The switchover of beneficial rights (usufruct) under Spanish Inheritance Tax

In Spain, the widowed spouse is entitled to usufructuary rights over all or part of the inheritance. The content and the nature of such rights varies in accordance to the applicable civil law. From a tax perspective, the switchover by the beneficiary of these rights for full ownership over other assets has been a recurrent practice and did not entail an additional tax burden on the acquisition of the inheritance. The case-law of the Spanish Supreme Court has changed this situation.

The switchover of all or part of the spousal beneficiary rights ("usufruct") has been a recurrent practice in inheritance acquisitions: beneficiary rights over certain assets were exchanged for full ownership over other assets. This practice led to a more efficient management and disposal of the inheritance assets and was less burdensome for the heir, as legal owner, who was liable for the Inheritance Tax and possibly also the corresponding Wealth Tax, without receiving any the returns from the assets under usufruct. As a general rule, Spanish Regions accepted the switchover of beneficial rights for full ownership, without other taxation in addition to that deriving from the inheritance (on the basis of the State legislation – article 57 of the Inheritance and Gift Tax Regulations - Reglamento del ISD).

Under Spanish Inheritance tax rules, beneficial owners will be taxed over the value of their beneficial rights, assessed in accordance with the age of such beneficial owners – first tax return –, whereas the legal owner must calculate the average tax rate applicable to the acquisition of the full ownership and apply it to the legal ownership acquired – second tax return –. The legal owner will eventually pay tax over the consolidation of the full ownership, upon the passing of the beneficial owner – third tax return. The switchover did not lead to any changes with respect to the filing and payment obligations described, save for the fact that, since there was no consolidation, there was not need to make a third filing. Note that potential additional tax consequences could arise, should the switchover result in assets being allocated to the spouse for a value in excess of his or her original beneficiary rights and therefore lead to additional transfer tax or inheritance and gift tax liabilities.

The Spanish Supreme Court (see rulings issued in July 2020 ROJ 2682/2020; 2688/2020 and 2717/2020) has altered this state of affairs. The Court is ruling on Catalan civil law, however its decisions can apply to other civil law regimes with similar provisions (We are aware that the criteria are being applied in other Regions with different civil law regimes). In its analysis of the Catalan regime, the court concludes that the law expressly provides for beneficial rights switchover only in cases of intestate succession. Where a will has been granted and the disponer has not specifically envisaged the switchover, such switchover will be taxed as a separate transfer, in addition to the transfer on death. The switchover would be deemed to amount to a taxable permutation or exchange of assets.

The tax consequences in such a situation would be as follows: the beneficial owner and the legal owner would bear Spanish Inheritance Tax on the acquisition of the beneficial rights and the legal right respectively, in accordance with the principles and on the values explained above. Additionally, the beneficial owner would bear transfer tax for the switchover as a permutation. Depending on the particular assets considered, transfer tax exemptions may apply. The legal owner would also bear tax upon consolidation of the full ownership rights. However, since such consolidation would not arise as a result of the death of the beneficial owner, other valuation rules would apply. The value of the beneficial rights received from these purposes would be the higher between the amount pending under Inheritance Tax rules (third return referred to above) or the amount deriving from transfer tax rules.

In all, heirs may be subject to additional costs, for which careful planning should take place when ordering the estate. Current wills should be reviewed to ensure that there is cover for the absence of legal coverage for the switchover. In this context, the Spanish Directorate for Taxes has issued a ruling dated 18 February 2021 (ruling number V0297-21), on the taxation of the switchover of the totality or a portion of the beneficial rights affecting all if the estate's assets ("universal usufruct") in a will subject to the State civil regime. The ruling looked at two situations: a case where the disponer orders the switchover or a case where the disponer allows for the switchover. In both cases, Spanish authorities held the same view: the switchover arises as a result of the will of the disponer and not as a result of the will of the heirs and as such, there is no other transfer in addition to the transfer upon death.

Several issues remain unresolved, such as the treatment of the switchover in the context of an intestate succession, subject to other civil law regimes, or in the context of a will but with subjection to other Spanish civil law regimes (aside from the Catalan). It is worth noting that, under the civil regime of Aragon, the beneficial rights (spousal usufruct) do operated as result of succession law but rather as result of matrimonial law.

In any case and regardless of the applicable civil regime, a taxpayer will always be in a better position to plan for succession tax costs, if he or she has granted a will, or amend a current will, to include the switchover of beneficial right as an option.