Spanish Inheritance Tax

Spanish Inheritance Tax - Use of Trusts in Spain

Much has been written about the use of trusts as a successful way of avoiding Spanish Inheritance Taxes.  Given that Spanish Inheritance Tax can be as much as 81.6% if you are a beneficiary not related to the person that has died, using a trust may be a very powerful tax reduction weapon.

A trust is a very popular way of potentially reducing taxes because when you put money into a trust, you normally no longer own it and if you have a special trust called a “discretionary” trust there are also no definite beneficiaries.  Spanish Inheritance Tax is payable by the beneficiary of an estate, so putting your money in a trust may be appealing as there is not a set beneficiary.

Different Opinions
Many advisers suggest trusts are not legal in Spain.  Others suggest that trusts are a legitimate way to plan for reducing inheritance taxes.  Who do we believe?

The Facts:
There have only been a few relevant legal cases that have been through the Spanish Courts and none specifically on trusts.  Trusts and Spain and therefore Spanish succession laws in relation to trusts are still very much a ‘grey’ area.

• Spain is a “civil law” country, with laws derived from the Napoleonic code i.e.  a written constitution.  There is no legal entity recognised under Spanish Law called a “trust”.  In short, trusts do not exist under Spanish Law, although other similar things such as “usufructos”, “testaferros” and pension schemes (which are protected from inheritance tax) do exist.
• The Hague Convention deals with recognition and agreement of principles under International Law.  Despite claims by some that Spain has signed the Hague Convention on trusts, on the Hague Convention website, Spain is still not listed as having signed the convention for trusts, nor has it been ratified in Spain.  There is, however, a mention of trusts included in the US-Spain tax treaty.  This is therefore inconclusive.
• Adams 1985 (English High Court): A UK resident and UK domiciled person passed away leaving both English and Spanish Assets but an English Will only.  The English Judge, relied upon case law relating to the Estate of the Duke of Wellington over 100 year before, as well as making a judgement i.e.  second guessing what a Spanish Supreme Court Judge would decide on the Spanish assets.  Judge Sir Nicholas H W Browne-Wilkinson decided that a Spanish Judge would have made a decision based upon the Laws of Nationality in Spain i.e.  he decided that a Spanish Judge would apply Spain’s Law of Nationality.  This is detailed in Article 9.8.
• Article 9.8 Spanish Civil Code: Law of Nationality: States that the law applicable on death to both testamentary (a Will in force) and intestate (no Will) succession is governed by the Law of Nationality at the time of death.  In short, on death of an English National whether in Spain or not, under Spanish Law, the Law of England and Wales applies.
• Denney 1999 (Spanish Supreme Court): An Englishman resident in Spain who died in Spain with a Spanish Will.  The Spanish Supreme Court Judge, His Excellency, Sr.  D.  Pedro González Poveda, confirmed that he would again apply the Law of Nationality of the deceased i.e.  on death and cited that the English Courts, in the Adams Case, were reluctant to “refer back” assets to be dealt with under Spanish Law and the Spanish Supreme Court agreed again that it should be dealt with under Laws of Nationality of Spain i.e.  English Law (see 9.8 above) prevails.

To summarise, under Spanish Law on death, English Law applies to the English, Scottish Law to Scots, French Law to the French and  US Law to US Nationals etc.
 
Will Spanish Courts look straight through a trust and tax it?

Alive v Death v Taxes
Case law both in the UK and Spain has dealt with the Laws of Nationality in Spain and we suggest this is therefore an established principle in both countries.  However, the key here is that Laws of Nationality apply on death i.e.  not when you are alive and are to do with estate distribution and not taxation.  Many trusts and money placed in trusts are set up when people are alive not dead and then people also then receive an income from the trust when they are alive.  

Second Guessing
Accepting there is still no case law or tax rules for trusts in Spain, as they are not recognised; we therefore are trying to second guess what a Spanish Supreme Court decision would be.  It is reasonable to expect that Article 9.8, Denney and Adams, would again be looked at alongside, usufructos, testaferros and pension wrappers, and therefore, whilst not proven, it is likely that a trust would be recognised on death and not "looked through".  So using a trust on death is likely to be effective.

Alive and Using Trusts
However, establishing a discretionary trust today and making a money gift to the trust is done when alive and not after death.  Therefore, any assumptions regarding Laws of Nationality for trusts in life and putting money into a trust when you are alive cannot be confidently relied upon and certainly may not reduce any taxes due anyway.

Trusts are recognised under English Law and for Discretionary Trusts, whilst potentially taxable in UK for larger sums, are also irrevocable contracts and similar in legal terms to a Pension Scheme in the UK and therefore, we see it as likely that Spain would recognise a trust if tested in a court.

Put Non Spanish Assets in a Trust
Even if Spain does recognise your trust, there is still a risk of Spanish Inheritance taxes payable immediately because within Spanish Law gifts or donations made “inter vivos” i.e.  between the living can be subject to tax actions when seeking to reduce your tax i.e.  deliberately setting up a trust to avoid Spanish taxes and you may get taxed anyway.  Therefore, we suggest you should avoid putting Spanish based assets in a trust.

Our conclusion therefore is a lifetime transfer for a UK National (Spanish resident) to a trust to avoid Wealth or Inheritance taxes in Spain should be for non-Spanish assets only.  Care must be taken to ensure the people setting up the trust are no longer UK domiciled at the time or only gifting amounts below the UK Inheritance Tax threshold as this may incur a UK Inheritance Tax charge.  

We would also reiterate again that although the Spanish Tax Authorities appear generally to ignore non-Spanish assets on death of residents for non-nationals, this position may change as tax collection becomes more aggressive in these difficult times and we also remind you that the use of a trust has still not been tested in a Spanish Court.  

We suggest using a trust to gift non-Spanish assets to non-Spanish residents or trustees is a calculated and acceptable risk.  Your estate and your beneficiaries have nothing to lose and can only gain if the trust is not contested and therefore no Spanish inheritance tax due.  You will of course still potentially by liable to income tax if you receive any regular income from the trust or potentially subject to Spanish Inheritance Tax if you receive irregular lump sum gifts back from the trust.

Tax and trust planning in Spain as you can see is exceptionally complex.  Contact us for award winning international advice.