The risk of acquiring tax residency in Spain without residing physically: the core of economic interests

10.2014

Contrary to common belief, tax residency is not determined by double taxation agreements (DTAs), which are designed solely to allocate taxing rights between two States, but by the domestic legislation of each country. Article 4.1 of the current DTA between Spain and Germany defines a tax resident as any person who “under the laws of that State, a federated state or any political subdivision thereof, is liable to tax by reason of domicile, residence, place of management or any other similar criterion, including that State, its federated states, political subdivisions and local authorities. This definition does not include individuals who are liable to tax in that State solely on income sourced therein or on property situated therein.”

Traditionally, the ordinary method for an individual to acquire tax residency in a country has been physical presence for at least 183 days, a criterion reflected, for example, in Article 9.1(a) of the Spanish Personal Income Tax Law (Ley del IRPF). However, each jurisdiction may apply specific rules regarding the calculation of this period and consider additional personal elements linking the individual to the territory, such as having a spouse or children resident in that country. Yet, there exists another less widely known and increasingly applied cause in Spain: the so-called “main base or core of economic activities or interests” (Article 9.1(b) of the Ley del IRPF). Acquiring tax residency in Spain under this provision entails taxation of worldwide income for the entire year and full liability to all Spanish taxes, without exceptions.

This second criterion, introduced in Spain in 1991, draws inspiration from the models used in DTAs, albeit with a significant distinction: while international agreements refer to the “centre of vital interests”, Spanish law focuses exclusively on economic motives. The interaction of these two criteria has generated frequent conflicts. The Spanish tax authorities initially stated that the second criterion would only apply when residency could not be established under the first criterion, that is, physical presence.

Herein lies the risk: could a person who habitually resides in Germany, maintains certain business interests in Spain that they visit regularly, and derives their main income from these activities—such as a retired individual—be considered a tax resident in Spain under this economic interest criterion? Spanish authorities and courts offer no definitive guidance, requiring a detailed case-by-case analysis. The first step involves comparing the individual’s economic interests in Spain with those in the other country, raising the question of whether foreign income should be assessed globally or on a country-by-country basis. Subsequently, continuity of the connection to Spain must be demonstrated, meaning that these interests are maintained in Spain for longer periods than elsewhere. Nevertheless, these guidelines provide limited certainty. The lack of transparency in administrative practice leaves considerable discretion to the official handling the case, and this is precisely the critical element: the second criterion is used to “assign” residency to non-residents whose economic ties to Spain are deemed stronger than those to the declared country of residence. In practice, this may operate as a quasi-sanction.

Typical cases involve individuals resident in tax havens without personal income tax obligations or in jurisdictions where Spanish-source income is not taxed, circumstances which the Spanish authorities may consider abusive. Authorities are aware that many foreign retirees would like to reside in Spain but refrain due to the fiscal consequences of acquiring residency. Consequently, a recent fiscal report prepared by experts at the government’s request has recommended excluding retirees from the standard residency criterion and subjecting them to the special tax regime for expatriates under Article 93 of the Ley del IRPF.

In conclusion, determining tax residency in Spain is far from straightforward. The existence of alternative criteria, the wide administrative discretion, and the lack of consolidated case law regularly generate disputes, some with potentially significant financial consequences for the taxpayer. A thorough understanding of these criteria and meticulous case-by-case analysis are essential to mitigate risk and ensure proper compliance with Spanish tax obligations.

++ Article originally published in German in the magazine “Economía” (3/2014), issued by the German Chamber of Commerce in Spain ++