An income reclassification cannot be used when a conflict in the application of tax provisions procedure should have been initiated

Spain - 10 / 01 / 2022

Spain Tax Commentary

A conflict in the application of tax provisions procedure requires a prior favorable report by the consultative committee as specified in article 159 of the General Taxation Law (LGT). Any assessments issued without implementing these guarantee mechanisms must be deemed null and void.

The National Appellate Court examined a personal income tax adjustment. The source of the adjustment was in a purchase of treasury shares by a company from several of its shareholders for their later redemption. According to the auditors, the purpose of the company’s capital reduction was not to redeem treasury shares, but rather to repay contributions to shareholders and they therefore reclassified the shareholders’ income from capital gains to income from movable capital.

In its judgment on November 18, 2021 (appeal 599/2018), the National Appellate Court examined whether the case involved a conflict in the application of tax provisions (as defined in article 15.2 of the General Taxation Law) or, to the contrary, a classification issue related to article 13 of the General Taxation Law, according to which tax obligations must be sought based on the legal nature of the fact, act or transaction, whatever form or nature taxpayers have given to them.

The auditors had implemented this last approach (reclassification). The appellant, however, considered that the first approach (conflict) should have been implemented, and therefore, because the steps legally required for this second type of procedure had not been implemented (including requesting a prior favorable report from the consultative committee as specified in article 159 of the General Taxation Law), the tax authorities’ assessment was null and void.

The court concluded that, because the auditors found that only a capital reduction with repayment of contributions had been carried out and that the single reason for using two transactions (purchase and capital reduction) was to evade tax, the company had to:

Reclassify the performed legal transactions through the conflict in the application of tax provisions procedure, report that the performed transactions were incorrect and describe which transactions would have been correct.
Request a prior favorable report from the consultative committee.

Therefore, because this procedure had not been implemented, the assessment at the root of the examined appeal had to be voided.

It needs to be underlined that before the judgment, the Valencian High Court had delivered other judgments in proceedings brought by the other shareholders that sold their shares, and reached the same conclusion. The National Appellate Court therefore held that it was compelled to reach that conclusion, in any event, under the principle of consistency, as an expression, in turn, of the principles of equality and legal certainty recognized in article 14 and article 9.1 of the Constitution, bearing in mind that it is the same legal transaction that is being examined in each case.