When the Panama Papers revelations shook the world in 2016, one thing became clear: offshore companies are not only used by corporations and financial experts, but also by smaller taxpayers, celebrities and politicians seeking to manage assets discreetly.

The idea of using an offshore company in a low-tax jurisdiction to reduce taxes while benefiting from a high degree of anonymity continues to be highly attractive. However, what may initially appear to be a smart financial strategy can quickly turn into a tax minefield.

What tax obligations are associated with offshore companies?

Where is the line between legal tax planning and illegal tax evasion?

In this article, we examine the relevant legal provisions in Spain, the EU and internationally, with particular emphasis on the risks associated with the use of offshore structures.

Offshore Companies: An Overview

An offshore company is a legal entity registered in a country other than the country of residence of its owner or shareholder. Where such a company lacks sufficient economic substance, one of its main characteristics may be the low taxation of income retained within the company rather than distributed to its shareholders.

Typical advantages associated with such structures include:

1. Tax advantages: Some jurisdictions offer low or even zero corporate tax rates. Income that might otherwise be subject to personal income tax may therefore be taxed at a significantly lower rate or, in certain cases, not at all.
2. Anonymity: Many offshore jurisdictions offer a high degree of confidentiality.
3. Less regulation: Administrative and regulatory requirements may be less stringent than in jurisdictions with more comprehensive regulatory frameworks.

Tax Obligations for Spanish Tax Residents

Spain applies the worldwide income principle, which means that Spanish tax residents are generally required to declare and pay tax on their worldwide income. Consequently, interests held in offshore companies are by no means automatically exempt from Spanish taxation.

The relevant legal provisions and reporting obligations include:

1. Ley General Tributaria (LGT – Spanish General Tax Law): This legislation establishes the general framework governing tax obligations and the disclosure of assets and income.
2. Modelo 720: An information return concerning certain assets and rights held abroad.
3. CFC rules (Controlled Foreign Corporation rules): Under certain conditions, income obtained by foreign companies established in low-tax jurisdictions may be attributed to and taxed at the level of the Spanish resident shareholder.

Example: The Case of a US LLC

An entrepreneur residing in Spain establishes a Limited Liability Company (LLC) in Delaware, USA, in order to benefit from favourable tax treatment and limited disclosure requirements. Although establishing such a company may be perfectly legal, the Spanish tax authorities may, depending on its characteristics and circumstances, treat the LLC as a tax-transparent entity. This may mean that the LLC's income is subject to the entrepreneur's personal income tax in Spain, particularly where the company is not substantially managed and operated in the jurisdiction in which it was established.

Economic Substance Requirements

In order to prevent offshore companies from being classified as shell companies, genuine economic substance in the jurisdiction of incorporation is essential.

Economic substance may include:

1. Office and permanent establishment: A genuine physical presence with an address, premises and operational resources, rather than merely a postal address.
2. Employees: Staff employed locally who perform essential functions.
3. Economic activity: Actual business transactions and operational activities should be carried out.
4. Management: Strategic business decisions should be made in the jurisdiction in which the company is established.

The legal framework governing economic substance requirements consists of an interaction between national legislation, EU rules and international standards arising from initiatives of the Organisation for Economic Co-operation and Development (OECD).

Where these requirements are not met, the Spanish tax authorities may consider that the company exists primarily for tax avoidance purposes and may seek to tax in Spain income generated by the company abroad. As this analysis of economic substance may also be relevant to Spanish companies (S.L.), please also see our article Tax Evasion through the Incorrect Use of Companies.

 

International Regulations and Transparency Initiatives

Spain participates in the OECD's Common Reporting Standard (CRS), which provides for the automatic exchange of financial account information between participating jurisdictions. This means that foreign financial institutions may be required to report information concerning financial assets and accounts held by Spanish tax residents to the relevant authorities, which can subsequently be exchanged with the Spanish tax authorities.

In addition, the EU Anti-Tax Avoidance Directive (ATAD) plays an important role in combating aggressive tax planning. It requires Member States to implement measures designed to counter certain tax avoidance practices. Spain has also implemented measures arising from the OECD's BEPS initiative (Base Erosion and Profit Shifting) to combat the artificial shifting of profits and erosion of the tax base.

Further information on international taxation can be found here.

Consequences of Non-Compliance

Failure to properly declare offshore interests may continue to have significant consequences:

1. Fines: Although the penalty regime was amended following the 2022 judgment of the Court of Justice of the European Union, failure to comply with the reporting obligations associated with Modelo 720 may still result in financial penalties and additional tax assessments.
2. Additional tax assessments: Undeclared income may be subject to additional tax liabilities and late-payment interest.
3. Criminal liability: In serious cases, failure to declare income or assets may result in criminal consequences.

Conclusion: Transparency Is Essential

For individuals resident in Spain, the use of an offshore company may offer legitimate advantages, but it also involves significant tax and legal obligations. Transparency and compliance with the applicable legislation are essential in order to minimise risks. Before establishing or using an offshore company, it is advisable to obtain comprehensive tax and legal advice. This can help prevent potential tax disadvantages and legal consequences while ensuring that offshore structures are used lawfully.

For individuals relocating their residence to Spain, the special tax regime commonly known as the Beckham Law may be an attractive option during the initial years of residence, as it can significantly affect the taxation and reporting of certain foreign-source income and assets. Further information can be found in our article: Beckham Law: 24% Flat Tax Rate for Expatriates.

Our firm will be pleased to assist you in analysing your specific situation, carrying out the necessary administrative procedures on your behalf and preparing and filing the corresponding tax returns. If you are interested in our services or have specific questions regarding this topic, please do not hesitate to contact us by email or telephone.

Author:

Lisa Wörfel
Tax Advisor
info@sspartners.es
Tel: (+34) 951 12 13 06
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