The EU Starts Action Against Spain for its Unfair Inheritance Tax Law

The European Commission made official complaints against Spain in May 2010 and February 2011 regarding its Inheritance tax legislation. These complaints were ignored and so the EC has commenced an action against the Spanish state through the European courts.

Spain's tax system has become decidedly odd.

A little background will help to understand what has happened that has so upset the EC.

Over the years, the Spanish state has ceded many taxes to the 17 Autonomous Communities (ACs). These are Andalucia, Aragon, Asturias, Balearic Islands, Basque Country, Canary Islands, Cantabria, Castilla la Mancha, Castilla Leon, Catalunia, Ceuta, Extremadura, La Rioja, Murcia, Madrid, Melilla, Navarra.

Political power in Spain is vested in central government but considerable power has been devolved to the 17 ACs, in accordance with the Spanish Constitutional Law. These regional governments are now responsible for many aspects of country's administration, including provision and regulation of education, health, social services, culture, tourism, environment, land development. The financing of the ACs is now mostly achieved from the ceded tax system.

The ceding of tax revenue to the ACs was accompanied by the right to modify the tax laws that originated from the state. Some ACs have substantially modified state tax law whilst others have just tinkered with the personal allowances.

The Impuesto sobre Sucesiones y Donaciones (ISD), Spain's inheritance and gift tax is one of the devolved taxes.

Inevitably, over the years, the ISD systems of the ACs have changed to the point that there are now considerable regional differences. The most significant of these are the substantial exemptions that a few of the ACs have introduced for inheritances between close family members.

The EC has been forced to start legal action against Spain because non residents remain subject to the state ISD system, regardless of where in Spain they might have property that would be subject to ISD.

Spanish ISD is charged to non resident beneficiaries when they inherit, or receive a gift of, Spanish immovable property or other assets that are subject to the application of Spanish law (Spanish company shares, vehicles, bank accounts etc).

By definition, non residents cannot be residents of the AC in which their property is located. In effect, the state has reserved the right to collect ISD in the case of non residents.

One particularly striking example of this inequality is Madrid. A parent can leave assets to a child and the inheritance is almost entirely tax exempt. In comparison, in the case of a foreigner owning the next door house, a child would not benefit from the Madrid exemption and substantial tax would arise.

The EC regards this as being contrary to the principles enshrined by the Treaty of Rome. In such cases of blatant discrimination, the EC always acts to force the offending EU state to change its laws.

This happened in Spain a few years ago with its capital gains tax. The rate charged to non residents was 35%, compared to a resident's tax rate of 15% (now 19%). It took a few years but Spain toed the line in the end.

Reforming tax, especially if this means generating lower tax revenue, is not high on the agendas of the Spanish political parties. The national elections take place in a few weeks time, on the 20th November. The only tax reforms that appear in the manifesto of the Partido Popular, generally expected to win by a substantial majority, are designed to attract voters. Non residents and the EC are not voters!

It seems certain that changes will be made in the ISD system in due course that will remove the obvious discrimination against non residents but, given the current state of the economy, it seems unlikely at present for ISD to be reformed to the extent that it ceases to be a problem for non residents.