On 14 January 2013, Spain and the United States signed a new Protocol ("the Protocol") amending the 1990 Tax Treaty. Under the Protocol, both countries agreed to substantial changes to the original Tax Treaty, entailing significant reductions in the taxation of payments and transactions between both countries. Since then, the entry into force of the Protocol had been blocked in the United States as a result of the political logjam. This logjam was finally unblocked on 16 July by the approval of the Protocol in the US Senate.
The Protocol introduces significant amendments to the Treaty and the following areas are particularly relevant: withholding rate reductions on dividend, interest and royalty payments; branch taxation; limitation of source-country taxation on capital gains; and important changes to the limitation on benefits clause and the mutual agreement procedure.
Withholding rate reduction over dividends, interest and royalties
The Protocol allows for source-country taxation over dividend distributions, but with the following maximum rates:
- 15% as a general rule;
- 5% withholding where the dividends correspond to a minimum holding of 10% of the voting rights; and
- No withholding in the case of a minimum holding of 80% of the voting rights, held during a minimum 12-month period prior to the determination of the entitlement to the dividend.
In order for this exemption to apply, the Protocol also requires that the shareholder comply with a series of requirements from the limitation on benefits clause. These requirements are stricter than those which would result from the direct application of the limitation on benefits clause, with a view to preventing restructurings designed solely to benefit from this exemption.
It is worth noting, also, that the Protocol affords a less favourable treatment to dividends from real estate investment vehicles and collective investment schemes, since it does not allow for the 5% reduced rate and only grants the 15% rate (and in the case of Spanish REITs, only if the holding from the US shareholder does not exceed 10%).
The Protocol gives a more favourable tax treatment to dividends since, under the previous wording of the Treaty, although the general withholding rate was also 15%, the only reduced rate available was 10% and a minimum holding of 25% was required.
As regards interest payments, the general rule is an exemption from source-country taxation. The Protocol, however, provides two anti-abuse exceptions on interest arising in the United States. The first exception relates to "contingent interest", which would not qualify for a domestic exemption and therefore, non-resident creditors may not benefit from a treaty exemption either (a 10% withholding rate would apply). The second anti-abuse exception relates to interest connected with special investment vehicles ("real estate mortgage investment conduit" – REMIC), which will be taxed in accordance with US law.
Note that, under the current Treaty, interest payments are subject to a 10% withholding rate, although exemptions apply in certain cases: for example, long term loans from financial institutions or interest connected to the sale on credit of industrial, commercial or scientific equipment.
Additionally, the Protocol also provides for a general source-country exemption for royalties. The definition of royalties under the treaty is simplified, so that payments for technical assistance and gains derived from the transfer of rights or properties included in the royalty definition will no longer be themselves considered royalty.
Source country taxation on capital gains
As an important amendment, the Protocol also removes the possibility to tax capital gains derived from the transfer of a holding in an entity, in which the non-resident shareholder has held at least 25% during the previous 12-month period.
The Protocol includes, as a new provision, the possibility for States to tax capital gains derived from the transfer of shares or other rights, which may entitle the owner to the enjoyment of immovable property located in the source country.
In contrast, the Protocol maintains the source-country taxation of capital gains resulting from the transfer of real estate located in the source country or attributable to a permanent establishment in such country. Moreover, Spain maintains its right to tax capital gains deriving from the transfer of stock (or other rights) in an entity, most of the assets of which are directly or indirectly real estate located in Spain.
The Protocol deletes the article specifically covering branch taxation, which allowed for withholding at the rate of 10%. Branch taxation is, however, not removed since it will be covered under the same article as dividend taxation, although the rate is reduced to 5%.
The new drafting of the limitation on benefits provision is also worth mentioning. The clause contains anti-treaty-shopping provisions. In general, the provision does not rely on a determination of purpose or intention but instead sets forth a series of objective tests. A resident of a Contracting State that satisfies one of the tests will be eligible for the benefits of the Treaty.
Finally, the mutual agreement procedure is completed with a mandatory arbitration clause. Where the competent authorities of both States have been unable to reach an agreement after two years since the initiation of the mutual agreement procedure, the case will be resolved through mandatory binding arbitration. Note that exceptions to this mandatory arbitration are allowed since, for instance, States can agree that a case is not suitable for arbitration.
Entry into force
The Protocol will enter into force 3 months after both countries have notified each other, through diplomatic channels, that they have competed all required internal procedures for entry into force. The provisions of the Protocol will then have effect:
- With respect to withholdings, on or after the date of entry into force;
- With respect to taxes determined by reference to a taxable period (for example, permanent establishment taxation), in taxable periods beginning on or after the date of entry into force;
- In all other cases, also on or after the date of entry into force.