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Will Spain apply the multilateral instrument more intensively after COVID-19?

Alternative Universe

Authors: Francisco da Cunha, Victor Sanlorien Cobo

7 minutes read

Amid the COVID-19 pandemic, Spain, whilst undertaking considerable efforts to keep its population safe, is also trying to keep its economy alive. The Spanish financial industry has not been immune from the effects of COVID-19 that has spread far and wide through the Spanish economy, and the full extent of the damage can only be fully assessed in some months’ time.  

Recovery is expected to require new measures to balance the pandemic’s fallout. In all likelihood Spain, which is expected to emerge from this crisis with a considerable public debt like other EU economies, will probably intensify its tax audit and collection efforts to help balance its public accounts.

In the midst of the pandemic, a further tool will be applied soon by EU Member States’ tax authorities, including the Spanish Tax Authorities (STA): the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) within the EU countries’ double tax treaty (DTT) networks. And, notably, the principal purpose test (PPT) to assess whether international investment platforms investing in the EU are “good” or “bad” DTT claimers. Furthermore, we understand that this trend will be implemented further within EU Member States due to the ongoing OECD work on Pillar Two, i.e., the Global Anti-Base Erosion Proposal (GloBE).1

This is relevant to all alternative asset classes, but specifically in the real estate (RE) sector—and Spain is one of the most popular and attractive European countries to invest in this asset class.


The MLI is the main outcome of BEPS Action 15. The MLI’s major aim is to ensure a homogenous implementation of standards and recommendations arising from BEPS in all existing double tax treaties. This is accomplished through simplified procedures based on one single overarching international treaty (the MLI). This means that, singlehandedly, the MLI is likely to modify almost all existing bilateral double tax treaties.

As of 22 July 2020, 94 countries have already signed the MLI, while another four have expressed their intention to sign it.2  For the MLI to apply to an existing bilateral treaty, both concerned countries must not only ratify the MLI, but also choose that treaty as one of their covered tax treaties and adopt matching provisions, unless the MLI’s relevant provision allows for an asymmetrical adoption under certain conditions.

Therefore, to apply a specific DTT—apart from checking whether it is considered a covered DTT by both parties under the MLI and which provisions the parties have chosen—it  also needs to be analyzed, whether and when each party ratified the MLI, to establish when it comes into force and when the provisions become effective.

The Luxembourg-Spain double tax treaty

On 9 April 2019, Luxembourg deposited its instrument of ratification for the MLI and it entered into force from 1 August 2019. However, Spain has not yet deposited its ratification instrument, although it has signed the MLI and presented its expected list of reservations.

Therefore, the MLI does not yet apply to the Luxembourg-Spain DTT. The Spanish ratification of the MLI is expected to happen soon and, once in force, will apply to the current DTT between Luxembourg and Spain (limited to the representations made by both countries).

Once the MLI applies to this DTT—apart from the minimum standard measures to counter treaty abuse (notably both the preamble and PPT provisions) and to improve dispute resolution—other provisions will apply, notably regarding transparent entities, on the application of methods for eliminating double taxation, the avoidance of permanent establishment (PE) status, and the arbitration procedure.3 4 

A deeper dive into the PPT

Although the preamble and transparency provisions are particularly relevant to Spanish RE investment structures, the PPT provision of this DTT will be a key area of assessment going forward.

The PPT is defined in Article 7(1) as follows:

“Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.”

Therefore, a successful challenge under the PPT will mean that previously invoked benefits (such as withholding tax [WHT] reductions or eliminations) could be at stake, which would naturally curtail the expected investors’ internal rate of return (IRR) on such a deal.

Regarding RE investment structures, the OECD has given a few hints on how local tax authorities like the STA could assess situations to determine whether the DTT’s benefit should be granted to a RE investment platform (i.e., PPT Example M of the Commentary on Article 29 of the OECD Model Tax Convention), and to a regional investment platform (i.e., PPT Example K of the Commentary on Article 29 of the OECD Model Tax Convention).

In the RE investment platform example,5 the OECD describes a situation where an investment fund performs a deal in a given jurisdiction. A Special Purpose Vehicle (SPV) is used to hold RE assets.

The OECD points out that the commercial and legal reasons for setting up the holding company are to:

  • Protect the company from liabilities of potential claims against the fund’s RE assets;
  • Facilitate debt financing (including from third-party lenders) and the creation, management and disposal of investments; and
  • Administrate the claims for WHT relief under any applicable DTT.

Furthermore, the decision to set up the holding company in State R (i.e., Luxembourg), is based on the country’s political stability, regulatory and legal system, familiarity to lenders and investors, access to appropriately qualified personnel, and extensive DTT network.

Moreover, Example M requires that the holding company cannot derive better DTT benefits than those to which the RE Fund’s investors would be directly entitled. Therefore, the OECD concludes that the SPV’s RE investments have a commercial purpose consistent with the RE fund’s investment mandate—and, in the absence of other facts or circumstances showing that the holding company’s investments are part of an arrangement, or relate to another transaction that is undertaken mainly to obtain the benefit of the DTT, it would be unreasonable to deny the benefit of the DTTs between both States.

Furthermore, Example K,6 which has a similar structure to Example M, does not require that the holding company cannot derive better DTT benefits than the fund’s investors. However, it highlights the importance of the holding company to maintain an appropriate level of economic and physical substance, and that the intention of any DTT is to encourage cross-border investment.

The examples provided by the OECD are non-binding, meaning that a factual assessment must be done in each case where there is a potential application issue. Also, the amount of economic and physical substance required for any Luxembourg holding company investing in Spanish RE will mostly depend on how the STA will regard and adopt this PPT guidance under domestic legislation and practice.

How a PPT challenge is likely to “piggy-back” off current practice

Even though the PPT is not yet in force for the Luxembourg-Spain DTT, this does not mean the STA will necessarily start from scratch when deciding how to enforce these provisions. To fully apply the PPT concept, the STA can refer to past years of practice regarding substance and beneficial ownership.

Furthermore, it is worth noting that Spain has been introducing domestic rules tackling abusive DTT situations over the past decade. Therefore, the key issue will be understanding the extent to which the application of the PPT provision will lead to a higher threshold of scrutiny compared to the existing domestic Spanish anti-abuse rules.

Here are a few examples where a similar type of consideration is already applied in Spain, which may already be affected by similar concerns today:

  • Interest payments from a Spanish property-owning company: the STA may challenge the eligibility of the domestic tax exemption for EU lenders, unless it is demonstrated in the case where the STA believes that the structure is not abusive and/or was not established with the main purpose (or one of the main purposes) of avoiding Spanish taxes. If the Spanish domestic exemption does not apply, the reduced 10% WHT rate of the DTT between Spain and Luxembourg may apply to the extent the Luxembourg company is the beneficial owner of the concerned income and meets the substance requirements. However, in the future, if the STA applies the PPT provision denying the application of the DTT, then the fall back would be to the normal WHT rate of 19% on interest payments to non-resident companies. For all intents and purposes, taxpayers are encouraged to establish a defensive file in order to sustain any of these tax profiles upon the payment of interest (eg, either under domestic tax exemptions or the DTT rate).
  • Dividend payments from a Spanish property-owning company: to be entitled to the WHT exemption on dividend payments and based on the interpretation made by the binding ruling V3194-13 , it is important that the Luxembourg holding company meets the Spanish substance requirements—which, depending on the type of investment, would generally require the Luxembourg company to be directly involved in the management of the Spanish company’s business.

Based on the binding ruling V1582-14  and the Spanish Non-Resident Income Tax Act, where a Spanish subsidiary is directly or indirectly held by a non-EU company, the Spanish domestic tax exemption may be denied if the non-EU company is not effectively involved in the business activity of the Spanish subsidiary, or if the non-EU company cannot manage the latter with the adequate human and material organization required. If the Spanish domestic exemption does not apply, the reduced 10% WHT rate (if the Luxembourg company holds at least 25% of capital in the Spanish company paying the dividends) or 15% WHT rate (in all other cases) of the DTT between Spain and Luxembourg may apply to the extent the Luxembourg company is the concerned income’s beneficial owner and meets the substance requirements. However, as discussed above, if the STA applies the PPT provision denying the DTT application, then Spain will apply the normal WHT rate of 19% on dividends payments to non-resident companies.

The Spanish Non-Resident Income Tax Act does not define a “direct involvement in the management” of the Spanish subsidiary, nor details of the adequate human and material organization required to manage it. Nevertheless, according to a reasonable interpretation of the law and the restrictive position of the STA, several substance requirements must be pointed out:

  • The Luxembourg holding company could be a member of the Spanish company’s board of directors, which would, in turn, appoint one of its managers or directors as a representative. The Luxembourg company’s director, which should be a qualified professional, should take an active role and be appointed as head of any committee of the Spanish company to the furthest extent possible.
  • Furthermore, the Luxembourg company could perform, among others, the following activities with regards to the Spanish company:
    • elaboration and discussion of strategic plans;
    • review of its financial statements;
    • review of its management accounts; and
    • control and supervision of its business activities.
  • The director from the Luxembourg company should have all the necessary means at his/her disposal (e.g., office, telephone line, internet and all the necessary support personnel) and be fluent in the language used by the boards/committees, which is usually Spanish. It is also important that the type of management activities attributed to the Luxembourg company is not also subcontracted to third party providers in parallel, as the STA could consider this as evidence that the Luxembourg company’s involvement is not real.

As regards to the beneficial ownership concept, the STA have been known to increase the level of scrutiny further to the so-called Danish Beneficial Owner cases.   

In particular, recent resolutions of the Spanish Central Economic Administrative Court (CEAC) have followed the criteria set out in the CJEU cases noted above, and recently denied the application of the domestic WHT exemption on interest payments made by a Spanish company to another EU tax resident entity.7

This was because

  • the recipient had limited substance;
  • it did not carry out an effective economic activity; and
  • it had limited powers of decision on the concerned income.

Concretely, the CEAC resolution established that it is possible to interpret the beneficial owner concept in line with the OECD Model Tax Convention and its commentaries. Furthermore, and following the CJEU decision, the CEAC resolutions confirm that the beneficial owner of the interest received should be the person with the legal capacity to freely determine its end use, including its effective use and enjoyment.

According to the CEAC, the existence of abusive practices requires that artificial conditions are created to improperly obtain benefits under EU law, among other factors.

In relation to the EU interest and royalties directive (IRD), artificial conditions may be demonstrated by certain hallmarks relating to substance and financial flows:8

  • Hallmarks relating to substance include:
    • The lender’s only undertaken activity is merely the receipt and repayment of funds connected to the loan (i.e., it undertakes no other business); and
    • The entity lacks true management, its books do not reflect a true cost structure with real expenses incurred, and it lacks appropriate staff, facilities and equipment for its business enterprise.
  • Hallmarks relating to financial flows include:
    • Incoming and outgoing cash flows (incoming debt servicing fees and outgoing debt repayments) are transferred in similar or identical amounts over a short timespan to entities not fulfilling the conditions to benefit from the IRD;
    • The lender generates an insignificant taxable income in connection with the financing; and
    • The lender lacks the capacity to economically benefit from the interest received because it has not been granted this right.

A further case law decision on the payment of dividends also arose recently.9 
Aligned with the previous stance on the shift of doctrine the Danish Cases prompted, the CEAC also considers this shift for the purposes of dividend payments in a European context (i.e. not limited to interest payments) with respect to the Spanish WHT exemption. The case analyzed by the Spanish Court deals with the payment of dividends by a Spanish Company to a Luxembourg one (in fine wholly held by a Qatar Beneficial Owner through a United States (US) LLC). The Court considers that the fact that the Spanish investment is one among many others (EU and non-EU investments) held by the Luxembourg Company and that, in proportion, said investment is not the most significant one would not be enough to satisfy the absence of abusive character of said structure and to confirm that the Luxembourg Company was established for valid economic reasons (when compared with the documentation/information received by the STA, e.g. absence of employees, company’s registered address in the official address of its third service provider, absence of 3rd party financing, relevant expenses with whole shareholder, etc).

Furthermore, the CEAC also denies the application of the DTT between Luxembourg and Spain, acknowledging that the Luxembourg Company was not the beneficial owner of the dividends distributed. According to the CEAC, the repatriation of such proceeds did not have to be done by way of dividends but could be achieved as well through interest payments or repayment of intra group debt. Indeed, the Spanish Court considers that the absence of dividend distributions from the Luxembourg Company to its non-EU parent company (i.e. the US LLC) during three consecutive years does not confirm that the Luxembourg Company was the beneficial owner of the dividends received from the Spanish subsidiary during the same period of time. Contrary, the CEAC considers that dividend income received by the Luxembourg company was distributed to the final Qatar Beneficial Ownership, de facto, through interest payments and principal redemption on the CPECs (hybrid instrument generally considered as debt from a Luxembourg tax perspective and equity from US tax perspective) towards the US LLC (fully controlled by the final Qatar Beneficial Owner).

It should be noted that CEAC resolutions are not final, since they may be appealed to the judicial courts. However, the approach taken by the CEAC in tax rulings has generally been followed by other administrative courts, (to the extent this position sets a judicial precedent), the tax authorities and the General Directorate of Taxes. Notwithstanding, this specific decision is under fervent discussion and the final decision at the judicial level is not yet clear.


Once the MLI and its PPT provision enters into effect and applies to the DTT between Luxembourg and Spain, any RE investment platform using a foreign holding company (whether located in Luxembourg or not) to invest in Spanish RE assets should fulfil the above-mentioned economic rationale and substance requirements.

As tax auditing and collection will be a major focus of the post-COVID-19 world, and as Spain will not be starting from scratch regarding these considerations, one can only expect increased scrutiny on this end—but hopefully within the spirit and good faith interpretations of the OECD examples given earlier.  

This is why a thorough and well-analyzed decision to invest in Spanish RE must take this into account—not only for now (on any immediate returns) but also for the future—and address upfront what a properly calibrated entity for substance and beneficial ownership should look like. Documentation is, of course, also key to be able to present a fully documented position to the authorities.

Therefore, a successful RE investment strategy must also consider tax. A step in the wrong direction may deliver additional tax costs and, as a result, heavily reduce the expected return.


1 For further information please refer to the OECD Public Consultation Document on the Global Anti-Base Erosion Proposal (GloBE) - Pillar Two. Available on:

2 OECD. Signatories and Parties to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Project Shifting. Available on:   

3 OECD. Spanish Status of List of Reservations and Notifications at the Time of Signature. Available on:

4 OECD. Luxembourg List of Reservation and Notification at the Time of the Deposition of the Ratification Instrument. Available on:

5 OECD. 2017 Model Tax Convention on Income and on Capital. Commentary on Article 29, paragraph 182 – Example M.

6 OECD. 2017 Model Tax Convention on Income and on Capital. Commentary on Article 29, paragraph 182 – Example K.

7 CEAC resolution of 8 October 2019 (R.G. 185/2017). Available on

8 Deloitte. Domestic administrative court rules on interest withholding tax exemption. Available on

9 CEAC resolution of 8 October 2019 (R.G. 2188/2017). Available on

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