Carried interest is a key form of compensation in the venture capital sector, but its tax treatment in Spain has given rise to various questions and interpretations. The recent Binding Ruling V2308-24 from the Directorate General of Taxes (DGT) analyzes a case in which a venture capital firm proposes a restructuring of the payment method for this incentive for its employees in Spain.
In this article, we explain what the consultation says, what the tax issue is, and what implications it has for professionals in the financial and investment sectors.
What is carried interest, and why is it relevant from a tax perspective?
Carried interest is a form of variable compensation received by investment fund managers, generally as a percentage of the fund’s profits, to reward their successful management. It is an incentive system designed to align the fund’s objectives with those of the manager. Its tax treatment has been the subject of debate in recent times.
In Spain, Additional Provision 53 of the Personal Income Tax Law (Law 35/2006) establishes specific treatment for this income, allowing only 50% of its amount to be included in the taxable base, provided that certain requirements are met. In other words, 50% of the income is exempt, which is no small matter.
One of these requirements is that the income not come from entities in non-cooperative jurisdictions, as we will see in this case.
The Case of Binding Advisory Opinion V2308-24
Facts Presented
A Spanish entity, part of a private equity group, manages investment funds. Its employees are entitled to carried interest, which is distributed through a structure involving entities located in Guernsey, a jurisdiction considered non-cooperative under Order HFP/115/2023. It is one of the Channel Islands, for those who haven’t heard of it.
To avoid the tax issues arising from this situation, the company proposes restructuring the carried interest distribution system and having payments to employees in Spain come from an alternative investment fund in Luxembourg, rather than from the entity located in Guernsey.
The inquiry focuses on determining whether this modification allows for the application of the special carried interest regime—that is, being taxed on only 50% of the amount included in the tax base.
Response from the General Directorate of Taxes (DGT)
The DGT concludes that the restructuring does not alter the actual source of the income; therefore, the tax benefits provided for in Additional Provision 53 of the Personal Income Tax Law cannot be applied.
Reasons for the denial:
1. Guernsey is a non-cooperative jurisdiction
- According to Order HFP/115/2023, Guernsey remains on the list of non-cooperative jurisdictions.
- Article 53 of the Personal Income Tax Law excludes favorable tax treatment if the income derives directly or indirectly from these jurisdictions.
2. The change in structure does not alter the nature of the revenue
- Although the payment is made from a fund in Luxembourg, the special economic rights remain linked to entities in Guernsey.
- The DGT considers this to be merely a change in the payment chain, with no real impact on the nature of carried interest.
3. Potential Conflicts in the Application of the Rule and Tax Avoidance
- The DGT warns that these types of restructurings may be subject to review by the Tax Agency under Articles 15 and 16 of the General Tax Law (LGT).
- If it is determined that the transaction is a sham or involves a conflict in the application of the regulation, penalties and late-payment interest may be imposed.
Conclusion: The proposed restructuring does not allow for the application of the special 50% tax regime, since the income continues to derive indirectly from Guernsey.
What Are the Implications for Investment Funds and Their Managers?
This ruling has significant implications for managers of alternative investment funds (private equity, venture capital, hedge funds, etc.) with employees or partners in Spain.
Key Considerations:
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- Review carried interest payment structures
If the payments come from entities in non-cooperative jurisdictions, the 50% reduction in the personal income tax base cannot be applied.
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- Analyze the restructuring from a tax and legal perspective
Changes to the method of payment must be based on a real economic rationale, not merely a tax objective. Otherwise, they may be challenged by the Tax Agency.
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- Avoid using non-cooperative jurisdictions
If the funds operate through structures in jurisdictions such as Guernsey, they could lose tax benefits and face a higher tax burden.
Not to mention possible penalties later on if the incentive is claimed without being eligible for it.
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- Keep an eye out for future regulatory revisions
The treatment of carried interest remains a topic of debate in the EU and in Spain, so it is advisable to stay informed about potential legislative changes.
Conclusion
Binding Ruling V2308-24 makes it clear that simply changing the entity paying the carried interest is not sufficient to qualify for the special tax regime. It is essential to ensure that the structure has no ties to non-cooperative jurisdictions and that the changes serve a genuine economic purpose.
For investment fund managers and industry professionals, this ruling serves as a reminder of the importance of strategic tax planning and the need for expert advice in this area.
If you have any questions about this, please feel free to contact us at Carrillo.
