The Supreme Court rules that Spanish tax legislation discriminates against nonresident hedge funds in Spain

Spain - 

Spain Tax Alert

According to the Court, nonresident hedge funds should be treated like residents if they prove that they are open-ended entities, that they have the relevant authorization, and that they are managed by an authorized management company pursuant to the terms of Directive 2011/61/EU.

In accordance with the Nonresident Income Tax Law, hedge funds resident in Spain are taxed at a rate of 1%, whereas hedge funds resident in other States are taxed at a rate of 19% (or at the more reduced rate resulting, as the case may be, from applying the relevant double tax treaty).

In a recent judgment of April 5, 2023, the Supreme Court (ruling on a proceeding in which Garrigues handled the case management) held that this different treatment is contrary to the free movement of capital regulated in article 63 of the Treaty on the Functioning of the European Union. 

In the Supreme Court’s opinion, the regulations in force in Spain for nonresident hedge funds are discriminatory and have no valid justification, so they must not be applied if the nonresident hedge fund’s characteristics are comparable to those of Spanish hedge funds. In other words, the treatment which the legislation establishes for resident hedge funds must be applied to them if the following requirements are met:

  • They are “open-ended”; that is, they raise capital contributions from the public in general (and any potential limitation on access by professional or qualified investors does not detract from that open-ended nature).
  • They are validly authorized to operate in their country of origin by the financial regulator equivalent to the Spanish National Securities Market Commission.
  • They prove that they are managed by an entity authorized to operate as an Alternative Investment Fund Manager pursuant to the terms of Directive 2011/61/EU.

According to the Court, the nonresident hedge fund has the burden to prove the fulfillment of these requirements. However, it clarified that due to the lack of specific regulations in Spain in this regard, a certain flexibility should be allowed, and they should not be required to furnish means of proof entirely equivalent to those required of Spanish hedge funds, or means of proof which are disproportionate or extraordinarily difficult to obtain. In addition, if the Spanish authorities have reservations about the documentation provided by the fund, they must initiate an exchange of information procedure with its State of residence.

Lastly, the Court concluded that the restriction on the free movement of capital could only be considered neutralized by the provisions of a double tax treaty if the treaty permits the hedge fund (not its members) to deduct the total amount of Spanish tax withheld in excess. However, given the way hedge funds operate and are taxed, that neutralization is impossible in practice.