56% in some regions. Under the new reform, these gains will be taxed as savings income, so the lower savings rates will apply.
There are also changes to pension plans: the deductible contribution has been cut from €10,000 a year to €8,000 as a general rule, which mainly hurts people over 50, who were allowed to contribute up to €12,500 a year.
On the other hand, the reform brings an advantage: as had been anticipated, liquidity windows will be introduced every 10 years, during which withdrawing money from a pension plan won’t carry a tax penalty. Withdrawals outside these windows will be taxed as before, as employment income.
For shares bought before 1995, the same rule as for homes will apply: the sale amount will count towards the €400,000 cap on the sale value of all such assets in order to apply the abatement coefficient explained in the previous section. This will also extend to investment funds bought before that date.
Alongside pension plans, a new savings product has been created: “Ahorro 5” plans. These plans, with a maximum contribution of €5,000 a year and 85% of the investment guaranteed, are tax-exempt. They are designed for five-year savings, and money can be moved between products of this type at no tax cost.
Finally, it’s worth pointing out the changes for investment in debt: once the reform comes into force in 2015, tax rates will be lower and gains generated in less than a year will be taxed like shares, which favours investing in debt.
5) Reform of business taxation
In this section we look at how the new tax reform affects the self-employed, SMEs and companies.
The self-employed
Under the current law, the self-employed have 21% income tax withheld, but under this law the withholding rate will be 19% in 2015 and 18% in 2016. For self-employed workers with income below €15,000, where this makes up less than 75% of their total income, the 15% withholding rate introduced in July remains in place.
There are also changes to the module system (Spain’s simplified flat-rate regime), which sets a ceiling of €450,000 in revenue and €300,000 in expenses for using it.
SMEs
At present, SMEs with profits of up to €300,000 are taxed at 25%, while profits above that amount are taxed at 30%. With the reform, on the view that this discourages growth, a general rate of 25% is introduced, so that from 2016, whatever their profits, they will always pay 25%.
But this won’t be the effective rate, because a mechanism called the “levelling reserve” (reserva de nivelación) has been created, which will allow SMEs to set aside up to 10% of their profits to offset possible losses over the next five years; if they don’t make losses, this amount must be paid at the end of the period.
The exception is what the Entrepreneurs Act provides for newly created companies, which will be taxed at a reduced rate of 15% on profits up to €300,000 and 20% on the excess.
Companies
With this new tax reform, the headline corporate tax rate falls to 28% in 2015 and again to 25% in 2016. On the other hand, tax incentives such as the deduction for reinvesting profits or for environmental investment disappear. Another incentive that goes is the deductibility of impairment losses on property, plant and equipment.
A cap on the deductibility of financial expenses is also set at 30% of operating profit, with the aim of discouraging capitalisation through borrowing. In line with this measure, a reduction of up to 10% in the tax base has also been introduced for companies that increase their equity. Practically the only deduction that remains is the one for R&D and innovation.
Finally, there are also changes to dismissals: a general exemption of €180,000 has been set for severance pay, and amounts above that will be taxed as employment income.
So, depending on your financial and tax planning, there’s still time to get ahead of the changes if you’re considering a major divestment (selling a property or an investment portfolio) or investment, bearing in mind the tax changes coming in.
Featured image: Javier Perez Montes, CC BY-SA 4.0, via Wikimedia Commons.
