Carried interest taxation under Spanish Personal Income Tax (IRPF)

With effect from January 1, 2023, Act 28/2022, of December 21, to boost the startup ecosystem, introduced an amendment to the Spanish Personal Income Tax Act (additional provision 53) regulating the tax treatment of carried interest. This term refers to the additional remuneration to the managers of certain investment entities (mainly private equity and venture capital) for successful management.

Under the caption "Income from employment derived from the management of funds linked to entrepreneurship, innovation and development of economic activity", this provision classifies as income from employment—50% of which may be included in the general tax base—any income derived directly or indirectly from equity, shares or other rights (including success fees) that grant special economic rights in certain closed-end entities regulated in Directive 2011/61/EU, and in other similar investment bodies, if they also meet a series of requirements. A detailed analysis of the approved regulation can be found in our Legal Flash | Keys to the "startups" act and in our Post | New developments relating to carried interest.

Since its entry into force, the approved regulation has raised certain interpretation-related doubts in the sector. The DGT has responded to these doubts in its binding tax ruling of July 31, 2023 (V2295-23). The following are the criteria provided by the DGT:

Clarification of the type of foreign entities included in the scope of application of the regulation

For the above tax treatment to be applicable, additional provision 53 of the Spanish Personal Income Tax Act stipulates, among other requirements, that the income from employment must come from the ownership of equity, shares or other rights (including success fees) that grant special economic rights in the following entities set out in paragraph 2: (i) venture capital entities foreseen in article 3 of Act 22/2014; (ii) European venture capital funds; (iii) European social entrepreneurship funds; (iv) European long-term investment funds; and (v) other investment bodies similar to the above.

As regards the interpretation of the expression "other investment bodies similar to the above", a doubt has been raised in relation to foreign investment vehicles. Although the DGT indicates that no generalization can be made as to which foreign investment vehicles can be considered "similar" to the above and that a case-by-case analysis should be carried out, foreign venture capital entities that meet the requirements set out in article 14.2 of Act 22/2014 regulating venture capital entities and other closed-end collective investment entities, they can indeed be considered similar investment vehicles for the purposes of the mandatory investment ratio of Spanish venture capital entities. This article refers to venture capital entities that meet the following requirements:

• They are established in EU Member States or in third countries that do not appear on the list of non-cooperative countries and territories of the Financial Action Task Force on Money Laundering and have signed a double taxation agreement with Spain that includes an exchange of information clause or an agreement for the exchange of information on tax matters.
• They carry out activities similar to those of the venture capital entities regulated in Act 22/2014, without the need to comply with the investment diversification ratios.

The DGT also points out that this equivalence does not exempt foreign venture capital entities from complying with the rest of the requirements of additional provision 53 of the Spanish Personal Income Tax Act, particularly the requirement that the special economic rights do not come directly or indirectly from entities resident in countries or territories classified as non-cooperative jurisdictions or with which there are no regulations on mutual assistance in the exchange of tax information.

Application of additional provision 53 of the Spanish Personal Income Tax Act to bonuses or incentives received by directors, managers or employees of the entities listed in paragraph 2 that are linked to the carried interest to which such entities are entitled

In certain cases, the special economic rights (bonuses or incentives) that generate income from employment are not attributed directly to the directors, managers or employees of the entities referred to in paragraph 1 (listed in paragraph 2) but are attributed directly to the entities themselves, in such a way that the directors, managers or employees obtain income that is determined and settled on the basis of such rights. These situations are relatively frequent, whereby the management company (or an entity of its group) is generally the holder of the special shares or equity or the success fee, and in turn has attributed all or part of the carried interest to its directors, managers or employees.

In remuneration structures such as the one indicated above, the question could arise as to whether the tax framework under additional provision 53 could be applied. The DGT is in favor of this treatment, insofar as the right to receive the bonus or incentive and the amount arise from equity, shares or other rights that grant special economic rights in the entities listed in paragraph 2 of additional provision 53.

Partial collections of carried interest before the five-year holding period required for equity, shares or other rights

Among the requirements stipulated in additional provision 53 of the Spanish Personal Income Tax Act for applying the carried interest tax framework is that the special economic rights derived directly or indirectly from equity, shares or other rights (including success fees) must be held for a minimum of five years, unless there is a causa mortis transfer, they are settled early or become ineffective, or they are totally or partially lost as a result of a change of management company, in which case, they must have been held uninterruptedly until such circumstances occur.

The approved regulation could raise doubts regarding whether the five-year holding period requirement should be construed as having been breached if the carried interest is received before the end of that period.

In relation to this issue, the DGT points out that advance collection of carried interest can be made before the five-year period has elapsed—even in cases other than those granted an exception under the provision—without this giving rise to a breach of the requirement as long as the economic rights, shares or equity continue to be held until the end of the above period.

Likewise, the DGT indicates that, where the carried interest has been received before the expiry of the five-year period—with its collection being subject to the tax framework set out in additional provision 53—if, subsequently, the above holding period is not completed, the taxable person would be required to regularize the tax situation under the terms of article 122 of the General Tax Act. In other words, the taxable person would have to include, within the tax period in which the holding period requirement was not met, the tax liability for 50% of the income from employment that was not included in the tax base, together with the applicable late payment interest.

Withholding tax

The DGT has clarified that the withholding base to be considered by the entity making withholdings of income from employment subject to the framework set out in additional provision 53 will be equal to 50% of the sums paid to the taxable person. This is so because the 50% inclusion rule provided in that provision is not a tax reduction or a partial exemption, but rather a rule of non-inclusion of income in the tax base.

Finally, the DGT points out that the applicable withholding rate will be 35% if the income from employment referred to additional provision 53 is received by the taxable person as a director or member of a representative body. If it is received as an employee, the applicable withholding percentage will be the one resulting from the calculation procedure set out in articles 80 et seq. of the Spanish Personal Income Tax Regulation.