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Spanish Supreme Court Confirms Position on Interpretation and Application of Tax Treaties — Orbitax Tax News & Alerts

The Spanish Supreme Court issued a decision on 23 September 2020 concerning the interpretation and application of Spain's tax treaty with Switzerland in relation to beneficial ownership. This follows an early decision issued in March 2020 in relation to permanent establishment provisions, with a similar result ({News-2020-06-11/T/2-previous coverage}). In both cases the Court has essentially ruled the OECD Model Convention and commentary, including relevant changes, may not be used as basis for the interpretation and application of the provisions the tax treaty as in force during the years concerned.

The case involved Colgate Palmolive Spain S.A., which made royalty payments to Colgate Palmolive Europe Sarl in Switzerland in 2006 and 2007, for which reduced tax (5%) was withheld as per the provisions of the 1966 Spain-Switzerland tax treaty. In reviewing the payments, however, the Spanish tax authority determined that the recipient did not qualify as a beneficial owner and should, therefore, be denied the treaty benefits and subject to tax under domestic withholding rules (25% in 2006 and 24% in 2007).

This position was challenged, with Colgate Palmolive arguing that restrictions based on beneficial ownership could not apply because this is not covered in Article 12 (Royalties) of the Spain-Switzerland treaty. Further, it was argued that if such restrictions did apply, then the 10% rate provided under the 1990 Spain-U.S. treaty should apply since Colgate Palmolive U.S. was the actual beneficial owner (note this treaty has since been amended to provide a 0% rate).

When its position was appealed, the tax authority held that although not covered in Article 12, the concept of beneficial ownership and restrictions on treaty benefits should apply on the basis of the OECD Model Convention and related commentary. The tax authority also held that it would not be appropriate to apply the Spain-U.S. treaty in this case as it would result in "multiple regulatory dysfunctions" if "a legally non-existent regime of fiscal transparency or income allocation would be applied" and further that it would not be easy follow the actual flow of income to determine the applicable treaty.

The court of first instance upheld the tax authority's position, finding that although Article 12 does not include beneficial ownership restrictions, such restrictions should be applied in accordance with the commentary to the OECD Model Convention and in light of the fact beneficial ownership restrictions have been introduced in other articles of the treaty (including for dividends and interest). The court also accepted the tax authority's position on the Spain-U.S. treaty.

In its decision, the Supreme Court found in favor of the taxpayer. The Supreme Court highlighted three main issues with the interpretation and application of beneficial ownership restrictions:

  • In no case may such an interpretation be applied retroactively for a case governed by a previous rule;
  • In no case may such an interpretation be based exclusively on commentary, models, or interpretative guidelines that have not been explicitly assumed by the Contracting States to the tax treaty; and
  • In no case may an interpretation adopted by the tax authority or the courts give rise to a situation of double taxation without previously assessing the effective taxation in the other Contracting State (Switzerland) and the possibility of avoiding double taxation as provided for in Article 23 of the treaty.

Further to the above, the Supreme Court also found that the court of first instance had erred in accepting the tax authority's rejection of the possible application of the Spain-U.S. tax treaty, especially given its defense of the application of the beneficial ownership principle.

Based on this, the Supreme Court accepted the appeal of Colgate Palmolive Spain and annulled the lower court decision.