Spain: First Draft Of The Bill Of Law Governing Spanish REITs

The Spanish Ministry of Economy and Tax has published a first draft of the Bill of Law governing Spanish REITs¹, the so-called Sociedades Anónimas Cotizadas de Inversión en el Mercado Inmobiliario² (SOCIMIs).

This Alert summarizes the most important tax and legal features of SOCIMIs. In future alerts we will provide a more comprehensive analysis of certain specific issues and report on the parliamentary progress of the mentioned Bill of Law.

1. Main corporate features

• SOCIMIs must be limited companies³ with the following main corporate purpose:

• In addition to the above, SOCIMIs may carry out ancillary activities.

• SOCIMIs must be listed on a regulated Spanish market or that of a European Union or European Economic Space Member State.

• SOCIMIs can only issue one class of shares.

• SOCIMIs shall have a minimum share capital of 15 million Euros and contributions in kind must be valued by an independent expert.

2. Investment requirements

Asset rules: SOCIMIs must have invested at least 90%⁴ of their total asset value in (i) urban property used for leasing which is located in Spain or in countries or territories with which there exists an effective exchange of tax information, and (ii) holdings in other SOCIMIs or REITs.

Income rules: at least 90% of the income earned during the tax year, excluding income from the transfer of the abovementioned property and holdings, must come from the leasing of qualifying property and dividends produced by holdings in other SOCIMIs or REITs.

Leverage: net equity must not account for less than 45% of the value of the qualifying property and holdings held by a SOCIMI. This requirement implies a maximum gearing of 55% for SOCIMIs.

Minimum property holding period: property comprising the company's assets must remain leased or offered for lease for a minimum period of three years, unless the property has been developed by the SOCIMI, in which case this period will be seven years.

3. Distribution obligations

SOCIMIs must distribute to their shareholders⁵ on a yearly basis:

• At least 90% of the profits derived from qualifying leased property and dividends from holdings in other SOCIMIs or REITs.

• At least 50% of the profits derived from the transfer of qualifying property and holdings. All remaining profits of this nature may be reinvested in other qualifying property or holdings during the next two tax years to that in which the profits were generated. Otherwise, said profits will have to be distributed, together with the profit earned in the second such tax year.

4. Special tax regime

Election

• The election to be subject to the SOCIMI regime must be approved at the General Shareholders' Meeting and notified accordingly to the office of the Spanish Tax Authorities corresponding to the company's registered address, within the last three months of the relevant tax year. Notification after such term will result in refusal of the special regime for the tax year concerned.

• The special tax regime will apply during the tax year that concludes after the notification has been made and thereafter to the tax years concluding prior to the date upon which the special regime is renounced.

• The option to be subject to this regime is incompatible with other special regimes governed by the Spanish Corporate Income Tax Act (CITA), as amended by Royal Legislative Decree 4/2004, dated 5 March, except with respect to Mergers, Spin-offs, Contribution of Assets and Exchange of Securities, Controlled Foreign Corporations and particular Financial Lease Agreements.

Special tax regime applicable to SOCIMIs

• There is 0% taxation of the taxable base comprised of income derived from qualifying property leasing, transfer of such property and dividends and income derived from the transfer of qualifying holdings.

• The 0% taxation will not be applicable to the pro-rata share of the profits obtained by a SOCIMI that corresponds to shareholders having (individually or jointly with other group entities⁶) a stake in the share capital of the SOCIMI of 5% or more. Such profits will be subject to the standard 30% CIT rate at the level of the SOCIMI. This tax cost will however be passed on to such shareholders when profits are distributed⁷, so that it does not have an impact on any other shareholder. This tax penalty on shareholders owning 5% or more is intended to discourage the existence of relevant or majority shareholders.

• Losses derived from qualifying activities cannot be offset against profits resulting from non qualifying activities⁸.

• Dividends distributed by SOCIMIs are subject to withholding tax (at an 18% rate under Spanish domestic law).

Special tax regime applicable to the shareholders of a SOCIMI

• Dividends distributed out of profits taxed at the 0% rate will not benefit from any tax credit or exemption for avoiding double taxation.

• Capital gains obtained on the transfer of the shares of a SOCIMI will be characterized as dividends for tax purposes. Income derived from securities lending concerning SOCIMIs shares will also be characterized as dividends for tax purposes.

• In this way, the typical REIT objectives of tax neutrality and elimination of double taxation are achieved, as there will be a single level taxation (at the shareholder level). Furthermore, annual distribution obligations (see section 3) will avoid tax deferrals.

• In the case of Spanish individual resident investors, there will also be an income "conversion" effect, given that income derived from an investment in a SOCIMI will be considered as "savings income" for tax purposes and as such be taxed at the reduced 18% rate (whereas real estate income is taxed at bracket rates which can be as high as 43%).

5. Rules applicable to the commencement – end of the special tax regime

Commencement of the special tax regime

• All carried forward tax losses generated in years where the company did not have SOCIMI status can only be offset against non qualifying income subject to the standard 30% taxation.

• Taxation of capital gains derived from qualifying property or holdings existing prior to the commencement of this regime and transferred in a SOCIMI tax year:

End of the special regime

• Once the company has lost SOCIMI status, surplus negative qualifying income with respect to positive qualifying income obtained during SOCIMI tax years may be offset against positive income obtaining in tax years in which the company is subject to the standard 30% taxation. For such purposes, the tax losses carry forward year of 15 years shall begin at the end of the tax years in which such negative income was obtained until the surplus is reached.

• Income that has been subject to the 0% rate and has not been distributed by the SOCIMI is to be taxed in the first tax year in which the company becomes subject to the standard 30% taxation, except when such profits are distributed during the last SOCIMI year.

• Taxation of capital gains derived from qualifying property or holdings existing upon commencement of the tax year in which the company becomes subject to the standard 30% taxation, which are subsequently sold in non SOCIMI tax years:

• With regard to the rules governing the transition to the special tax regime, mention should be made of the absence of an exit tax⁹. Bearing in mind the current economic downturn, it appears that Spanish legislators have opted for a tax neutral model (with no exit tax) that does not trigger tax costs upon the transformation of a standard company into a SOCIMI.

6. Reporting obligations

SOCIMIs are subject to certain reporting obligations with third parties (annual accounts), their shareholders (for correct taxation thereof) and the Tax Authorities (correct application of the special tax regime, in particular with respect to the existence of shareholders with stakes equal or higher than 5% of the SOCIMI).

Footnotes

^{1. Real Estate Investment Trusts.}

^{2. Listed Public Limited Investment Companies in the Real Estate Market.}

^{3. Sociedad Anónima.}

^{4. This threshold should be closely observed during the parliamentary process, given that in the Ministry of Economy and Tax press release dated 19 September 2008, it was announced that the percentage would be 75%. In addition, 90% would contradict the threshold of 75% mentioned in article 11.1.e) of the mentioned Bill of Law.}

^{5. After complying with the relevant corporate obligations.}

^{6. In the sense of article 42 of the Spanish Commercial Code.}

^{7. Pursuant to the rules established in article 6.2 of the Bill of Law.}

^{8. However, it will be possible to use carried forward losses derived from qualifying activities once the company looses SOCIMI status, as explained in section 5.}

^{9. Reduced exit taxes have been used in other jurisdictions (for example, in France).}

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.