Spanish inheritance tax along with general tax legislation, falls under the banner of Napoleonic law. Succession and gift tax, Impuesto sobre Sucesiones y Donaciones (ISD), apply to beneficiaries of gifts and inheritances for Spanish tax residents. ‘Forced heirship’ rules determine how an estate must be divided and what rate of tax applies to beneficiaries. There are four categories of beneficiary, ranging from direct descendants such as children and adopted children to in-laws, step-children and ascendants.
Napoleon’s reason for creating new succession laws was mainly political. His aim was to break up land ownership amongst aristocrats into smaller packages, thus reducing power bases. This was all done in the name of equality and simplification. Before these changes were enacted, succession legislation was complicated and open to abuse. The net effect was that aristocratic families hardly paid any tax and were able to retain their considerable interests in land ownership. Napoleon realised that by breaking up estates and charging tax on the proceeds after the death of the owner, many beneficiaries would either choose to sell up or be forced to, as a result of not having sufficient liquid wealth to cover tax bills. The state then accepted ownership of land in lieu of tax liabilities; this meant that the balance of state and privately-owned land gradually changed. To this day, more land is state-owned in countries that practiced forced heirship laws of succession; Spain is no exception.
Spanish inheritance tax and Double Tax Treaties
Despite Napoleon’s attempts at simplifying succession laws, it is still a complex area. This is particularly the case for expats who might own assets in different countries and (maybe without knowing) are still considered domiciled in their home country. Thankfully, Double Tax Treaties (DTT’s) exist within the EU and further afield. These are designed to ensure that no-one pays tax twice on the same asset.
A basic example of how DTT’s work in practice can be found in the case of a British expat, who is tax resident in Spain, but domiciled in the UK. This situation may arise as a result of the expat not having lived outside of the UK for long enough, or perhaps retaining financial interests in the UK.
Property can present specific issues for beneficiaries as it is an immovable asset; there is thus no doubt as to where it is situated. Being domiciled in the UK means tax is payable on worldwide income and also capital. This conflicts with Spanish legislation which insists that tax is paid on assets based in Spain if the owner is tax resident there. The DTT will ensure that upon death, the deceased’s heirs won’t pay tax twice. However, the process is not straight-forward.
The Spanish and UK tax authorities do not discriminate in terms of which assets are owned when they dispatch the tax bills. For cash and readily realisable savings and investments, this usually presents few problems. Non-liquid investments (including many esoteric UCIS funds) and property can therefore create problems for descendants similar to those faced by aristocratic families of 18th century France.
Having to sell a house, apartment or land in the UK in order to pay a Spanish inheritance tax or UK tax bill can present challenges. The market may have recently corrected, making it a bad time to sell, or it may not be possible to sell at all due to oversupply or recessionary times. To further complicate matters, a mortgage lender might also push for the sale of a house in order to recover their loan. The tax authorities still want their money though; they rarely allow more than 6 months for the beneficiaries or estate to pay.
Spanish Inheritance tax in Andalucia
Understanding the ‘ins and outs’ of Spanish inheritance tax is always a challenge for expatriates. Andalucia has always been considered a relatively high taxed region of Spain. Things have been changing, however, perhaps spurred by tax competition between other Spanish regions and nearby Portugal.
2018 marked the first stage in what has become a major upheaval of inheritance and gift tax laws in the region. Previously, the tax-free allowance for class 1 and 2 beneficiaries (spouses, parents and children) was c. €250,000. This meant inherited funds over that amount would be taxable at rates starting at 30%, and could be as high as 80%+ in the case of an unrelated beneficiary with a high level of existing wealth. Andalucia had been governed by the PSOE party from 40+ years, but their grip on power was then reduced to the point where they had to form coalition agreements with right wing parties, who insisted on tax reform in return for political support.
Consequently, the Spanish inheritance tax exemption was raised to €1m per beneficiary. This was a welcome step, however critics would point out that the associated rule, which prohibited those with assets in excess of €402,678 of being eligible for the new exemption, meant little had effectively changed. Smoke and mirrors!
One might question the value of a rise in reliefs (and consequent reduction in tax take) when the region, and country, needs tax receipts to be as high as possible, due to the devastating effects of the financial crisis. Indeed, wealth tax, which was first imposed in 1979 as an emergency measure following the fall of Franco’s government, then abolished in 2008, only to be re-imposed in 2011, is also under the spotlight as some feel the negative tax effects are worse and, in fact, reduce overall receipts. Legislation exists whereby Wealth Tax will be eliminated in 2020. All things being equal, this should go through, unless the politicians consider the country to be in a new emergency situation!
We live in a time of tax competition. Not only between countries, but also regions in Spain. The high tax regime in Andalucia has discouraged wealthier individuals from living, working or retiring to the area. This, in turn, has had a negative effect on tax taken from other sources such as transfer tax, IVA (VAT), income and corporation tax and property rates. The real consequences of Andalucia’s tax policy have been that wealthy people and companies prefer to be based in lower taxed regions such as Valencia and Madrid. Additionally, the favourable tax treatment of pensions and dividend income in Portugal has prompted many to relocate there. Italy is also getting in on the act by applying heavily reduced property transfer tax, and other incentives, to try to repopulate dying communities.
April 11th 2019 then saw new inheritance tax (and other taxes) reformed once again. This time the smoke and mirrors were disposed of, and real significant changes have been enacted. Andalucia has followed Madrid and Valencia (as well as many other regions) in introducing a discount of 99% of inheritance and gift tax liabilities. The €1m tax-free exemption still applies, but this time it really means something. So, anyone inheriting less than €1m pays zero Spanish inheritance tax. Inheritances over €1m will only be taxed at the nominal 1% rate. Similarly, no tax will be payable on gifts, which compares highly favourably with the previous complex and penal system.
This all means more money can be passed to future generations, which can only be a good thing. As with all financial planning issues, no single element should be considered in isolation. This equally applies to the macro planning decisions governments have to take. More money in the hands of individuals means less will be dependent on state assistance in future. This is especially important as Spain, along with many other countries around the world are dealing with the demographic time-bomb caused by more people being retired and fewer working, leading to less funds available to pay for more services.
One last bit of good news on inheritance tax. A consequence of the reduction in gift tax is that transferring property by deed of gift is now only subject to 1% tax, rather than the 8-10% pre-2019 rate.
It has never been more important to take a holistic approach to financial planning. Any country can appear to be a high tax territory if we don’t take advantage of all available allowances and exemptions. The new inheritance tax rules in Andalucia, combined with proposed reductions in wealth tax and being able to manage investments in a highly tax effective way by using a Spanish Compliant Bond, makes Andalucia an even more attractive place to live, work and retire.
Pretty good, especially when we add in the glorious weather, great food and wonderful cultural experiences on offer.
Things to consider in terms of Spanish inheritance tax
- The first step is to value your worth. List all assets, liabilities, investments and savings
- Make a will, or perhaps even two, depending on where your assets are located
- Ensure your Executors know who wrote your will(s)
- Update your financial records regularly
- Use gifting laws to your advantage
- Speak to your financial adviser about Spanish inheritance tax and legal tax avoidance strategies
- Wrap your strategy in solid professional advice from a properly qualified tax specialist
Lastly, it is interesting to note that the DTT between Spain and the UK does not specify rules regarding Spanish inheritance tax and succession laws, other than confirming tax won’t be paid twice. This is due to this subject being complicated; for every rule there will be exceptions. No two people have the same situation regarding tax liability. With the correct advice you will be able to create your own personal tax strategy which should reflect your overall financial position and family circumstances.