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Tax fraud in international loans and royalties; withholdings of non-residents

A publication issued by “infoLibre” media on February 22nd, 2021 reported that - as a consequence of a notice spread through the "Football Leaks" portal - Real Madrid apparently accepted a financial operation with a serious tax risk. Independently to the criteria that we may have concerning the news or with regard to anyone’s behaviour, it may be interesting to review this topic with a highlight on the relevancy of the concept of beneficial owner, when it comes to perform international transactions; in addition to the tax damage that may be caused by its incorrect application or interpretation.

Tax fraud in international loans and royalties

In fact, a closer view at the notice mirrors on a Spanish legal entity (in this case “Real Madrid”), who has made payments to a legal entity in another EU country, in this case Luxembourg. Our previous post refers to the European Council Directive 2003/49/EC, say: "Interest or royalty payments from a Member State shall be exempt from any tax on such payments (whether collected by withholding tax or by assessment) in that source State, provided that the beneficial owner of the interest or royalties is a company of another Member State, or a permanent establishment situated in another Member State of a company of a Member State".

Certainly, the controversy arises because the beneficial owner actually seems to be a company based in a country outside the European Union; in this case the Cayman Islands. Is that really a problem? Absolutely none! The directive would simply not apply, while the country issuing the payments usually would be obliged to make a withholding on account of non-resident income tax, in this case 24%, as the beneficial owner is from outside the EU (unless a possible agreement limits this taxation).

All this may seem to affect only large multinational companies, but this is not necessarily the case. Let us view the following example, which will give us an accurate idea of the impact:

Spanish company “X, S.L.” (of limited liability) enters into an agreement with Italian company “Y” to exploit its trademark, whilst execution of royalty payments of 100,000 euros per year. At first and by virtue of the aforementioned European Directive, these payments will be exempt from withholding tax in Spain and the Italian company will declare them as income for Italian corporate income tax purposes. However:

What would happen if the beneficial owner is, in fact, a company based in a third country “Z”?

The following scheme will help us to understand the differences:

For the Spanish company there is no difference, at all; it pays the same either directly to the owner of the royalty, or by making the relative withholding. However, if no withholding tax was applied but effectively due, then the Spanish tax department may require that amount. Subsequently, a disbursement of 100.000 € will additionally raise 24.000 € required by the Authorities (plus penalties and interest).

While some countries, such as Portugal, do have specific procedures for this purpose, the form does not officially exist in Spain, by now. Other means for compliance shall apply.

Therefore, when working with non-resident companies, we recommend reviewing the performances "a priori" to avoid problems "a posteriori". In too many cases, bearing the initial cost of analysing a transaction accurately will turn into a very profitable investment, in the future.

Do you need further assistance with this? Contact us. Our International Department will be glad to help you.

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