Breaking Down US-Spain Tax Treaty Withholding Rates

The United States and Spain have a tax treaty designed to prevent double taxation for individuals and companies operating in both countries. A primary function of this agreement is to reduce the standard tax rates that one country imposes on income paid to a resident of the other. This is accomplished by lowering the withholding tax, which is a tax collected at the source of the income before it is sent to the recipient.

For Americans earning income from Spanish sources, or for Spanish residents earning from U.S. sources, this treaty can lower tax obligations. However, accessing these benefits requires understanding the specific provisions and complying with the necessary procedures. The treaty sets maximum withholding rates for different types of income, such as dividends, interest, and royalties.

Key Provisions of the US-Spain Tax Treaty

The treaty establishes specific maximum tax rates that the source country can apply to various types of income. These rates are often lower than the domestic statutory rates, providing significant tax savings.

Dividends

The treaty sets two different withholding rates for dividends. The first is a general rate of 15% on dividends paid by a company in one country to a resident of the other.

A lower rate of 5% applies if the beneficial owner of the dividends is a company that directly owns at least 10% of the voting stock of the company paying the dividend. This encourages direct corporate investment between the two nations. In some cases, dividends may be exempt from withholding entirely, such as those paid to pension funds.

Interest

For interest income, the treaty generally caps the withholding tax at 10%. This applies to most interest payments flowing from one country to a resident of the other.

However, certain types of interest are exempt from withholding, resulting in a 0% rate. This exemption applies to interest paid on the sale on credit of equipment or merchandise, interest paid to government bodies like the U.S. Export-Import Bank or the Spanish Official Credit Institute, and interest paid to or by the central banks of either country.

Royalties

The treatment of royalties is more detailed, with payments being exempt from withholding tax. Royalties are defined as payments for the use of, or the right to use, certain intellectual property.

This includes payments for copyrights of literary, artistic, scientific, or other work, including software and motion pictures. It also covers patents, trademarks, designs, models, plans, and secret formulas or processes. Payments for information concerning industrial, commercial, or scientific experience, known as “know-how,” are also exempt.

Capital Gains

The treaty provides a clear rule for capital gains. Gains from the sale of property are generally taxable only in the seller’s country of residence. For example, if a U.S. resident sells Spanish company stock, any capital gain is typically only subject to tax in the United States.

The main exception to this rule involves real property. Gains from the sale of real estate may be taxed in the country where the property is located. This provision also extends to gains from selling shares in a company whose assets consist principally of real property.

Pensions and Annuities

For retirees, the treaty stipulates that private pensions and other similar remuneration are taxable only in the recipient’s country of residence. This means a U.S. resident receiving a private pension from a Spanish source would only pay U.S. tax on that income. The same rule applies to annuities.

Social Security benefits are treated differently. Under a specific provision, these payments are taxable only by the country making the payment. A U.S. resident receiving Spanish social security benefits would owe tax to Spain on that income.

Limitation on Benefits (LOB) Provision

The US-Spain tax treaty includes a Limitation on Benefits (LOB) article. This provision ensures that only legitimate residents of the U.S. and Spain who have a substantial connection to one of the countries can receive treaty benefits. Its purpose is to prevent “treaty shopping,” where residents of third countries structure their investments through a U.S. or Spanish entity merely to take advantage of the treaty’s lower rates.

To claim treaty benefits, a person or company must be a “qualified person.” The treaty provides several objective tests to determine if a resident meets this standard. Meeting any one of these tests grants access to the treaty’s benefits. The primary tests include:

• Publicly Traded Company Test: A company is a qualified person if its principal class of shares is regularly traded on a recognized stock exchange in either the U.S. or Spain.
• Subsidiary of a Publicly Traded Company Test: A company is qualified if 50% or more of its shares are owned by five or fewer companies that meet the publicly traded company test.
• Ownership and Base Erosion Test: This two-part test requires that at least 50% of the company’s ownership belongs to qualified persons and that less than 50% of the company’s gross income is paid out to non-residents in the form of deductible payments.
• Active Trade or Business Test: If a resident is not a qualified person, they may still claim benefits for income derived from an active trade or business in their resident country, provided the income from the other country is connected to that business.

How to Claim Treaty Benefits

To claim the reduced withholding rates under the treaty, the income recipient must provide the correct documentation to the income payer. This certifies their residency and eligibility for treaty benefits.

For individuals who are residents of Spain receiving income from the U.S., the required form is IRS Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals). This form establishes foreign status and claims treaty benefits.

For entities, such as Spanish corporations or partnerships, the required form is IRS Form W-8BEN-E. This is a more detailed form that requires the entity to specify which LOB provision it satisfies to prove its eligibility for treaty benefits. In some situations, a U.S. taxpayer may need to file Form 8833, Treaty-Based Return Position Disclosure, with their tax return to disclose a position that the treaty overrules or modifies U.S. tax law.

Common Pitfalls and Considerations

The most significant challenge in applying the US-Spain tax treaty is navigating the Limitation on Benefits provision. Companies, particularly those with complex international ownership structures, must carefully analyze the LOB tests to confirm their eligibility. Failure to qualify can result in a denial of treaty benefits and the application of the full statutory withholding tax rate, which is 30% in the U.S.

Proper and timely submission of documentation is also necessary. An incorrect or incomplete Form W-8BEN or W-8BEN-E can lead to payers withholding tax at the higher statutory rate. It is the responsibility of the income recipient to provide this certification to the payer before payment is made to ensure the reduced rate is applied.