Directors’ remuneration again under scrutiny
The tax treatment applicable to the remuneration of directors and board members has historically been a source of conflict when it comes to the deductibility of such expense. The grounds of such conflict are that the relationship between the director and the company is ruled from a labour and commercial law perspective, providing divergent legal treatments, whilst the tax law provides the rules regarding the deductibility of such expense for corporate income (CIT) purposes, and links such deductibility to the fulfilment of the criteria set for labour and commercial law purposes. As can be easily inferred, this led to uncertainty and disputes with the tax authorities.
In accordance with the jurisprudence of the Spanish Supreme Court until 2014, the expenses of remuneration of the members of a Board of Directors were only deductible in Spain when two requirements were cumulatively met: (i) the remuneration of the position was foreseen by the company's bylaws and, (ii) the General Shareholders' Meeting set the maximum limit of such remuneration. If these requirements were not met, the Spanish Tax Authorities considered that the expense did not derive from a legal or statutory obligation of the company, and should therefore be deemed as non-deductible for CIT purposes.
A special situation does apply to those senior staff that are appointed as well as directors, or to those that (being board members) are appointed as managing directors, i.e. directors with broad executive functions. The remuneration for these delegated functions was only deductible if they qualified as a common employment relationship, or were of a professional nature, or, alternatively, if the bylaws expressly foresaw a remuneration for such a position. If none of these requirements was met, the expense was treated as a gift, and therefore not tax-deductible for CIT purposes.
In addition, and in compliance with corporate law regulations, the managing director had to sign a contract with the Board of Directors in which the remuneration concepts were detailed, and the remuneration amount was ascertained. However, in those cases where the executive functions qualified as senior management relations, the Supreme Court considered that the commercial relationship prevailed (i.e. that deriving from the status as member of the Board) over the senior management, which is a labour law relationship. This case law doctrine became known as the “Bond Theory” (“Teoría del Vínculo” in Spanish).
Position from 1 January 2015
Following the amendment of Article 15.e) CIT Act with effect for fiscal years starting on or after 1 January 2015, remuneration paid to directors and managing directors, as well as senior staff, was expressly excluded from the classification of gift if such amounts were paid for the performance of senior management rather than executive duties. This new Article led both tax scholars and the tax authorities to interpret that such remuneration would be deductible even if the company's bylaws did not expressly foresee a remuneration for such positions, as long as it was agreed in writing between the individual and the company, irrespective of whether it was a labour law or a commercial law agreement. The reasoning was that Article 15.e) CIT Act allowed a differentiation between the deliberative function (strategy and control function carried out as a deliberative member of the Board) and the executive function (regular management function carried out individually through a statutory or contractual delegation of executive powers), considering that the latter was not a function inherent to the director relationship, but an additional function arising from the legal relationship. This interpretation was in line with the jurisprudence of the Court of Justice of the European Union on employment, which admits the existence of a double employment relationship (judgments of 11 November 2010, Case C-232/09 (Danosa) and 9 July 2015, Case C-229/14 (Balkaya)). In a nutshell, this new wording of Article 15.e) CIT Act solved a tax treatment that had generated discussions and triggered disputes for decades.
2018 Supreme Court Judgment
Notwithstanding the above, on 28 February 2018 the Supreme Court issued a new judgment which states that the remuneration of managing directors, the most relevant, must be provided for in the company's bylaws and be subject to the control of the General Shareholders Meeting. The judgment also foresees four requirements which must be included in the bylaws when setting the remuneration scheme for directors: (i) the bylaws have to express whether the functions of the directors will be remunerated or not; (ii) the Shareholders Meeting has to determine the maximum annual global remuneration of the directors; (iii) the remuneration must be reasonable according to the importance of the company from an economic perspective, and in accordance with the standards of comparable companies; and (iv) the global remuneration agreed by the Shareholders Meeting must be distributed by the Directors among them, if not previously done by the Shareholders Meeting.
Central Economic Administrative Court resolutions in 2019 and 2020
The Central Economic Administrative Court (TEAC) issued two resolutions on 8 October 2019 and 17 July 2020, following the above judgment of the Supreme Court, which has re-opened Pandora’s box. The TEAC considers that the executive functions delegated to a managing director are functions inherent to the director status rather than independent functions that can be granted or not. Therefore, if a person is appointed as director, this new role absorbs all other functions this person may have been granted, including executive ones. This interpretation entails that, as it is no longer possible to distinguish between deliberative and executive functions, in order for the managing director's remuneration to be considered deductible, it is not sufficient to merely sign a contract with the Board, such remuneration will have to be expressed in the company's bylaws, also setting the remuneration scheme that must comply with the four requirements mentioned above.
This return to the Bond Theory for labour law purposes has been quickly adopted by the Spanish tax authorities, which have included this as one of the main aspects to be reviewed in current tax audits, challenging the deductibility of the remuneration paid to senior staff that have deliberative functions beyond their executive functions.
Based on the above considerations, multinational enterprises operating in Spain through subsidiaries should review the remuneration schemes applicable to their senior staff, and adapt themselves to the new scenario by carrying out a sense check, i.e. a review of the corporate bylaws, and identify their functions, in order to redefine the remuneration, and prepare for future tax audits by drafting a defence file that supports the remuneration paid.