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The Holding Company as a Model to Organize the Family Business Assets in a Tax Efficient Way
In the context of family businesses, it is common to hear about the possible advantages or benefits of the creation of holding companies, that is, companies whose sole or main purpose is to hold shares in another companies.
But, is a structure composed of companies owned by a holding company really so profitable from a tax perspective? Or is it simply one more system of control and commercial organization of a business group? What are the main advantages of this structure, if any?
First of all, we must define the essential requirements to be met by a holding company to be considered as such. Then, we will explain the rest of conditions to be fulfilled by the company in order to benefit from the possible advantages that will be analyzed later.
Apart from the fact that its main purpose must be to hold shares in another companies, to be considered at such, a holding company must perform a business activity. Otherwise it will be a “passive” holding company (entidad patrimonial).
After the Spanish Corporate Income Tax Reform was introduced by Law 27/2014, the concept of ‘business activity’ was included as an express and separate term. Therefore, in order to determine if a company has a business activity or not (that is, if it is considered a passive holding company, or to the contrary, it is classified as a company with business activity as defined by the Spanish Corporate Income Tax law), every entity where more than 50% of its assets consist of securities is automatically considered as not having a business activity.
However, when it comes to classifying a company as “passive” (entidad patrimonial) it will not be counted as securities those shares that constitute at least 5% of the share capital of a company with business activity and which are held for a minimum period of one year with the aim of managing its own shares (of the investor company itself not the activities of the investee company), and provided that the investor company has the necessary organization of material and personal means.
Therefore, as long as these three essential requirements are met:
- minimum shareholding of 5% in the investee companies;
- purpose of managing the own shares, and
- organization of personal and material means
together with the specific requirements corresponding to each of the possibilities and taxes which will be explained below -, the creation of a holding company can carry the following advantages from a tax perspective:
1 - Exemption in case of distribution of dividends of the investee companies.
Provided that the essential requirements are met (that is, holding at least 5% of its subsidiaries or an acquisition value of more than EUR 20 million), the dividends distributed by a subsidiary to its parent holding company shall be exempt from taxation in the holding company.
In addition, such distribution will not be compulsorily subject to tax withholding as it happens when the shareholder that receives the dividend is a natural person.
In comparison with the above, taxation of dividends received by individuals would range from 19% for dividends received annually of up to € 6,000 to 23% for amounts in excess of € 50,000, with a prior tax withholding of 19%.
Obviously, once the dividends are received by the holding company, the shareholders of the company (individuals) can distribute them or not, and include them in their own income and pay taxes for what is strictly necessary.
However, what remains in the holding company will allow it (either directly or indirectly through the creation or contribution of the surplus to other subsidiary companies), either to undertake new investments or to meet the financial needs of the subsidiaries with no cost. It should be noted that both, capital increases and contributions to companies, are Corporate Operations exempt from Stamp Duty (Impuesto de Transmisiones Patrimoniales y Actos Jurídicos Documentados).
In short: this scheme allows to transfer the “surplus” of a company from the company generating it to the holding company and vice-versa, and, in turn, from the holding company to the company finally receiving it at no cost.
2 - Prevention of double taxation through Corporate Income Tax in case of transfer of the shares held by the holding company in the subsidiaries.
Similarly to what was explained in the previous section on the exemption in case of dividend distribution, the transfer of shares of a company (resident or not, although in the latter case the non-resident company must be subject to a tax similar to the Spanish Corporate Income Tax at a minimum tax rate of 10%) carried out by the holding company will benefit from a full capital gains tax exemption.
The essential prerequisite for this to occur is that the holding company which holds the shares to be transferred has either a shareholding of at least 5% in the investee company uninterruptedly during the year preceding the day on which the shares are to be transferred, or a value of more than EUR 20 million.
The application of the exemption does not depend neither on the percentage of shareholding transferred nor on the percentage maintained after the transfer, nor does it depend on the acquisition value of the shareholding which has not been transferred, if any.
3 - Possibility to benefit from the special tax consolidation regime of Corporate Income Tax.
A group of companies controlled by a holding company may choose to be taxed under the special tax consolidation regime provided that all the companies comprising the group comply with a series of additional requirements (be taxed at the same tax rate, having the same fiscal year, etc.)
This means that the taxpayer will be the group as a unit, acting as a single taxpayer, and the entity responsible for paying the tax debt would be the holding company, whose percentage of share capital and voting rights in each one of the investees must be of 75% (70% if they are admitted to trading on a regulated market or if the shareholding is indirect through subsidiaries admitted to trading on regulated markets).
This special tax regime will allow access to a series of advantages that can be summarized as follows:
- absence of tax withholdings on payments of interests, dividends or others (which in principle should be subject to withholding) made between the companies of the group;
- cancellation of intragroup results
- tax assessment on net income which allows to automatically compensate the profits obtained by certain companies with the losses that may have suffered other entities of the group.
- greater possibility of enjoyment of tax deductions, tax benefits, etc. since the requirements and conditions to their application are set at group level and not at individual level. This will allow certain tax reductions to be applied even though the individual situation of the company giving rise to such right would have not allowed it (for example, when a company is entitled to a certain R&D deduction, but its effective application is not possible because the concerned company already benefits from a reduced amount of the tax or even equal to zero).
- possibility to eliminate the taxpayer’s specific documentation related to its operations with other companies in the group.
4 - Possibility of benefiting from the special regime for VAT Groups
The main requirement to qualify for this special VAT scheme is that the holding company owns 50% of the share capital and voting rights of the other companies in the Group. On the other hand, the holding company cannot depend on any other company located in the same VAT territory. Finally, to this end, even the companies whose sole purpose is the holding of shares of the investees will also be accepted as holding companies. The main advantages of this regime will vary according to the modality chosen between the two existing ones:
- Simplified modality: financial benefits.
The application of the special regime for VAT Groups allows the companies of the group to balance their respective VAT bills out, whether it be VAT to be paid, reclaimed or compensated.
In addition, regarding the taxation of the transactions carried out among the companies of the group, since they all are considered as a single taxable person, don’t have the obligation to submit VAT Return for the intra-group transactions. Therefore, only transactions carried out with third parties outside the group must be declared for VAT purposes.
Having recourse to this possibility will therefore be of special interest for those groups where there are companies that are usually creditors and debtors with the Tax Agency since by choosing this option they will no longer be obliged to submit individual VAT returns. Instead, the group shall submit an aggregate self-assessment, which must be prepared and presented by the holding company which will in turn pay the VAT or compensate it in the following period as the case may be.
- Advanced modality: This option is particularly advantageous for companies which carry out transactions exempt from VAT and not entitled to deduction.
Under this regime, there is the possibility to waive the exemption for intra-group transactions. This waiver will allow the companies of the group to transfer the amount of the tax paid for the purchases of goods and services necessary for such transactions to the Group which in turn can deduct the whole amount of the VAT paid by the companies.
5 - Simplification in the obtaining of tax benefits for family business in order to get:
- exemption from Wealth Tax
- 95% reduction in the tax base of Inheritance and Gift Tax
- exemption for capital gains resulting from gifts in the Personal Income Tax.
Even if when a family group owns several companies it is usual that every one of them, individually, meet the requirements required by tax legislation to benefit from important tax advantages, once we analyze those requirements, we will see how the existence of a holding company ensures and greatly facilitates compliance in this sense.
The requirements for obtaining tax benefits are as follows:
a) To get the exemption from Wealth Tax:
- Shareholding: equal to or higher than 5%. This percentage will be 20% when computed for the whole family group altogether. (spouse, ascendants, descendants or second-degree collaterals, irrespective of whether the relationship is by blood, affinity or adoption).
- Management and remuneration: by the holder or, if the percentage is computed for the whole family group altogether, by any of its members representing more than 50% of the net income from work and business and professional activities.
In calculating the percentage, the income from business activities must not be computed since these activities are also exempt from Wealth Tax. Besides, in case of having shares in several companies of the Group that meet the rest of the requirements for exemption, the calculation of the abovementioned percentage of 50% must be done separately for each one of them.
- Business activity: the company must carry out a business activity.
However, in this case, it must be taken into account that the management of movable or immovable property is not considered as a business activity.
In this context (Wealth Tax), it is understood that a company manages a movable or immovable property and therefore does not carry out a business activity when, during more than 90 days of the fiscal year, more than half of its assets consist of securities or when the company is not engaged in any business activities as described under Personal Income Tax Law (articles 27 and 29).
In particular, it should be considered that:
- the leasing of real estate will be considered as a business activity only if for the performance of the activity there is at least one person employed with a full-time employment contract.
- to determine the part of the assets consisting of securities or elements not attached to any business activity the following will not be considered as such:
- those securities that grant at least 5% of the voting rights and are held for the purpose of managing the shareholding, provided that the necessary organization of material and personal means is available, and that the investee’s business activity in turn is not the management of a movable or immovable property.
- those securities or elements whose acquisition price does not exceed the amount of undistributed profits obtained by the entity both in the same year and in the ten preceding ones, provided that such profits come from the carrying out of business activities.
Therefore, although all these requirements can be fulfilled individually by each company of the family group, it is obvious that, considering the complexity of the said requirements, those will be much easier to control and comply with if everything is simplified into a single company: the holding company.
In turn, this exemption from Wealth Tax, will practically guarantee - almost automatically - the following tax advantages that will be analyzed herein and that will also affect the Inheritance and Gift Tax as well as the Personal Income Tax.
b) To get the reduction in the tax base of Inheritance and Gift Tax:
Since the Inheritance and Gift Tax is a tax transferred to the Autonomous Communities (administrative divisions of the Spanish territory) the regulations of the corresponding Autonomous Community must also be complied with (some requirements such as the percentages of reduction or the periods might vary from an Autonomous Community to another). Nevertheless, in general, a reduction of 95% in the Inheritance Tax shall be applied for the mortis causa acquisitions by certain relatives of the deceased (at most collaterals up to the third degree) on the tax base resulting from the value of the shares that qualify for the exemption from Wealth Tax according to the terms analyzed in the previous section.
Likewise, but with some additional requirements and affecting different degrees of kinship depending on the Autonomous Community, the same reduction of 95% in the Gift Tax shall be applied on the tax base resulting from the value of the transferred companies. Those additional requirements are, among others, as follows:
- the donor must be 65 years old or has permanent disability
- the donor must stop exercising management duties from the moment of the transfer / gift
- the donee must keep the property acquired for a certain period of time (10 years according to the state regulations)
- during that period, the donee must also retain the right to the exemption from Wealth Tax
c) To get the exemption from the Personal Income Tax on gifts made on companies in which the donee benefits from a 95% reduction in the tax base.
In this case, apart from the requirements stated in the preceding section b), there is an additional requirement: in the case of assets belonging to the company coming from personal assets, those must have been assigned to the company for at least five years prior to the date of the gift.
In summary: as a rule, each company that forms part of the family business assets must comply with the requirements of the tax legislation for the purposes mentioned above. But, if any of them fails to comply with such requirements, it will no longer benefit from the aforementioned tax advantages and, depending on the weight of such company, it may cause the unfulfillment of all the other companies.
However, with the creation of a holding company, the situation is simplified: the family or the interested party concerned will just have a direct shareholding in the holding company and if this one complies with the legal requirements, the tax benefits will reach all corporate assets: both, the assets directly owned (the holding company) and the assets indirectly owned (the subsidiaries owned by the holding company).
In view of this favorable and advantageous scenario, can the fiscal cost of creating the holding company by the owners of the different companies, assets or businesses be a disadvantage?
By applying the general tax regime, this operation will involve the contribution to a single company (the holding company) of the various existing entities or businesses. This would entail high costs, both in direct taxes for the capital gains generated, and in indirect taxes in case of application to the operation of the corresponding VAT resulting from the transfers.
This high cost could make unfeasible the business reorganization through a holding company.
However, and with the main objective of avoiding such costs, it is worth remembering the existence of the special tax regime of mergers, divisions, contributions of assets and exchange of securities provided for in the Corporate Tax Law. As long as the corresponding legal requirements are met, this special tax regime allows the elimination of the fiscal cost for the reorganization of corporate groups resulting therefore in a tax neutral regime.
Therefore, under the abovementioned special tax regime, the partners (natural or legal persons) will be able to carry out the necessary business reorganization operations, without the associated taxation being an obstacle.
For all these reasons, the incorporation of a holding company should be taken into consideration, since it offers the opportunity to obtain a business structure with greater organizational control by reducing risks and providing greater tax savings and financial flexibility.
In short, the configuration of a corporate estate under a structure headed by a holding company is one of the best options for a proper management within the family business, not only from a fiscal perspective, but also from an organizational and administrative point of view.
One of the things Mr. Balcells like most about his job is when you get a safe, legal and fair tax situation for the sake of the taxpayer's tranquility and economy, both in previous structuring and planning, and when certain criteria have to be defended before Tax administration.
As a lawyer, he always try to put himself in the place of the one who asks for advice, so that all the options or alternatives that are considered as solutions, are those that would adopt at a personal level if the interested party is himself.