Participation loans in Spain in case of company losses

01.2010

In times of crisis participation loans can be very helpful. From a commercial standpoint, this type of loan, which can be applied for by a company partner or an independent third party, is accounted for as share capital for accounting purposes thanks to article 20 of law 7/1996. This means that, in its conclusion and accounting, the loan is registered as a regular loan; however, from a commercial standpoint, when calculating the company's net asset value at the end of the year, the loan accounts for as share capital.

This avoids the risk of having to put the company into liquidation due to accumulated losses that make the company's net capital not exceed certain amounts, as established by Spanish commercial legislation. The loan can be paid back when the company has profits (that is, unlike normal loans, regular interest payments are not compulsory), and interests depend on obtained profit. The only commercial formality required is that this loan must appear in the company's balance sheets with detailed information of its conditions.

From a tax standpoint, this participation loan works like a normal loan. Thus, the loan's financial contribution to the company is not liable for the 1% tax that is applicable to share capital increase. It should be stressed that, in order to avoid this loan to be regarded as disguised equity capital (and thus liable for a 1% tax), it is indispensable to refund the loan within a reasonable period of time. The tax administration has not established a specific time limit, as it depends on each case.

These types of loans are common in real estate operations in which a foreign company loans capital to a Spanish construction company in order to build houses or buildings. The loan and its interests will only be refunded to the foreign company when the houses or buildings have been sold in Spain. Interests usually represent a substantial percentage of the profit made in Spain.

Foreign companies also usually use participation loans during the early years of their entrance into the Spanish market, as there are usually losses in the company's first years of activity, which can rapidly make a cause of liquidation.

Unlike share capital payments in the form of dividends, the payment of interests is tax- deductible in the paying company. It must be stressed that there are no thin capitalization limits provided the parent company who has loaned the money is EU-resident. The loan's amortisation is not subject to any tax, unlike reduction of share capital in case of repatriation of reserves to the parent company, which requires taxing the operation with a 1% tax.