Although entrepreneurs are generally free to carry out their activity either as sole traders or through a company, there are tax-related limits governing the relationship between a company and its shareholders which, if disregarded, may result in the improper use of the tax advantages associated with a corporate structure.
From the perspective of the Spanish Tax Agency, the issue lies in the tax advantages that a company may offer compared with operating as a sole trader and the associated legal requirement that transactions between the company and its shareholders must be valued at market value, i.e. on an arm's-length basis. You can find further information on the tax advantages of companies in our article Self-Employed or Company: Tax Aspects.
Although this issue may arise with all types of companies, businesses providing professional services are particularly affected, as they generally require fewer material and human resources than businesses operating in other sectors of production.
The absence of such "material and human resources" is frequently one of the main reasons why the Spanish Tax Agency may conclude that a company is merely a "shell company". Where material and human resources do exist, the next issue examined is often whether transactions between the company and its shareholders have been valued correctly and comply with the arm's-length principle.
The tax risks associated with the improper use of a company can therefore be summarised in two main areas:
A) The company as a "shell company" which, due to the absence of material and human resources, does not add value to the services provided.
According to the Spanish Tax Agency, the following aspects are examined:
1. "Whether the material and human resources used to provide the services (or carry out the transactions under review) belong to the legal entity or to the individuals (shareholders)."
2. "Where both the individual and the legal entity have the material and human resources used to provide the services (or carry out the transactions), whether the company actually participates in their performance."
Since the first question examined is whether both the individual (shareholder) and the company have material and human resources, potential confusion can be avoided where these resources are held exclusively by the company. In other words, rather than operating simultaneously as self-employed and through a company, the activity is carried out solely through the company.
In this respect, the following aspects may be taken into consideration, for example:
- Does the company own an office or pay an arm's-length rent for its premises?
- Does the company have employees under employment contracts who work continuously for the company, or are "freelancers" involved in providing the services?
- Does the company record sufficient material resources in its accounts to provide the services, such as PCs, mobile phones, laptops, etc.?
If the Spanish Tax Agency concludes that the company does not have such material and human resources and should therefore be regarded as a "shell company", the entire profit could, by applying the rules on simulation under Article 16 of the Spanish General Tax Law (LGT), be taxed under the personal income tax of the individual who actually provides the services (the shareholder), at rates of up to 46%, rather than under corporate income tax at 15% or 23%. In addition, surcharges ("recargos") of up to 20% of the unpaid tax and penalties of up to 50% of the unpaid tax may apply.
It should be noted that classification as a "shell company" presupposes a complete absence of material and human resources or that the company itself is entirely irrelevant to the provision of the services. Since this situation is relatively uncommon in ordinary businesses with employees and office premises, the Spanish Tax Agency generally focuses instead on the valuation of transactions between the company and its shareholders:
B) Correct valuation of transactions between related parties, in particular between the company and its shareholders.
If it cannot be argued that the company lacks sufficient human and material resources or that these resources are not actually involved in providing the services, the Spanish Tax Agency will generally examine whether transactions between the company and its shareholders (related-party transactions pursuant to Article 18 of the Spanish Corporate Income Tax Law) have been correctly valued on an arm's-length basis.
In this context, the following situations can be distinguished:
1. Income splitting between the company and the shareholder.
As shareholders must receive remuneration at market value in proportion to their actual involvement in providing the services, tax savings may arise if not all of the profit is paid out to the shareholders. For shareholders subject to the highest personal income tax rates, taxing part of the profit under corporate income tax at 15% or 23% may result in tax savings.
In order to determine the appropriate remuneration, it is necessary to consider who actually performs the work, whether other employees or collaborators are involved, whether the service is provided personally by the shareholder and whether the contribution of other persons has also been valued at market value.
Two specific examples:
A) A company has a single shareholder who works as a YouTuber, has no employees or business assets and generates annual turnover of €300,000. The company decides to pay its sole working shareholder a salary of €100,000 and retain €200,000 as profit within the company.
On the €100,000, the shareholder would pay approximately €34,000 in personal income tax, while approximately €30,000 in corporate income tax would be payable on the company's profit. The shareholder and the company would therefore pay approximately €64,000 in taxes in total. Without the company, the shareholder would have paid approximately €126,000 in personal income tax on the €300,000, resulting in tax savings of approximately €62,000. In this case, however, the Spanish Tax Agency could argue that the company is merely a "shell company" because it lacks human and material resources, or that the transaction between the shareholder and the company was not valued at market value because the entire profit was effectively generated by the sole shareholder.
B) A company has two shareholders who are accountants, rents an office and employs several full-time accountants and economists. The company generates annual turnover of €300,000 and decides to pay each working shareholder a salary of €80,000, while paying its employees total salaries of approximately €40,000 and retaining the remaining approximately €100,000 as profit within the company.
In this case, it would be difficult for the Spanish Tax Agency to argue that the company is merely a "shell company", as it has both human and material resources. It would likewise be more difficult to argue that the services provided by the shareholders and the company were not valued at market value, since the services were provided both by the shareholders and through the company's own material and human resources.
2. Income splitting between shareholders.
Where several shareholders work for the company, their remuneration should reflect each shareholder's actual contribution to the provision of the services. Professional companies (S.L.P.) are even subject to certain minimum requirements in this respect. Paying a particular salary to each shareholder may become problematic where there is no objective justification for the allocation or where the remuneration should actually be attributed to another shareholder.
For example, in the case of a company with two shareholders who are married and each receive the same salary, the Spanish Tax Agency could examine whether both shareholders actually work for the company or whether the remuneration of one shareholder has merely been split between the two in order to benefit from progressive income tax rates and thereby save up to €18,000 in tax. In our article "Self-Employed or S.L.: Tax Aspects" you will find a table and further examples.
3. Splitting income through dividends.
Under this approach, part of the profit generated in the example in the first section is distributed to the shareholders as dividends. As investment income, such income is taxed at rates between 19% and 23%, meaning that even after taking into account corporate income tax of 15% or 23%, this may result in a tax advantage compared with the marginal personal income tax rate.
To justify the distribution of dividends, they should represent a return on the capital invested in the company rather than remuneration for the individual work performed by the shareholders. The existence of sufficient material and human resources may also help to reduce potential issues in the event of a tax audit by the Spanish Tax Agency.
4. Services provided to shareholders free of charge or at a reduced price.
Another, more obvious issue arises where services are provided to shareholders without charging the usual market price or where company assets are used for private purposes. The following examples are frequently encountered in practice:
- Shareholders use a property, yacht or company car without paying rent or accounting for the benefit in kind as remuneration.
- Shareholders rent their own property to the company for use as office premises, etc., but the rent is either too low or too high compared with the market rate.
- Shareholders receive a long-term loan from the company or lend money to the company without charging an arm's-length rate of interest (which is mandatory, in particular, for loans extending beyond one year).
5. Payment of shareholders' personal expenses.
Although this practice also violates accounting principles, shareholders sometimes record private expenses as business expenses of the company. This allows them to avoid paying these expenses out of their personal assets after tax and therefore reduces the personal income tax that would otherwise be payable. Examples include unnecessary travel expenses, the purchase of unnecessary goods, or the purchase of goods or services that are unrelated to the company's business activity.
In summary, the correct use of a company can provide tax advantages, but improper use can also entail significant tax risks. As is often the case, it is particularly important not only to structure the above matters correctly, but also to document them properly and to be able to provide supporting evidence.
Use our legal form self-assessment tool to obtain an initial recommendation when choosing between self-employment and a company.
In our blog "Autónomo or Company" you will find further articles on liability, timeframes, costs, shareholders' residence and other relevant aspects.
Our firm will be pleased to assist you in analysing your specific situation, carrying out the necessary administrative procedures and preparing and filing the relevant tax returns on your behalf. 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:
Christoph Sander
Lawyer and Tax Advisor
CEO, Partner, Director
info@sspartners.es
Tel: (+34) 951 12 13 06
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