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The National Court has recently handed down a ruling that has set alarm bells ringing in the family business sector, as it calls into question some key principles in the taxation of inter vivos transfers of company shares. Specifically, it rules on the consequences of failing to meet the requirements for applying tax benefits.
The ruling (rec. no. 1957/2021) analyses a case in which shares in a company are donated, with the donor claiming non-taxation (deferral) of the capital gain reported in their personal income tax return because the requirements set out in Article 20.6 of the Inheritance and Gift Tax Law are met.
It should be emphasised that this tax benefit does not imply an exemption, but merely a deferral: the capital gain is not taxed at the time of the donation, but in return, the donee is subrogated to the donor's position with regard to the date and value of acquisition of the shares.
However, in this case, considering that the requirements for applying this regime were not met, the Administration regularises the donee's income tax, despite having previously denied them the tax benefits in the ISD. This leads to a clear situation of legal double taxation: two incompatible tax regimes are applied to the donee for the same transaction.
This decision is not only debatable from a technical point of view, but also creates significant legal uncertainty, as we will see below.
Background to the case
In 2010, a father donated shares in a company to his son. The transaction was formalised in compliance with the requirements for applying two significant tax benefits:
- For the donee, a 95% reduction in inheritance tax, as provided for in Article 20.6 of the Inheritance Tax Law for the donation of shares in family businesses, and
- For the donor, the deferral of the gain realised on the donation, in accordance with the provisions of Article 33.3.c) of the Personal Income Tax Law.
In order to apply these benefits, and for the purposes of this article, the donee must maintain the shares exempt from Wealth Tax (IP) for at least 10 years and, in return, will retain, for tax purposes, the values and dates of acquisition that the shares had for the donor (Article 36 of the Personal Income Tax Law).
The deed of donation expressly included both benefits, and the son also declared the exempt shares in his IP.
In 2012, however, the Madrid Regional Tax Agency initiated an audit and concluded that the donee did not meet these requirements at the time of the donation, as his position in the company did not involve effective involvement in the company's decisions, i.e. he did not perform management functions.
The donee accepted the adjustment and paid the corresponding difference, i.e., he paid inheritance tax without applying the tax benefits.
Subsequently, in 2014, the son sold the shares and, in his personal income tax return, calculated his capital gain using the acquisition value declared in the donation. However, in 2015, the tax authorities regularised his personal income tax, understanding that he should have applied the donor's original value (by application of the subrogation regime), thus generating a much higher gain.
Regulatory interpretation in the event of non-compliance with the requirements for the application of tax benefits
When the conditions established in Article 20.6 of the ISD Law for applying these tax benefits are not met, the consequences are as follows:
- For the donor, they must pay tax on the capital gain generated by the donation, which was deferred. This deferral is conditional on compliance with the requirements that determine the application of the reduction in the ISD base.
- For the donee, such non-compliance implies:
- The loss of the 95% reduction in ISD and,
- Correlatively, the updating of the acquisition cost for income tax purposes.
In other words, if the requirements of the regime are not met, the logic of subrogation is broken, and each party must assume the corresponding tax consequences.
Position of the National Court
However, the National Court dismissed the taxpayer's appeal and upheld the adjustment made to the donee, based essentially on two arguments:
- Application of the doctrine of estoppel: In the deed of donation and in his IP returns, the son acted as if the requirements for a family business were met. According to the National Court, he cannot now retract his statements in order to benefit from a higher acquisition value for the purposes of calculating the capital gain.
- Absence of regularisation by the donor: Given that the father did not file a supplementary income tax return to pay tax on the capital gain derived from the donation, and following the criteria of the Directorate-General for Taxation, the Administration considers that there has been no effective taxation of the gain and transfers that tax burden to the donee, considering him liable for tax on the untaxed portion.
At this point, it is clear that the Administration can no longer regularise the donor, as the limitation period has expired. However, it is attempting to recover that amount through the donee, even if this means shifting the tax burden to a person other than the actual beneficiary.
Consequently, although the regional administration denied the son the tax benefits of the regime on the grounds that the requirements were not met, the National Court supports a proposal by the Inspectorate that necessarily implies the application of the regime.
In other words, it automatically applies the full subrogation regime, which in practice means that the donee is taxed twice: first, in inheritance tax, on the total value of the shares received, without applying the 95% reduction, as if the regime did not exist; and second, in personal income tax, when transferring the shares, the acquisition value cannot be updated, as if the regime had been applied.
This contradiction creates a situation of double taxation that is completely unjustifiable.
A technically and legally worrying ruling
This ruling raises a fundamental question: can the donee be harmed by the donor's failure to regularise the situation? Does it make sense to attribute a ‘fiscally fictitious’ gain to the donee when the requirements for subrogation to the donor's position in terms of dates and acquisition values are not met?
From our point of view, the answer is clear: no. The donor's failure to regularise their situation should be completely irrelevant to the donee. It is not acceptable to attribute a capital gain to the donee when, in reality, the subrogation mechanism provided for in Article 36 of the Personal Income Tax Law does not apply, as this would distort the logic of personal income tax and violate the principle of prohibition of double taxation.
From a technical and practical point of view, this ruling is highly concerning. The National Court automatically applies the subrogation of Article 36, even when the Administration has previously denied the existence of a family business for tax benefit purposes. This not only affects the taxpayers involved, but also sends a message of uncertainty to many other family businesses planning their generational succession.
In short, this ruling highlights, once again, the need for the Administration and the courts to apply tax principles consistently and rigorously.
At our firm, we insist on the need for extreme caution in transactions involving the transfer of shares in family businesses. Having solid preventive advice is not only advisable, but essential.
- More information about Family Business
Ana Delgado – Family Business Group
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