The consideration of financial assets as held for the purposes of the family business activity – Specific reference to Spanish Inheritance and Gift Tax

The issue arises as to whether the Inheritance and Gift Tax benefit applicable to the acquisition of family businesses (be it inter vivos or mortis causa) should be reduced in the amount of cash or cash equivalents and financial assets registered as part of the company's assets. One could also argue, on the contrary, the tax benefit should also cover these items, insofar as they can be considered as held for the purposes of the economic activity of the business.

At State level and, to a similar extent, at the level of certain Autonomous Regions, Spanish Inheritance and Gift Tax provides for a reduction in the taxable base covering 95% of the value of the family business, provided certain requirements are met. Among such requirements, the company must have been exempt for the purposes of Spanish Wealth Tax. Therefore, the tax benefit for Inheritance and Gift Tax purposes requires the prior exemption under Wealth Tax provisions, which in turn is established by reference to Spanish Personal Income Tax (PIT). The last clause of Article 29.c) of the Spanish PIT Act, specifically refers to assets held for the purposes of a business activity and considers that items representing an equity holding in an entity or a debt instrument should not be deemed to be held for the purposes of a business activity.

Additionally, article 6 of Royal Decree 1704/1999, dated November 5, ("RD") under the title "valuation of holdings and calculation of the exemption amount", establishes the requirements and conditions for professional and business activities and for holdings in entities to qualify for the corresponding Spanish Wealth Tax exemptions. Such article provides that, in order to determine whether an asset can be deemed to be held for the purposes of a business activity, reference should be made to article 27 (currently article 29) of the Spanish PIT Act, except as regards the assets referred to under the last clause of subparagraph (c), which, as the case may be, may be held for the purposes of a business activity.

Up to now, the above cross-references had been interpreted with a certain degree of logic: the taxpayers had to prove the need for cash or cash equivalents or financial assets for the purposes of the business activity and, therefore, they had to prove whether such assets were held for the purposes of an activity, within the meaning of Spanish Wealth and Inheritance and Gift Tax provisions.

Among indicators which could contribute to prove that assets were held for the purposes of the business activity, the following could be considered relevant: the economic context and sector in which the entity carries out its activity, the average payments terms for both clients and suppliers, working capital ratios, business investment plans and any other circumstance, depending on each particular case, which could impact the need for the business to hold cash or cash equivalents.

There are numerous precedents on this issue, although it is worth mentioning the ruling dated 10 December 2019 (case number 40/2016) from the Superior Court of Aragon. In such ruling, the Court confirmed the criteria from the Central Administrative Tribunal, upholding the position of a taxpayer who had been gifted a stake in an entity. The assets of such entity included holdings in a money market fund. Tax Authorities excluded these holdings from the Inheritance and Gift Tax benefit. This decision was reversed by the Administrative Tribunals and the Court, on the basis that the Tax Authorities had not provided sufficient evidence that such temporary investments were not held for the purposes of the business activity.

This case is especially relevant, since the Aragon Regional Government has filed an appeal with the Spanish Supreme Court. The parties were granted leave to appeal, in an Order dated 24 September 2020 (appeal number 1563/2020). The Court should therefore rule on whether, in cases where the object of a gift can be deemed to include equity holdings or debt instruments, the Inheritance and Gift Tax Benefit can apply as a result of article 6 RD or whether, on the contrary and as a result of article 27 – currently article 29 – of the Spanish PIT Act, such assets may never be deemed to be held for the purposes of a business activity.

The Spanish Supreme Court must make a determination, not as to the amount of cash or cash equivalents and financial assets which may be deemed to be held for the purposes of a business activity, but as to whether certain financial assets, regardless of evidence, should always be excluded from the tax benefit on the basis of a literal interpretation of the legal provisions.

It is difficult to see how the Supreme Court would follow the criteria of the Regional Tax Authorities in this controversy, as such an interpretation seems to contradict business logic. The limit provided for under the Spanish PIT Act would make sense in the context of individuals, where the distinction between business assets and own assets is not always clear-cut. However, such a confusion may not arise in the case of a company which carries out a business activity, where the cash has clear business origin. This view has been upheld by the Tax Authorities and the Central Administrative Tribunal (for instance ruling dated 11 June 2019). Moreover, the opposite view would directly contradict certain legal provisions, which evidence a clear interest to incentivise financing via own funds (interest barrier rules, capitalization reserve tax benefit requiring taxpayers to maintain a certain equity level or even Resolution dated 6 may 2020, on the conditions for borrowings from the Spanish Official Credit Institute, where dividends distributions are expressly prohibited). It would seem incompatible to, on the one hand, promote financing through own funds and, on the other, impose an additional tax burden on the transfers of companies following with these incentives, in comparison to those companies with financial leverage.

Additionally, all the above issues become more pressing in the current context of economic and health crisis caused by the Coronavirus. The ability to survive for companies which may not be able to rely on their own funds will become especially complicated, in particular as regards small and medium companies which may see their access to bank financing drastically reduced. In this scenario, it would be difficult to understand that the Supreme Court would exclude financial assets from the tax benefits afforded to family businesses, given that such assets will precisely allow family businesses to survive the current economic crisis and to face the challenges of an uncertain future.