Candour

More and more people are investing in Spanish property. Individuals are attracted by a number of reasons including the thought of retiring in an agreeable climate and taking advantage of Spain`s booming holiday and golf industries.

Historically, the wise investor has purchased Spanish property through an offshore company to minimise their tax liabilities. However, now this loophole has been closed, it is vital the property purchaser is aware of the potential tax liabilities

Taxes on some income and on capital gains may be avoided in Spain by careful planning, but tax liabilities on wealth such as inheritance tax (IHT) are more difficult to leave behind.

The rules governing Spanish Inheritance Tax and Gift Tax are currently set out in Law 29/1987 of 18 December and in Royal Decree 1629/1991 of 8 November on the Impuesto Sobre Sucesiones y Donaciones (ISD).

ISD is the Spanish equivalent of the UK`s Inheritance Tax and death tax in other jurisdictions. In contrast to the UK and US systems, ISD does not tax the estate of the deceased, but taxes the real value of the portion received by each heir or legate. Transfers between spouses, which virtually always occur when one spouse dies, are not exempt from inheritance tax in Spain.

ISD is levied on the net market value of each heir’s portion (gross assets less liabilities), by applying progressive tax rates ranging from a start base of 7.65% through to a top rate of 34%. Once the standard tax has been calculated, the law provides for a surcharge based on two different factors, (a) the heir’s relationship to the deceased and (b) the heir’s pre-existing wealth. The surcharge applied increases the more distant the relationship to the deceased is, and as the wealth of the heir or legatee increases. Unrelated wealthy heirs have been known to pay a rate of ISD in excess of 80%.

In the case of the deceased being a resident in Spain for tax purposes, all the assets transferred to an heir or legatee, wherever the assets are situated in the world, will be subject to the ISD tax.

In the case of non-residents of Spain, then only those assets situated in Spain, or the rights capable of being exercised or enforced in Spain, will be subject to the tax. For non-residents these assets could include Spanish property (holiday villa or apartment), funds in Spanish bank accounts (opened for the purpose of paying local taxes and other charges and outgoings in respect of a holiday home), and cars registered in Spain. For most non-residents the greatest value asset would be the Spanish property.

The ISD tax assessed is payable within six months of death, and the ISD payable is the liability of the heir(s) or legatee(s), and cannot be taken from the deceased’s estate.

Therefore, where a Spanish property is inherited (even between spouses), the property itself cannot be used as collateral security to provide a loan to pay the ISD, nor can it be sold until the ISD tax has been paid. Should the ISD tax remain unpaid after a period of six months, then additional interest and fees also become payable.

So what does this mean in practice?

The following example is based on a jointly owned property by a married couple valued at €750,000 and which is to be willed to two non-resident children over 21 years of age upon second death as equal inheritances.

On the first death, we will assume this to be Mr Smith, the transfer will be Mr Smiths half of the property to Mrs Smith; in monetary terms €375,000. Mrs Smith receives an allowance of €15,956.87 leaving a taxable transfer of €359,043.13. The resultant tax due based on today’s standard tax charges is therefore €69,905.70 which has to be paid before the property can be totally transferred to Mrs Smith’s sole name.

Mrs Smith is now the sole owner of the property still valued at €750,000. Upon her death, her two children inherit the asset on an equal basis, i.e. an inheritance of €375,000 each. Both are entitled to their respective allowance of €15,956.87. The tax calculation for each of them is identical to that of their mother’s. Therefore, each has a tax amount to pay based on today’s standard tax charges of €69,905.70. The total tax due on the death of Mrs Smith is 2 x €69,905.70 = €139,811.40. Once again, these taxes have to be paid prior to the children inheriting the property.

Over both deaths the total ISD that has to be paid equates to 3 x €69,905.70 = €209,717.10. This represents approximately 28% of the properties value, and one half of the property has in fact been taxed twice.

Additionally, on larger inheritances, this may also create an inheritance tax liability in Mrs Smiths country of domicile. For example, if Mrs Smith is British, she may also be taxed in the UK for his Spanish property, as part of his worldwide assets as there is non inheritance tax provision in the double taxation treat between the two countries.

So what can be done to mitigate this liability?

Under Spanish law, if a ‘charge’ is legally registered against the Spanish property(ies), then the outstanding amount would be deducted from the property(ies) asset value, before arriving at the net amount subject to Spanish ISD on the overall estate.

As such, by releasing the equity from a property and placing this in an offshore trust, the equity in the property is outside Spain and the individuals’ estate for inheritance tax purposes

For the example above, let us assume a ‘charge’ is registered against the property equivalent to 75% of the properties value - in other words a loan is issued for 75% of the €750,000 = €562,500.

Upon death of Mr Smith the ISD assessable value of Mr & Mrs Smith’s house is now reduced to only €187,500 (€750,000 less the charge of €562,500). Thus on the death of Mr Smith only one half of this amount is transferred to Mrs Smith - €93,750, and the resultant tax is reduced to €15,146.32 after allowances have been deducted, compared to €69,905.70 as illustrated above.

Upon the second death, €187,500 transfers to the two children, and once again this is to be divided in equal proportions. Again, both are entitled to their respective allowances of €15,956.87, and once more the ISD calculation is identical to that of their mother’s. The total tax payable upon the death of their mother is 2 x €15,146.32 after allowances = a total of €30,292.64.

Over both deaths the total ISD tax payable is 3 x €15,146.32 = €45,438.96. This represents a saving of approximately 78% on the amount that would have been due.

What to do next

There are a number of packages on the market that will take you through the whole process from obtaining finance for equity to release to establishing a suitable offshore trust and selecting appropriate assets to be held within the trust. These packages will generally include a panel of solicitors and notaries which you can call upon for the legal advice and registering the charge.

However, the contents of this document only represent a general summary and should not be a substitute for specific advice. The tax consequences for each individual will depend upon the laws of the jurisdiction or jurisdictions to which that participant is subject so it is essential that individuals take appropriate professional advice in relation to their own particular circumstances.

Please feel free to contact me if you need further information or would like details of a provider of this sort of tax planning service.

coralsoft

Some questions.
1. Presumably, creating an offshore charge is only something that can be used by non-residents?
2. If, as in the example, the people involved are non-resident in Spain, they will usually (but not necessarily) be resident somewhere else. If we assume that to be the UK, what will be the additional UK inheritance tax to be paid in each stage of the scenario?
3. Can 2. be mitigated by taking residency in a more amenable location with less onorous inheritance taxation? And what is the liklihood that international "tax harmonisation" initiatives led by UK and other governments will persuade these regimes to change in favour of governments?
4. What options for inheritance tax mitigation are open to Spanish residents?
5. Obviously the tax savings to be made against the Spanish system far outweigh any likely costs of setting up such a scheme, where the property is of significant value, but is this still the case when UK tax, for example, is included in the costs.
6. Is it possible to take out life insurance against the estate owner, such that, on their death, the payout can be used to pay off the inheritance tax liabilities incurred by the inheritors? Is it possible to keep the payout outside the estate of the deceased such that it can be used?

Candour

Some questions.
1. Presumably, creating an offshore charge is only something that can be used by non-residents?
Offshore Companies can be established by anyone. However, they are rarely an efficient tax planning tool these days.
2. If, as in the example, the people involved are non-resident in Spain, they will usually (but not necessarily) be resident somewhere else. If we assume that to be the UK, what will be the additional UK inheritance tax to be paid in each stage of the scenario?
UK inheritance tax is based on domicile not residence so all UK nationals will be liable to inheritance tax wherever they live in the world. Unless the inheriting spouse is non-UK domicile there is no inheritance tax between husband and wife in the UK so no tax will be payable in the UK on the death of the first spouse. This will however create a liability in Spain.
It is on the death of the second spouse when the assets are passed on to children (or others) that the UK inheritance tax liability arises. As such, a Spanish property can be taxed twice - in Spain when it is passed to the husband/wife and then in the UK & Spain when it is passed to the children/relatives!
3. Can 2. be mitigated by taking residency in a more amenable location with less onorous inheritance taxation? And what is the liklihood that international "tax harmonisation" initiatives led by UK and other governments will persuade these regimes to change in favour of governments?
No. As the property will remain in Spain and the owner will retain British domicile. The only chance of future 'harminisation' may be on the second death so that the estate in not liabile in two countries. This is usually set out in a diuble taxation treaty.
4. What options for inheritance tax mitigation are open to Spanish residents?
The only real option remaining is to remove equity from the Spanish property and place this outside the estate whilst retaining control over both assets. Candour Consultancy can advise on how this can be done. However, each case is individual so generic advice is hard to give.
5. Obviously the tax savings to be made against the Spanish system far outweigh any likely costs of setting up such a scheme, where the property is of significant value, but is this still the case when UK tax, for example, is included in the costs.
Potentially, substantial tax savings will be made both in Spain and the UK. The equity removed from the property is usually placed in a offshore trust to avoid tax either on growth or transfer.
6. Is it possible to take out life insurance against the estate owner, such that, on their death, the payout can be used to pay off the inheritance tax liabilities incurred by the inheritors? Is it possible to keep the payout outside the estate of the deceased such that it can be used?
It is, via setting up a whole-of-life life assurance policy written in trust from outset. Again this is an area Candour Consultancy can advise on and quote for. For life assurance, Candour Consultancy is an approved agent of all the major international life assurers including Aviva (Norwich Union), Friends Provident Internation, Generali International & Scottish Life International.

Candour Consultancy can be constacted at [email protected]

Spanishliferules

I have been informed, maybe incorrectly, that in the absence of a will in Spain, then in the resulting death of myself or spouse. Then half of that inheritance would be automatically equally shared between my three children, with Spanish law protecting the rights of the reaming spouse, to stay in the property until death. Then again the same as procedure would follow, if this were correct then this would save a payment of inheritance as described in your example, or am I misinformed?

Finance isn’t my strong point, however thanks for this info very interesting.

Candour

This may well be correct - I am far from an expert on Spanish Intestate Laws. We do not really get involved in this to deeply as we are not tax advisors or solicitors. Instead we are a firm of expatriate financial advisers who make people aware of the potential liability and, if this is of interest/concern to them, we can introduce them to the people are experts in this field.

One thing to remember is that your spouse and each sibling only has a small tax allowance (approx. Euro 16,000) As such, if you have a property worth Euro 200,000 that is unencumbered the following would occur on your death:

1. 50% (euro 100,000) of the property would be passed to your wife. She has an allowance of Euro 16,000 so Euro 84,000 would be taxable - likely to be in the region of Euro 16,000.

2. The other 50% would be split between you 3 children (Euro 33,333 each). They too have a tax allowance of Euro 16,000 so each would have a tax liability on Euro 17,333 - likely to be in the region of Euro 3,500 each.

As such, you family will have to pay the spanish taxman over Euro 26,000 within 6 months of your death or sell the property to realise sufficient funds. Additionally, if you are a UK national and wish to pass other assets to your children, the 50% you have passed on to your children will be deemed as part of the UK IHT allowance - now £275,000.

This is an over-simplistic example and is not meant to be a precise tax calculation, purely an indication of how the system works.