The complexities of the Inheritance and Donation Tax
June 02, 2017
The Spanish Inheritance Tax (Impuesto de Sucesiones y Donaciones or “ISD”) is a complex tax that, despite being covered by basic state legislation, can differ substantially due to the different tax regimes in force in the various autonomous communities of Spain. In contrast to other European Union Member States, such as Germany, France and the United Kingdom, where all aspects of inheritance tax are typically regulated by a central or federal administration, the Spanish ISD has been to a large extent delegated to the autonomous administrations that have traditionally used it as a political and budgeting tool.
This unique, distinctive factor of the Spanish tax system has currently resulted in a system whereby the effective taxation of this matter differs considerably due to the different scales, exemptions and settlements applicable in the various regions. This problem - known only too well to the tax advisers of Spanish investors with considerable assets - returned to the political agenda in January 2017, as part of the Conference of Regional Government Presidents, at which various important regions, such as Andalusia, Catalonia and Madrid, expressed very different positions in this regard.
Both experts in the matter (to this end, we should recall the Lagares report) and the central government (the measure is already considered in the inaugural agreement between PP and the Citizens) appear inclined to standardise this tax nationwide in the future, although the end result will largely depend on how negotiations unfold regarding autonomous financing matters. Nonetheless, one of the few aspects that is currently clear is that, regardless of a possible ISD tax reform, said tax will continue to exist and will continue to play a key role in the inheritance planning of all taxpayers residing in Spain with considerable assets.
Accrual and application of Inheritance Tax: a key aspect in inheritance tax planning in Spain
As is well known, ISD applies to all acquisitions of assets and rights, free of charge, by inheritance or donation. In the event of inheritance, by default, the current autonomous legislation in force in the testator's region of residence applies (i.e., the autonomous community in which the deceased had resided for the highest number of days in the last 5 years). Therefore, in a standard situation, without suitable inheritance planning, all heirs residing in Spain or in a country of the European Economic Area (EEA) will be taxed according to the tax legislation of the relevant autonomous community applicable at the time of the testator’s death; this can prove to be extremely expensive, especially if the heirs are not the children of the testator and the assets inherited are considerable. Examples currently include regions such as Andalusia, Valencia, Catalonia and the Balearic Islands.
In contrast to the case in terms of ISD applicable to ordinary inheritance, a life insurance contract is subject to specific treatment under the scope of ISD legislation, which means that accrual of the tax can be deferred to a time after death, as long as the contract is drafted from the outset with the suitable parameters and conditions. In concrete terms, all life insurance provisions, the effectiveness of which is subject to a condition or term being met or other such limitation, inherently means that the tax is only accrued when said limits cease to apply, at which point an assessment is required as to which tax framework should be applied to the inheritance tax, depending on where the beneficiary resides at the time, amongst other aspects.
This type of ISD planning was validated as many as 20 years ago by the Directorate General of Tax in a consultation run in February 1995 and the question has not been raised since in terms of its defining elements; this means that it can be declared that a life insurance contract is an efficient Spanish ISD planning tool that is entirely compliant with legal and tax legislation and which is particularly attractive to clients with significant assets.
Regardless of the foregoing, it should be noted that heirs residing in Spain and abroad may be affected at any time by ISD taxation, as the first will be personally obliged to be taxed (the Spanish resident testator's global assets will be subject to ISD) and the second by actual obligation (only the Spanish resident testator's assets situated in Spain will be subject to ISD).
Therefore, all Spanish investors with considerable assets and their families should be aware that efficient succession planning should not only cover any possible heirs residing in their national territory, but also those who have decided to establish their place of residence abroad. To this end, it is important to note that the situation can prove to be particularly costly for heirs not residing in an EEA country, as, by default, state ISD legislation would apply (the most expensive form) and they would benefit from none of the exemptions, deductions or settlements existing in the autonomous community of the testator. It should be noted that residents of the United Kingdom may find themselves in this situation once Brexit becomes a reality.
On this specific point, Luxembourgish life insurance returns to being a tax-efficient solution that is entirely compliant with the ISD Law given that, as envisaged by the latter in its Article 18, all life insurance contracts stipulated with a foreigner insurer outside of Spain shall fall outside of the scope of application of said tax. Effectively, in the specific case of Lombard International Assurance, a Luxembourgish insurer operating in Spain offering the free provision of services under the scope of European Community regulation, all its contracts are issued and stipulated from Luxembourg.
Therefore, in all cases of families coming under multiple jurisdictions, Luxembourgish life insurance may make for an optimum tax response that is compliant with Spanish tax legislation, avoiding a tax burden on all beneficiaries once the tax accrues, having consolidated residence abroad for the purpose of ISD. This is regardless of both the Spanish residency of the policyholder testator and the nature, type and custody of the financial assets underlying the insurance policy.
In conclusion, Luxembourgish unit-linked life insurance is an efficient inheritance tax-planning tool that allows both private clients with significant assets and its trusted advisers to plan for future inheritance, avoiding unforeseen and undesired tax consequences.
By Pablo Peciña and Gonzalo García Pérez
This article was originally published on the FundsPeople portal in Spanish.