In recent years, an important debate has unfolded in Spanish courts regarding withholding tax imposed on dividends paid by Spanish companies to US Regulated Investment Companies (RICs).
At its core, the discussion revolves around the alleged discriminatory treatment by the Spanish Tax Authorities towards non-resident investment vehicles and whether such discrimination is justified under the principles enshrined in the Treaty on the Functioning of the European Union (TFEU) due to the possible “neutralization” of such discrimination.
In Spain, domestic investment funds are subject to a preferential 1% tax rate on dividends from Spanish companies, whereas foreign funds typically incur a higher rate of 19%, subject to treaty reductions.
In 2010, Spain extended the favorable 1% rate to EU-regulated investment funds (UCITS), however, funds from third-party countries and non-UCITS funds remain excluded, raising concerns of discrimination under Article 63 of the TFEU.
Spanish authorities, on the other hand, have contended that any potential discriminatory effects are neutralized by the double taxation treaty (DTT). This treaty refers to the internal regulations of the United States, which permits US RICs to mitigate the higher Spanish withholding tax through credits or deductions in their home jurisdiction.
However, practically speaking, the specific tax regime in the US, particularly the "pass-through" nature of many RICs, means that these funds often distribute dividends to their shareholders without incurring corporate-level taxation, making it difficult to fully recover or neutralize the Spanish withholding tax.
Over recent years, several Spanish court rulings have shaped this debate. In 2019, the Spanish Supreme Court issued a landmark ruling clarifying the criteria for comparability, holding that US RICs and Spanish IICs must be assessed against the standards set out in EU directives, and not Spanish domestic law.
This critical decision set a precedent, paving the way for discrimination claims by non-EU investment entities based on EU standards of comparability.
Furthermore, the Spanish National Court, in its 2023 ruling, explicitly found that US RICs had no effective means under Spanish law to recover the difference between the higher withholding rate and the 1% rate applied to domestic funds.
The court held that the lack of a practical neutralization mechanism amounted to unjustified discrimination against US RICs under EU law.
In another recent judgment concerning foreign hedge funds, the Spanish Supreme Court emphasized that restrictions on capital movement are only neutralized when a fund can offset tax through a DTT credit equivalent to the domestic tax gap.
If the fund isn’t taxed in its home country, such a credit isn’t possible. Moreover, the taxation of unitholders was deemed irrelevant in this case, as Spanish law assesses the fund independently of its investors.
In a pivotal move on 11 February 2025, the Spanish Supreme Court referred a set of preliminary questions to the European Court of Justice (ECJ), seeking clarity on a fundamental issue: whether the theoretical ability of a US RIC to neutralize Spanish withholding tax through mechanisms available under US law and the DTT satisfies the requirements under Article 63 of the TFEU.
The case arose from ISHARES EUROPE ETF’s claim for a refund of withholding tax levied at 15% on Spanish-source dividends received between 2007 and 2010. ISHARES argued that it should have been subject to the same 1% rate applied to Spanish investment funds.
Although the fund transferred its foreign tax credit to its investors under the US “pass-through” regime, it did not itself use the credit to offset tax, raising a critical question: is the mere possibility of neutralization sufficient, or must actual neutralization at the shareholder level be proven?
The Spanish Supreme Court noted that the domestic tax treatment of RICs in the US, particularly their ability to elect out of corporate taxation by distributing income directly to shareholders, complicates the assertion that neutralization is effectively achieved.
The court emphasized that, in line with prior ECJ case law (e.g., Miljoen and Commission v. Germany), a theoretical right to relief is not enough. For a restriction on free movement of capital to be justified, the DTT and domestic law must guarantee full neutralization of discriminatory effects in practice.
Furthermore, the Supreme Court underlined the importance of evidence: it questioned whether the Spanish tax authorities could discharge their burden by simply asserting that the credit could have been used, or whether they must prove that it was actually applied to eliminate the tax disadvantage.
The Court also rejected the idea that the fund’s choice to transfer the credit to its shareholders automatically neutralizes the discrimination.
Ultimately, the Supreme Court has decided to refer to the ECJ the question whether a restriction to the free movement of capital can be considered neutralized when a non-resident fund can choose to either pay tax directly or transfer its tax credit to its participants, even if it hasn't directly deducted the tax incurred in Spain.
This referral to the ECJ represents a crucial juncture, with the upcoming ECJ decision expected to provide definitive guidance on the standards that EU countries must meet when justifying differential tax treatment of foreign investment entities.
The ECJ’s ruling on this matter will significantly influence the approach Spanish and other EU tax authorities will have to take towards withholding taxes imposed on non-resident investment entities.
If the ECJ sides with the viewpoint that practical—not theoretical—neutralization is required to justify a restriction on capital movement, Spain and potentially other EU jurisdictions may need to adjust their withholding practices, potentially leading to significant tax refunds for RICs and other similar foreign entities.
Conversely, an unfavorable decision (or one that emphasizes theoretical neutrality) could reinforce existing withholding practices and underscore the complexities faced by non-EU based investment vehicles operating within the EU.
In preparation for the ECJ decision, impacted funds should proactively review their historical dividend receipts from Spanish entities, and consider protective refund claims where appropriate.
WTax is actively monitoring all developments in this market. In the meantime, we encourage you to promptly get in touch with WTax’s regional specialists.