The Supreme Court and the family business: settling a new controversy?
Taxes and regulations
Emma S. Corretger
It is not new that, in recent years, the Supreme Court has been making pronouncements in order to clarify various controversial questions on when the requirements for applying the tax benefits of the so-called "family business" must be understood to be fulfilled, which have generated rivers of ink and conflicts between taxpayers and the criteria issued by the Inspection bodies of the Tax Administration, the Administrative Courts and the judiciary.
Tax benefits of family businesses
As is well known, the main tax benefits of family businesses are: exemption from Wealth Tax on family business shares, a 95% reduction in the value of these shares in Inheritance and Gift Tax, and in the case of a donation, the deferral of the capital gain produced by the transfer of the shares.
Application in Catalonia
The application of these tax benefits can imply, in some autonomous communities such as Catalonia, a very significant reduction in the payment of the aforementioned taxes. Let us suppose, for example, a succession in Catalonia in which the deceased's estate amounts to 3,000,000 euros: if he leaves it as an inheritance to his son and does not apply the family business reduction, the heir will pay a tax of approximately 614,000 euros; if he applies the family business reduction to this estate, the heir will pay a tax of approximately 13,400 euros.
In order to be able to apply these tax benefits, it is necessary to comply with a series of requirements, which at first glance appear to be very easy to comply with.
What is more, in practice, many people are convinced that they are complying with these requirements, and that, at the time of the death of their parents, for example, they will be able to apply these tax benefits, but experience shows that it is not that easy and there have been and there are many administrative and legal proceedings in which the applicability of these tax benefits has been called into question on the grounds that some of the requirements have not been fulfilled.
This is confirmed by the fact that the Supreme Court itself, through its rulings, is trying to put an end to these controversies on how and when these requirements should be understood to have been fulfilled.
New Supreme Court ruling
On this last occasion, we talk about the recent ruling number 801/2020, dated 18 June 2020, of the Supreme Court, Third Chamber, for Contentious-Administrative Matters, which resolves by means of an appeal in cassation.
In this ruling, the well-known remuneration requirement is resolved, i.e. for the application of tax benefits on family business shares, one of the requirements is that the taxpayer effectively exercises management functions in the family business company, receiving remuneration that represents more than 50% of the total business, professional and personal work income. In the case of the existence of a kinship group, as defined by the applicable legislation, in the present case - mother and children who had a shareholding of more than 20% in the company - the rule allows that the management functions and the remuneration derived therefrom can be carried out by at least one of the persons in the group.
In addition, the rule itself establishes that, for the purposes of determining whether more than 50% of the total business, professional and personal work income comes from the family company, income from other family companies that meet the requirements for the application of the tax benefits will not be taken into account.
The problematic question that arises in this ruling and which is resolved by the Court is whether or not the remuneration received by subsidiaries of the family business is taken into account. That is, in the present case, it was an inheritance from mother to children of the family company. The person who should have fulfilled the remuneration requirement was one of the children, but his main remuneration was received from subsidiaries of the family business and not directly from the family business. The taxpayer claimed that the remuneration from the subsidiaries did not count as they were family companies, thus fulfilling the requirement that more than 50% of the son's income came from the family company.
Faced with this scenario, both the Inspectorate and the Regional Economic-Administrative Court of Madrid, as well as the High Court of Justice of Madrid, denied the application of the tax benefits of the family business to the succession due to non-compliance with this requirement, on the understanding that he did not receive more than 50% of his remuneration directly from the family business company, but that the remuneration of the subsidiaries should be included, and therefore the requirement was not fulfilled.
The Supreme Court ultimately confirmed this criterion, arguing that only remuneration received from other family companies does not count when it meets all the requirements of the regulations. In view of this Supreme Court ruling, we should keep an eye on the forthcoming consultations to be issued by the Directorate General for Taxation.
It should be remembered that the Directorate General for Taxation has issued several binding consultations establishing that the remuneration could be paid by the subsidiary company if it is stated in the corporate documentation of the parent company and the subsidiary that such remuneration is received for performing management functions of the parent company, although it is paid by the subsidiary company. It is also worth remembering that it is highly advisable to check whether remuneration in kind is received from the subsidiary company which should be taken into account and could lead to a breach of the remuneration requirement analysed.
As can be seen from this article, we have only analysed one specific aspect of the remuneration requirement that has been very controversial and which may not have been fully resolved, given the variants that can occur. As we have already mentioned, given that the application of these tax benefits can have a very considerable economic impact, it is highly advisable to review them, no longer on a one-off basis, but on an annual basis, given that they must be complied with annually, for example, in Wealth Tax, or we may not be able to control when they must be complied with, as in the case of Inheritance Tax.
We remain at your disposal for any questions or clarifications you may have in this regard.