Spain-United States International Income Tax Treaty Explained

US Spain Tax Treaty

US Spain Tax Treaty: International Agreements “US Tax Treaties” between the United States and foreign countries have existed for many years — and the US Spain Tax Treaty is no different. An Income Tax Treaty like the income tax treaty between Spain and the United States is designed to minimize inconsistent and double taxation — although a tax treaty cannot (unfortunately) shield certain tax implications of items such as a foreign pension. Spain and the United States have been engaged in treaty relations for more than 50-years and first entered into a modern-day tax treaty nearly 35-years ago, The treaty has been updated and revised — with the most recent version being 2003. The purpose of the US/Spain Tax Treaty is to help Taxpayers determine what their tax liability is for certain sources of taxable income involving parties to the treaty. While the US Spain Tax treaty is not the final word on how items of income will be taxed — it does help Taxpayers better understand how either the US Government and/or Spain will tax certain sources of income; what the IRS reporting requirements are — and whether or not the saving clause will further impact the outcome. Let’s review the basics of the US Spain Income Tax Treaty – and which income is taxable:

Saving Clause in US Spain Tax Treaty

As we work through the treaty, one important thing to keep in mind is the saving clause. The saving clause (essentially) provides that, despite any information provided in the treaty — both countries reserve the right to tax certain citizens and residents as they would otherwise tax them under the general tax principles of their respective countries.

What does the Saving Clause Say?

• • • 3. Notwithstanding any provision of the Convention except paragraph 4, a Contracting State may tax its residents (as determined under Article 4 (Residence)), and by reason of citizenship may tax its citizens, as if the Convention had not come into effect.

Saving Clause Limitations in the Spain/US Tax Treaty

Despite any limitation created by the saving clause, certain portions of the tax treaty are immune from the saving clause — which means the tax treaty will stand despite the Savings Clause.

The provisions of paragraph (4) shall not affect:

• • • The provisions of paragraph 3 shall not affect

      • (a) the benefits conferred by a Contracting State under paragraph 2 of Article 9 (Associated Enterprises), under paragraph 4 of Article 20 (Pensions, Annuities, Alimony, and Child Support), and under Articles 24 (Relief from Double Taxation), 25 (Non-Discrimination), and 26 (Mutual Agreement Procedure); and

      • (b) the benefits conferred by a Contracting State under Articles 21 (Government Service), 22 (Students and Trainees), and 28 (Diplomatic Agents and Consular Officers), upon individuals who are neither citizens of, nor have immigrant status in, that State.

Resident: Article 4 of Spain & US Tax Treaty

• • • For the purposes of this Convention, the term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of similar nature, provided, however, that this term does not include any person who is liable to tax in that State in respect only of income from sources in that State.

What does this Mean?

It means that for purposes of the tax treaty, a resident is essentially a person who intends on being a resident of that country by way of domicile, place of management or incorporation — or any other situation when considering the totality of the circumstance, would tend to show that the person intended on being treated as a resident of that country.

Permanent Establishment: Article 5 of Spain & US Tax Treaty

• • • For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

    • The term “permanent establishment” includes especially (a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; and (f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.

    • A building site or construction or installation project, or an installation or drilling rig or ship used for the exploration or exploitation of natural resources, constitutes a permanent establishment only if it lasts more than six months.

What does this Mean?

When it comes to Permanent Establishment rules — it can get very complicated, since it involves business and especially with the introduction of the TCJA, the rules are still kinda sorta in a state of flux. The most important concept of permanent establishment is that unless a company has a permanent establishment “fixed place of business” in this specific country then they are generally not going to be taxed by that country on the income generated in that country.

Real Property Income: Article 6 of US Spain Income Tax Treaty

• • • Income derived by a resident of a Contracting State from real property (including income from agriculture or forestry) situated in the other Contracting State may be taxed in that other State.

    • The term “real property” shall have the meaning which it has under the law of the Contracting State in which the property in question is situated. The term in any case shall include property accessory to immovable property, livestock and equipment used in agriculture and forestry, right to which the provision of general law respecting landed property apply, usufruct of immovable property, and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources. Ships, aircraft, and containers used in international traffic shall not be regarded as real property.

    • The provisions of paragraph 1 shall apply to income derived from the direct use, letting, or use in any other form of real property.

    • The provisions of paragraphs 1 and 3 shall also apply to the income from immovable property of an enterprise and to income from immovable property used for the performance of independent personal services.

    • Where the ownership of shares or other rights in a company or other entity entitles the owner of such shares or rights to the enjoyment of real property held by the company or other entity, the income from the direct use, letting, or use in any other form of such right of enjoyment may be taxed in the Contracting State in which the real property is situated.

What does this Mean?

When it comes to real property income, the Spain & US Tax Treaty provides that any income generated from the real property situated in one of the contracting states may still be taxed in that state — in other words, for example, if a US person resides in the United States and has an income generated in Spain, then Spain can still tax the income even though the person is a resident of the other contracting state — and nothing would prevent the state of residence from taxing it as well. (Foreign Tax Credits should minimize the tax outcome).

Dividends: Spain & US Tax Treaty

• • • Dividends paid by a company that is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

    • However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, except as otherwise provided, the tax so charged shall not exceed:

    • (a) 5 percent of the gross amount of the dividends if the beneficial owner is a company that owns directly at least 10 percent of the voting stock of the company paying the dividends;

    • (b) 15 percent of the gross amount of the dividends in all other cases. This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.

What does this Mean?

When it comes to dividends, the general proposition is that even if dividends are paid by a company of one contracting state (Spain) to a resident of the other contracting state (US), it is the other contract state that gets to tax the dividends (US) — although they can still be taxed in this state of source but only up to a limited amount of tax. When it comes to dividends, there are many exceptions, exclusions and limitations to be cognizant of — which will vary based on the taxpayer-specific facts and circumstances.

Interest: US Spain Income Tax Treaty

• • • Interest arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State.

    • 2. Notwithstanding the provisions of paragraph 1 of this Article:

      • (a) interest arising in the United States that is contingent interest of a type that does not qualify as portfolio interest under United States law may be taxed by the United States but, if the beneficial owner of the interest is a resident of Spain, the interest may be taxed at a rate not exceeding 10 percent of the gross amount of the interest; and

      • (b) interest that is an excess inclusion with respect to a residual interest in a real estate mortgage investment conduit may be taxed by the United States in accordance with its domestic law.

      • 3. The term “interest” as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor’s profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures, and all other income that is subjected to the same taxation treatment as income from money lent by the taxation laws of the Contracting State in which the income 7 arises. Income dealt with in Article 10 (Dividends) and penalty charges for late payment shall not be regarded as interest for the purpose of this Article.

What does this Mean?

The taxation of interest is a bit more straightforward than dividends, but still has its own set of complexities to be aware of. From a baseline perspective, interest earned in a contracting state (Spain) which arises from the beneficial ownership for a person in the other contracting state (US) is only taxable in that other state — shall vs may. Of course, there are some exceptions and exclusions to the first paragraph which taxpayers should evaluate carefully for their specific situation.

Capital Gain: Spain & US Tax Treaty

• • • Gains derived by a resident of a Contracting State from the alienation of real property situated in the other Contracting State may be taxed in that other State.

    • Gains from the alienation of stock, participations, or other rights in a company or other legal person the property of which consists, directly or indirectly, mainly of real property situated in Spain, may be taxed in Spain. 

    • Gains from the alienation of personal property which are attributable to a permanent establishment which an enterprise of a Contracting State has or had in the other Contacting State, or which are attributable to a fixed base which is or was available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, and gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or such a fixed base, may be taxed in that other State.

What does this Mean?

Capital gains are also a common source of passive income. Essentially, if real property is alienated which culminates in a taxable event in a contracting state, then it is taxable in that contracting state. There are specific definitions to be aware of depending on whether the property is located in Spain or the United States –and different rules may apply to each based on their own respective tax regimes. In addition, there is specific definitions involving what is termed as “real property situated in a contracting state.”

Exchange of Information: US Spain Income Tax Treaty

• • • The competent authorities of the Contracting States shall exchange such information as is foreseeably relevant for carrying out the provisions of this Convention or to the administration or enforcement of the domestic laws concerning taxes of every kind and description imposed by a Contracting State to the extent that the taxation thereunder is not contrary to the Convention. The exchange of information is not restricted by paragraph 1 of Article 1 (General Scope) or Article 2 (Taxes Covered).

    • Any information received under this Article by a Contracting State shall be treated as secret in the same manner as information obtained under the domestic laws of that State and shall be disclosed only to persons or authorities (including courts and administrative bodies) involved in the assessment or collection of, the enforcement or prosecution in respect of, the determination of appeals in relation to the taxes referred to in paragraph 1 of this Article, or the oversight of such functions. Such persons or authorities shall use the information only for such purposes. They may disclose the information in public court proceedings or in judicial decisions. The competent authority of the Contracting State that receives information under the provisions of this Article may, with the written consent of the Contracting State that provided the information, also make available that information to be used for other purposes allowed under the provisions of a mutual legal assistance treaty in force between the Contracting States that allows for the exchange of tax information. 

    • In no case shall the provisions of the preceding paragraphs be construed so as to impose on a Contracting State the obligation:

      • (a) to carry out administrative measures at variance with the laws and administrative practice of that or of the other Contracting State;

      • (b) to supply information that is not obtainable under the laws or in the normal course of the administration of that or of the other Contracting State;

      • (c) to supply information that would disclose any trade, business, industrial, commercial or professional secret or trade process, or information the disclosure of which would be contrary to public policy.

What does this Mean?

The exchange of information portion of the tax treaty is commonplace. It basically provides that each contracting state will exchange information with the other — necessary to carry out the purpose of the treaty. It also explains how the exchange of information may not be restricted under certain other articles of the treaty — but there are also limitations regarding the requirements that a contracting state may or may not have to adhere to.

Pension & Social Security in the Spain/US Tax Treaty

One of the most important aspects of tax treaty law is how pension income is taxed. This is especially true, so that retirees can plan for their golden years.

Pension

• • • Subject to the provisions of Article 21 (Government Service):

      • (a) pensions and other similar remuneration derived and beneficially owned by a resident of a Contracting State in consideration of past employment shall be taxable only in that State; and

      • (b) social security benefits paid by a Contracting State to a resident of the other Contracting State or a citizen of the United States may be taxed in the first-mentioned State.

    • Annuities derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State. The term “annuities” as used in this paragraph means a stated sum paid periodically at stated times during a specific time period, under an obligation to make the payments in return for adequate and full consideration (other than services rendered).

    • Alimony paid to a resident of a Contracting State shall be taxable only in that State. The term “alimony” as used in this paragraph means periodic payments made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support, which payments are taxable to the recipient under the laws of the State of which he is a resident.

    • Periodic payments for the support of a minor child made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support, paid by a resident of a Contracting State to a resident of the other Contracting State, shall be taxable only in the first-mentioned State.

    • Where an individual who is a resident of one of the Contracting States is a member or beneficiary of, or participant in, a pension fund that is a resident of the other Contracting State, income earned by the pension fund may be taxed as income of that individual only when, and, subject to the provisions of subparagraph (a) of paragraph 1 of Article 20 (Pensions, Annuities, Alimony and Child Support), to the extent that, it is paid to, or for the benefit of, that individual from the pension fund (and not transferred to another pension fund in that other Contracting State).” 

What does this Mean?

This article refers to Pensions and Social Security —

Social Security

When the payments refer to payments that are Social Security — and payments are being made to a resident of the other state or to a citizen of the United States – it is taxable in the first state (in other words, the state that made the payments) — but does not provide that it shall only be taxable in the state of source. 

Pensions

Pension is only taxable in the residence state, not the country of source — BUT it is limited by the Saving Clause, so for example the US would presumably tax the pension as well if it is being received by a US Person residing abroad.

Public Remuneration in the US Spain Income Tax Treaty

• • • (a) Remuneration, other than a pension, paid by a Contracting State or a political subdivision or a local authority thereof to an individual in respect of services rendered to that State or subdivision or authority shall be taxable only in that State.

    • (b) However, such remuneration shall be taxable only in the other Contracting State if the services are rendered in that State and the individual is a resident of that State who:

      • (i) is a national of that State; or

      • (ii) did not become a resident of that State solely for the purpose of rendering the services.

    • (a) Any pension paid by, or out of funds created by, a Contracting State or a political subdivision or a local authority thereof to an individual in respect of services rendered to that State or subdivision or authority shall be taxable only in that State.

    • (b) However, such pension shall be taxable only in the other Contracting State if the individual is a resident of, and a national of, that State. 

    • The provisions of Articles 15 (Independent Personal Services), 16 (Dependent Personal Services), 18 (Directors’ Fees), 19 (Artistes and Athletes), and 20 (Pensions, Annuities, Alimony, and Child Support) shall apply to remuneration and pensions in respect of services rendered in connection with a business carried on by a Contracting State or a political subdivision or a local authority thereof.

What does this Mean?

It means that in general, government compensation (other than pension) is going to be exempt from tax in the other jurisdiction. And there are some limitations in the situation in which, for example, the Taxpayer resides in Spain, performs the services in Spain, is a payee and national of Spain — and is not a national of the United States.

Reporting Forms for Spain Pension

The following is a summary of five (5) common international tax forms.

FBAR (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investments funds, and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938

This form is used to report “Specified Foreign Financial Assets.”

There are four main thresholds for individuals is as follows:

• • • Single or Filing Separate (in the U.S.): $50,000/$75,000

    • Married with a Joint Returns (In the U.S): $100,000/$150,000

    • Single or Filing Separate (Outside the U.S.): $200,000/$300,000

    • Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520

Form 3520 is filed when a person receives a Gift, Inheritance or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

• • • Gift from a Foreign Person: More than $100,000.

    • Gift from a Foreign Business: More than $16,815.

    • Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

• • • Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.

    • Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.

    • Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.

    • Category 4: Control of a foreign corporation for at least 30 days during the accounting period.

    • Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company). The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to filing.

Received a Gift or Inheritance From Spain?

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in Spain Report U.S. Account Holders?

There are thousands Foreign Financial Institutions within Spain that report US account holder information to the IRS. The list can be found here: FFI List:.

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much broader spectrum of assets and accounts, including:

• • • Bank Accounts

    • Investment Accounts

    • Retirement Accounts

    • Direct Stock Ownership

    • ETF and Mutual Fund Accounts

    • Pension Accounts

    • Life Insurance or Life Assurance Policies

Totalization Agreement & the United States/Spain

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

As provided by the IRS:

• • • An agreement, effective July 1, 1988, between the United States and Spain improves Social Security protection for people who work or have worked in both countries. It helps many people who, without the agreement, would not be eligible for monthly retirement, disability or survivors benefits under the Social Security system of one or both countries. It also helps people who would otherwise have to pay Social Security taxes to both countries on the same earnings.

    • The agreement covers Social Security taxes (including the U.S. Medicare portion) and retirement, disability and survivors insurance benefits. It does not cover benefits under the U.S. Medicare program or the Supplemental Security Income (SSI) program.

    • This document covers highlights of the agreement and explains how it may help you while you work and when you apply for benefits.

The United States has entered into 26 Totalization Agreements, including Spain (as of 1988).

US Spain Income Tax Treaty is Complex

In conclusion, The US and Spain tax treaty is a great source of information to help better understand how certain income may be taxed by either country depending on the source of income, the type of income, and the residence of the taxpayer. The tax outcome may be changed depending on whether or not the savings clause impacts how tax rules will be applied for certain types of income.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure on matters involving the United States-Spain Tax Treaty.

Contact our firm for assistance.