Taxing a rent free commercial property

Picture the scene: with youth unemployment in Spain currently hovering around the 50 per cent mark for under 25s (source Eurostat), you decide to give your son a helping hand by letting him set up business in an empty shop you happen to own.

        Spencer Clarke Property Tax

As he is your child and you don’t need the money, you are letting him have the premises entirely rent-free. This altruistic gesture is good news not just for your son, but also for the Spanish economy—after all he will be employing staff who will all pay taxes and social security contributions.

So you would of course expect the taxman to make life as easy as possible for all concerned to smooth your son’s path into the world of employment.

But does he? If your son is receiving the premises free of charge, what income tax and VAT (known as IVA in Spain) liabilities do you incur?

The first thing to know is, free or not, you have to declare such a transfer of business premises for income tax and VAT purposes. This does not necessarily mean you or your son will have to pay anything but failure to submit the correct paperwork will almost certainly result in penalties.

Let us start at the beginning with some simple definitions:

Implications for income tax
An office or shop premises is an economic asset because it has the potential to earn you income. If you cede its use—permanently or temporarily—without charging for it, you are obviously not earning anything from it. As income tax is a tax on earnings then logically—and in practice—there is no need to declare an income from it. Neither does your son have to pay any tax retention, as would be the case if he was paying rent.

So far so good. However (nothing is ever that simple in Spain) there IS a tax liability, as we will explain below...

Imputation: You still have to pay tax against the capital value of the asset, in this case in the form of a ‘fictional’ income that since 2015 is calculated as follows:

In general, you declare 2% of the cadastral value of the premises. If the cadastral value has been updated within the past ten years, the percentage drops to 1.1%.

Expenses: If you have incurred costs in adapting the premises for the commercial needs of your son you will not be able to deduct them from the tax on the imputation, as it focuses on the value of the asset. Your improvements will be considered to have added value to the capital asset.

Nor can you claim expenses against the imputed rent for any renovations to prepare the premises for the commercial activities of your son, even if it may be considered as an extension or improvement of the premises. Any benefit will come in the future should you decide to sell the premises, when you will pay less tax.

In other words, the sales value of the property against which you are being taxed in this case is assumed to grow when you update or renovate it. On the other hand, the costs incurred in the process are deducted from the profit obtained should you sell the property in the future, so they will result in a lower capital gains tax at the time.

When you cede commercial premises without payment it is classed as personal use or ‘consumption’.

Beware – this means you should deposit a small sum with the Hacienda (tax authority) to cover the IVA (VAT) due. It is calculated as follows:

The assessment base to be used is the cost incurred in owning the premises. This includes rates, taxes, maintenance, community fees, etc. Also include amortisation at 3% of the acquisition cost – or the rateable value if this is higher – but without the land.

Once you have calculated the taxable base, the standard VAT rate of 21% is applied, though with subtraction of any VAT paid in the course of earlier costs incurred—such as for renovation work.

Income: You will need to issue an invoice to your son on December 31 each year, detailing the base and tax to be paid. From this, declare the applicable VAT to be paid in the statement for the last quarter of the year and deduct that from your expenses. Your son will not have to pay the full amount of the invoice, just the VAT, which is tax deductible at the rate that applies to his business activity.

This means that while the tax procedures will have been satisfied, neither you nor your child will have incurred costs on balance. In other words, even though it won’t cost either of you one cent, you still have to make sure the paperwork is in order. And if you don’t, you may be liable to penalties. Don’t you just love red tape?

In summary: for the purpose of income tax, a rent should be imputed based on the rateable cadastral value of the premises. For VAT purposes, you should prepare an invoice for your ‘free tenant’ whose payable VAT rate is based on all the annual costs you incur as owner of the premises. 

For queries regarding this and any other tax issues in Spain, please contact our accounting experts at Spence Clarke.