How Brexit will affect the taxation of Spanish holiday homes
ARTICLE REVIEWED AND UPDATED 16 OCTOBER 2019. Alistair Spence Clarke, founding partner of Spence Clarke & Co. in Marbella, Spain, explains how Brexit will affect the taxation of Spanish holiday homes and investments. This includes rental income, inheritance/gift tax and deferral of exit tax among other points.
One of the unexpected consequences of Brexit will be that UK residents who have bought holiday homes or invested in Spain will suffer at the hands of the Spanish tax system. This is because of their loss of status as residents of the European Union (EU) or European Economic Area (EEA).
The problem arises because Spanish non-resident tax law mentions explicitly the EU/EEA status of taxpayers. EU/EEA resident individuals and companies are granted beneficial tax treatment compared with residents of the rest of the world.
|Spanish tax treatment: comparison of EU/EEA and non-EU/EEA status|
|Rental income received by UK resident individuals or companies
||Tax payable at 19%
||Tax payable at 24%
|Deductions are allowed for most property costs
||No deductions allowed. Tax applies to gross rental income
|Deemed rental income assessed on non-residents’ holiday homes
||Tax payable at 19%
||Tax payable at 24%|
|Dividends paid to a UK company that owns less than 10% of the share capital of a Spanish company
||No tax payable in Spain
||10% tax will be withheld in Spain
||Taxpayer may choose between the state
|The state system will be mandatory|
|Exit tax charged on unrealised capital gains when an individual leaves Spain
||In the case that the individual moves elsewhere in the EU/EEA, tax is deferred until the asset is sold or for 10 years
||No deferral. Tax has to be paid with the filing of the last annual Spanish tax declaration
|Capital gains tax on the sale of principal private residence when departing Spain
||In the case that the individual moves elsewhere in the EU/EEA, the capital gain is exempt if the net sales proceeds are reinvested in a new home
||No exemption from capital gains tax is available
The UK/Spanish double tax treaty of 2014 protects UK residents from some of the worst effects, but some potentially very serious disadvantages remain, as shown in the table.
EU/EEA residents are entitled to deduct reasonable property costs from rental income. These include maintenance, utilities, local taxes, community charges, loan interest, depreciation, rental agents and related legal costs. Tax is payable at the fixed tax rate of 19%.
However, non-EU/EEA residents pay 24% tax and cannot deduct any property costs, as illustrated in Example 1.
Deemed rental income on non-residents’ holiday homes
An oddity of the Spanish tax system is that all second homes are deemed to generate rental income that is assessed on the owner(s) as general income for income tax purposes. The ‘rental’ income is calculated at either 1.1% or 2% of the valor catastral (rateable value) of the property. 2% applies if the rateable value has not been revised during the previous 10 years, which is usually the case. UK residents will pay 24% income tax on this rent, instead of the current 19%.
Dividends paid by Spanish companies to a UK parent company
Spain’s adoption of the EU parent/subsidiary rules provides complete exemption of Spanish withholding tax when the parent company holds at least 5% of the Spanish subsidiary’s share capital or the cost of the shares exceeds €20m.
This will change with Brexit and article 10 of the UK/Spanish treaty will apply, requiring that the parent holds at least 10% of the Spanish subsidiary’s share capital. Otherwise, withholding tax of 10% will be applied to the dividend from Spain.
The Spanish inheritance/gift tax (IGT) system taxes each beneficiary, not the estate.
Non-Spanish-resident individuals are taxed on the acquisition by gift or inheritance of real estate or other assets located in Spain or subject to the jurisdiction of Spanish law (eg, shares of Spanish companies, bank accounts).
The 17 autonomous regions of Spain collect and regulate IGT but the state has its own system that only applies to non-resident beneficiaries. In effect, Spain now has 18 IGT systems.
The original state IGT system has hardly changed since it was enacted in 1987 but the autonomous regions, which started out with the state system, have made many changes over recent years.
As a result, the IGT systems in Spain now diverge considerably, to the extent that some regions have almost completely exempted IGT for close family inheritances whereas others have increased the tax rates.
The widely-diverging systems applicable to non-residents and residents result in the unfair treatment of non-residents. This was challenged in the tax tribunals and led to the Court of Justice of the European Union (CJEU) requiring Spain to adjust its tax treatment of EU/EEA citizens. Spain did this by simply granting EU/EEA residents the right to choose, as they preferred, the state IGT system or the IGT system of the autonomous region where property is located.
UK residents will lose this right when they cease to have EU/EEA resident status, as illustrated in Example 2.
Admittedly, this example is based on unusual circumstances, but it serves to emphasise how seriously Brexit will affect UK families with holiday homes in Spain. All the autonomous regions in Spain provide more generous IGT allowances than the state system.
In fact, for close family members, the Andalucia and Madrid regions provide a very generous exemption of 99% of the tax normally payable. It’s hard to imagine that these parts of Spain have become low tax jurisdictions!
The UK/Spanish tax treaty undoubtedly does much to protect UK residents, but it does not cover all the problems that will arise from Brexit. Inheritance tax falls completely outside the provisions of the tax treaty and the injustices this could cause are truly appalling.
Deferral of exit tax
In 2015, Spain introduced an exit tax. Individuals who leave Spain with investments exceeding €4m are liable to pay capital gains tax on the unrealised profit of their investments valued on the last day of the last year of assessment. The limit is reduced to €1m when the individual holds more than 25% of a company.
There is no right of set-off of any latent capital losses.
If the individual moves to another EU/EEA country then they benefit from the right to defer payment of tax until the sooner of either the disposal of the particular investment or 10 years.
The maximum capital gains tax rate in Spain is 23% and is the same in all the autonomous regions.
Individuals moving to the UK will lose this right of deferral.
Sale of principal private residence when departing Spain
In Spain, the sale of the principal private residence is not necessarily exempt from capital gains tax. Only those over the age of 65 benefit from a general exemption on tax payable on any capital gain. This applies as long as the individual has lived in the home for at least three years prior to the sale.
Other owners may only claim exemption where they invest the net proceeds of sale in a new home. Partial reinvestment results in pro rata exemption. A problem arises when an individual sells a home in Spain to move to another country; the exemption is lost unless the individual moves to another EU/EEA country.
Post-Brexit, persons moving to the UK will not be entitled to exemption on the capital gain on the sale of their homes.
The case for change
It is not common practice for the Spanish government, whatever its political persuasions, to make changes to tax law, even when it is obviously unfair, unless forced to by the CJEU or its Constitutional Court. Much as the UK is a very important source of buyers in the Spanish property market, this alone will not be enough to bring about a change in tax law for the benefit of UK residents.
Arguably, some of the areas of tax law analysed in this article contravene article 31 of the Spanish Constitution that requires the tax system to be 'just and inspired by the principles of equality and progressivity and never confiscatory'. The courts do eventually overturn bad law in Spain but the process is painfully slow, and tax has to be paid pending an appeal.
In the meantime, it will be all too easy for the Spanish establishment to simply brush aside criticism and claim that UK residents should suffer the consequences of their decision to leave the EU and that there is no justification for UK citizens to be treated differently from, say, residents of the US.
As to when the changes will kick in, at the time of writing we are awaiting the text of a new withdrawal agreement, assuming that a deal is finally made between the UK and the EU. Perhaps this will contain clarification as to whether EU status will apply to UK residents during the withdrawal period.
Jane bought an apartment in Spain with a mortgage and is renting the property until retirement when she will move to Spain. She receives €1,000 a month in rent, has property running and mortgage costs that total €8,000 a year and she is entitled to deduct depreciation of a further €3,000.
Pre-Brexit her annual net income of €1,000 results in annual tax of €190.
Post-Brexit she will pay tax of €2,880, ie, tax at 24% on her gross rental income of €12,000.
Jane will be €2,690 worse off post-Brexit. She will not be able to claim a tax credit in the UK for most of the extra Spanish tax because the UK system allows reasonable deductions for property costs and so she will pay little or no corresponding tax in the UK.
Peter dies after Brexit, leaving his holiday home in Andalucia, valued at €750,000, to his only son John. The property was originally owned by Peter and his wife, and Peter inherited his wife’s share on her death a few years ago. Peter and his wife were originally residents of Andalucia but when his wife died he decided to return to the UK to live with his family. The Spanish property was Peter’s only substantial asset.
John is subject to the state IGT tax system and is only entitled to deduct the tax-free allowance of €16,000. His IGT liability is €195,200. No UK IHT is payable on the estate because of the combined nil rate band of John’s parents and so John is not able to benefit from UK unilateral tax relief.
Had Peter died pre-Brexit, John would have paid no tax at all, because he would have had the right to apply Andalucia IGT which exempts inheritances valued up to €1m.
About the author
Alistair Spence Clarke, founding partner, Spence Clarke & Co. in Marbella, Spain, and member of bodies including Asociación de Asesores Fiscales de España