Current state of affairs as regards the Municipal Tax on the Increase in Value of Urban Land and commentary on the Spanish Supreme Court ruling dated 9 July 2018

The ruling from the Spanish Supreme Court, dated 9 July 2018, which determines the correct interpretation to be given to the ruling from the Spanish Constitutional Court, number 59/2017, and dated 11 May 2017, in relation to the Municipal Tax leaves too many unsolved questions. These should be addressed in a future reform of this tax.

In our January edition of this Newsletter, we concluded that, in order to be solved, the controversy surrounding the Municipal Tax on the Increase in Value of Urban Land ("Municipal Tax") requires a ruling from the Spanish Supreme Court ("SC") and the enactment of the Proposal to reform this tax, published on 19 January 2018 in the Official Gazette of the Spanish Congress.

In the present Newsletter, we will be commenting on the SC ruling dated 9 July 2018, which attempts at answering the controversy created by the ruling from the Constitutional Court dated 11 May 2017, holding that articles 107.1 and 107.2.a) of the Spanish Local Taxation Act ("LTA") should be considered unconstitutional and that article 110.4 should be null and void.

This SC ruling should put an end to the chaos created by various appellate courts from different Spanish regions, where different solutions have been given to identical factual situations subject to the Municipal Tax.

The SC ruling establishes the following criteria for interpreting the unconstitutionality of the Municipal Tax:

"(…) 1º Articles 107.1 and 107.2.a) LTA, following the interpretation we have made of the ruling and of the fifth legal ground of the Constitutional Court ruling 59/2019, should be seen as only partially unconstitutional and voidable. In this context, these articles would be constitutional and, thus, fully applicable in all those situations where the taxpayer has not been able to prove, (…) that the transfer of title to the land, regardless of the method, has not revealed an increase in value or, likewise, a financial capacity which can be subject to tax by virtue of article 3.1 of the Spanish Constitution.

2º Article 110.4 LTA, however, is unconstitutional and null and void in all cases (complete unconstitutionality) since, as the Constitutional Court ruling 59/2019 holds, "it does not allow the taxpayer to come to an amount different than that which would result from applying the valuation rules contained in such article". In other words, it would not allow the taxpayers to prove that he is in situation where there would be no financial capacity (rulings from the Constructional Court 26/2017 and 37/ 2017). The fact that such article is completely null is precisely what gives taxpayers the opportunity, since ruling 59/2017, to prove to the Tax Authorities or the courts the lack of increase in value in the land. Should this not be proven, articles 107.1 and 107.2.a) LTA become fully applicable (…)."

It is worth pointing out that, with the annulment of article 110.4 LTA, the burden of proof relating to the decrease in value on the land would fall on the transferor. It would be up to the transferor therefore to prove that there has been no taxable event for the purposes of the Municipal Tax.

In order to do so, taxpayers should provide the necessary elements to show that there has been no increase in value which may be subject to the tax. The ruling describes which means would count as evidence: the acquisition and transfer value deriving from the corresponding deeds; an appraisal or any other means, in accordance with article 106 of the Spanish General Tax Act, through which the decrease in value as a result of the transfer of the land can be shown (and accordingly the inapplicability of the Municipal Tax).

The SC ruling however leaves many open issues, such as the following:

Firstly, there is no indication on how to interpret situations where the tax burden is greater that financial capacity which is being subject to such tax is; i.e. where the tax payable is actually greater than the capital obtained in the transaction.

Moreover, the ruling does not question the calculation method for the municipal tax: taxable base x cadastral value x yearly percentage x ownership period. Such formula is widely criticised for not being consistent with the economic reality of a transaction and for giving rise to fictitious capital gains. There is a ruling from the High Court of Castilla-La Mancha dated 17 April 2012 in this regard which has been appealed to the Spanish Supreme Court.

The Spanish Supreme Court, in the same way as the Constitutional Court, considers that it is the Spanish Parliament which should enact the corresponding amendments to the Municipal Tax. The Parliament show ensure that such tax is compliant with article 3.1 of the Spanish Constitution, which establishes the principle of financial capacity, the corner stone of our tax system. However, there is no clarity as to how to deal with situations while the new provisions are enacted or whether there will be a specific transitional regime.

A final word on this issue may well be that there are still many unsolved issues around the Municipal Tax and that, despite this ruling from the Spanish Court, there will be situations in which a "capital gain" which is not a real gain will still be taxed. Possible effects may go as far as to lead to confiscatory results.

The above comments, however, may need to be reviewed in light of the final proposal of reform of this tax which will be enacted.