Gerard Garcia-Gassull's Blog

Treatment of interests in the Venezuelan Tax Convention with Spain: 0% is the cost of interest withholding tax on loan transactions

The Agreement between Venezuela and Spain to avoid double taxation was entered into in June 15, 2004 and in its Protocol includes a most favoured nation clause.

Thus, Article 11 of the Agreement determines a 10% withholding on interest accrued on loans granted by any entity other than financial institutions, in which case the withholding rate is 4.95%.

However, Section VII of the Protocol attached to the Convention includes the key to this 0%:
"After the signature of this Convention, should a Contracting State conclude a Double Taxation Convention with a Member State of the European Union where the taxation is lower than that determined in Article 11, the provisions of the Convention entered into after this one shall also be applicable to this Convention from the date they enter into force."

After entering into the Agreement with Venezuela, Spain has concluded not only one but several Conventions with European Union State Members, which include a lesser withholding tax than the one stated in the Convention with Venezuela.

For example, the Agreement with Malta of 7 September 2006 and with Cyprus of 26 May 2014 establish, in both cases, a zero-rate withholding tax.

Specifically, Article 11 of each Convention provides as follows:

- Malta: "Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed only in that other State."

- Cyprus: "1. Interest arising in a Contracting State, the beneficial owner of which is a resident of the other Contracting State, may be taxed only in that other State."

For that reason, withholding tax on interests in loan operations between Venezuela and Spain was de facto reduced to 0% by the ratification of the Agreement with Malta in September 7, 2006.

An investment fund is a vehicle to channel different people’s savings for the purchase of shares and debt issued in an official and regulated market.

This vehicle is virtually identical to a SICAV. The distinctive feature is that the share of diversity of people involved in is greater. It is defined as a collective vehicle because of that participation of people.

Investment funds are required to maintain a portion of the capital raised in cash in order to facilitate any partial or full withdrawals of their investors.

This investment vehicle is governed by the Regulations proposed by the promoting entity. This regulation refers to the mode of investment and divestment, the manager’s remuneration, the type of assets it invests in and the type of financial markets, among others.

Investing mutual fund allows you to enjoy several advantages:

1. Managing the savings of an individual through investment funds allows that person to operate as if he/she had his own SICAV. The reason is:

i)   Both types of entities have identical taxation (1% on profits);

ii) Qualified investment funds are those classified as UCIT 4. Unit holders in a qualified investment fund are not taxed when they disinvest provided the amount received is used to invest in another qualified investment fund. So, the saver can modify the investment profile as if he/she had a SICAV;

2. Regarding the professionalism of management, it should be noted that most savers do not have the means or time to make adequate decisions in the face of market developments. The investment through funds offers a professional management with the capacity and resources to face the investment decisions.

There is a mistaken belief that investing in shares is clearer than investing through investment funds. However, this perception is far from reality. Choosing between one or more shares is not even close to the saver’s ideal investment. The reason is the lack of risk perception: an individual does not have the quality and amount of information available to professional managers.

In addition, management allows the taking of protective decisions with derivatives or hedges. These mechanisms are beyond the reach of individuals both because of its specialization and the opportunity cost.

The remuneration of the fund manager is determined in the regulations of each fund and it is under the supervision and approval of the regulatory body, in this case, the CNMV. Sometimes managers ask the regulator for an improvement in their remuneration conditions, especially when the fund has a high success rate.

3. Thirdly, the key of investment funds is the possibility of diversifying investment. An investment fund can invest capital in different assets, regardless the country or sector in which it is invested.

In this way, an investment is more secure since the diversification has as a direct consequence: the risk minimization.

4.  Lastly, the most attractive aspect of funds is their tax advantages.

Investment funds are exempt from taxation until their repayment. In addition, funds are transferable in an unlimited way, and the investment can be transferred from one fund to another without taxation provided that the capital is not available to the investor. Taxes will only be paid when the investment is fully or partially refunded, giving rise to the corresponding effects on Personal Income Tax.

Each investor has his own specific objectives. Given the characteristics of the investment fund and the diversification of investments, it is very feasible to achieve the objectives set in each case.

The Convention to Avoid Double Taxation between Barbados and Spain contains a rule for the taxation of interests in the creditor’s place of residence.

Thus, Article 11 provides:

"1. Interest arising in a Contracting State whose beneficial owner is resident in the other Contracting State may be taxed only in that other State.”

However, the same Convention establishes a restriction on the application of this standard in the Convention’s Memorandum. The purpose of this restriction is to prevent, through the triangulation of Conventions, that one of the two countries ends up granting an exemption that would not have been applicable if the transaction would had been carried out directly.

Thus, paragraph 1.B. (a) of the Memorandum restricts the right to the application of the Convention to Articles 10 (Dividends), 11 (Interests), 12 (Canons) and 13 (Capital Gains) to the event that: “the income obtained by a Contracting entity which is paying dividends, interests, royalties or capital gain to a resident in another Contracting State arises in a territory without an agreement to avoid double taxation with that other Contracting State”.

Let's take an example:

Imagine a Barbados company granting a loan to a Spanish company and the Spanish company uses those resources to grant a loan to a company in Costa Rica.

According to the website of the Ministry of Finance of Costa Rica there is no CDI between Costa Rica and Barbados.

Consequently, and since Costa Rica lacks a Tax Convention with Barbados, the treatment of Article 11 of the Barbados-Spain Agreement would not apply. In the event of non-application of the Agreement, Spanish legislation on the taxation of non-residents operating in Spain will apply.

In this case, article 25 (f), 2º of Non-Resident Income Tax Law applies since it establishes a withholding tax of 19% for "interest and other income obtained from the transfer of own capital to third parties”.

In this made-up story that we are using as an example, it should also be considered that the agreement between Costa Rica and Spain determines a 10% withholding on interest on loans for a period not exceeding 5 years.

Mexican Capital Repatriation Decree

Mexico, like many other countries, has followed the trend of tax amnesties. We could almost lose track of the number of countries applying such measure in recent years.

What is new in the case of Mexico is that the amnesty approved in 2017 determines an 8% rate without sanctions, whereas the amnesty approved a year ago established a 35% rate (applicable rate for the taxation of natural persons in Mexico) and the only thing that you avoided were sanctions.

However, in order not to be sanctioned, Mexican tax authorities had to include you in a list. Appearing in that list, which was public, became a real risk because of criminal organizations operating in the country.

Due to that insecurity, the current amnesty mechanism does not require such publishing. Furthermore, taxpayers are required to repatriate the money they have abroad and invest it in productive assets in the country.

In any case, criminal organizations are so infiltrated in the country that they are able to obtain information from bank employees and tax officials.

It should not be forgotten that tax returns filed anonymously have been permitted since recent days (now prohibited by the Government of Peña Nieto). This form of submission was created to solve other local problems but taxpayers used it to preserve their confidentiality and to fulfil the IRS.

Be that as it may, we must admit that this is an opportunity offered by Mexican Treasury to those taxpayers who may consider that they have not duly fulfilled their tax obligations. This measure may be of special interest as we are on the threshold of global banking transparency thanks to the agreements of the North American FATCA and CRS driven by the OECD.

To enjoy this measure the following actions have to be done:

a) Repatriate the funds the taxpayer holds abroad;
b) Invest them in Mexican productive assets;
c) Keep them in Mexico for at least 2 years;

However, before accepting this opportunity, another alternative should be considered: analysing those financial products which have been invested in during the last 5 years and how they should have been taxed. The reason is that Mexican tax regulations offer several mechanisms of tax deferral for the taxation of savings that could imply that unpaid taxes are more acceptable than repatriating the funds.

A Mexican taxpayer may be interested in keeping funds abroad for various reasons linked to country risk:

a) Mexico is traditionally dependant on oil revenue (it represented 33% of its income historically but nowadays it is less than 16%) and the fall of crude oil prices led Mexican peso value to be exchanged from 16 to 22 to 1 US dollar in a short period, which is a lot.
This fall in revenue has tightened its treasury and forced the Government of Peña Nieto to stop a large number of planned actions.

If the price of crude fails to consolidate the recovery, the peso could suffer again in the international markets and, therefore, tax savings offered by this amnesty would become a real cost for loss of value of the peso against other currencies.

b) Data protection risk, a real risk difficult to combat.

Let me point out that when a person believes to be at risk of being kidnaped, the first thing that comes to his mind is flee the country. You never know the scope of the criminal organization that attempts extortion. Having savings abroad allows you to face the flight. 

Proof of this insecure data protection is that not even a year ago the list of Mexican voters was available on e-bay...