Limitation of the family business exemption in the Spanish Wealth Tax

Recently, the Spanish General Directorate of Taxes (GDT) has published a binding ruling (V2390-23) that has generated some controversy as to the interpretation of the management functions requirement to apply the Wealth Tax exemption on shares or participations held in family companies.

The facts

The facts of this ruling by the GDT concerned a consulting taxpayer and his spouse who respectively held an 11.5% and 3.5% stake in a family business entity whose main activity was not the management of movable or real estate assets.

The taxpayer's spouse had been the director of the entity's commercial department for the past few years, although this position was not explicitly stated in the employment contract. A later novation of the contract expressly included the position as director, with the spouse receiving a remuneration for those functions which represented more than 50% of his total income corresponding to the fiscal year 2023.

The ruling aims to analyse whether the legal requirements to apply the Wealth Tax exemption on the taxpayer's shares were fulfilled.

Scope of the Wealth Tax exemption on individual shareholding

Article 4.8.2 of the Wealth Tax Law establishes that the following requirements and conditions must be met on the accrual date for the family business exemption to apply:

• That the entity's main activity is not the management of movable or real estate assets.
• That the participation of the taxpayer in the capital of the entity is at least 5%, computed individually, or 20% jointly with the family group (spouse, ascendants, descendants or second-degree collaterals).
• That the taxpayer effectively exercises management functions in the entity and that, for the management functions performed, the taxpayer receives a remuneration that represents more than 50% of the total income.

In this specific case, the controversy revolved around whether the management function requirement could be fulfilled by any member of the family group or whether it must have been met by the taxpayer whose shares or participations were computed individually. 

The GDT examined whether the spouse, who held a 3.5% stake in the entity, could perform the management functions when the consulting taxpayer held a 11.5% stake. The GDT argued that since the joint participation of the consulting taxpayer and the spouse was 15% (11.5% and 3.5% respectively), the participation in the entity was not joint with the spouse (at least 20%). Therefore, the taxpayer did not meet the management functions and remuneration requirement.

When the participation in an entity is joint with one or more of the previously indicated persons, the law allows for remunerated management functions to be carried out by at least one person in the kinship group, without prejudice to the fact that all of them are entitled to exemption.

However, when the taxpayer's participation in the entity is computed individually and the management functions are performed by a third party (in this case, the spouse), the requirements for applying the exemption are not met. In this case, and given that the 20% joint participation was not met, the GDT concluded that the spouse's remunerated management functions were not relevant in order to fulfil the requirement.

It is worth noting that the GDT had previously issued more restrictive rulings, similar to the present one, in which it established that taxpayers had to perform management functions when their individual shareholding exceeded 5%. However, this criterion was superseded by the application of several rulings issued by the Supreme Court in 2016, which established that the person performing the management functions did not necessarily need to be a shareholder and that those functions could be carried out by any person within the family group.

This new binding ruling represents a change of approach compared with the recent rulings where the GDT applied the Supreme Court rulings. It re-establishes a more restrictive criterion where the exemption is not applicable to a taxpayer whose participation in the entity is less than 20% (when computed jointly with the family group), if the remunerated management functions are carried out by another family member.

Osborne Clarke comment

Although the ruling merely reproduces the literal wording of the law, without really introducing a new criterion, the GDT is once again adopting a more restrictive interpretation than the one it had been applying until now in line with the Supreme Court's case law.

With this, the GDT intends that, in order to apply the family business exemption in cases of individual participation (at least 5%), the management functions in the entity should be personally and directly exercised by the taxpayer whose participations benefit from exemption from Wealth Tax.

Further judicial pronouncements and any changes in criteria with respect to this recent doctrine applied by the DGT should be kept under constant review.