ZEC: A GREAT TRADING REGIME

Introduction

It is broadly known that those territories called DOMs (in French referring to Département d’Outre-Mer, meaning something like “overseas land”) are islands that count with tax incentives as a way to attract foreign investment to compensate their distance from the continent. It is the case of the British Virgin Islands, of the Channel Islands (Jersey and Guernsey), of the Isle of Man, etc. The downside of these islands is that most of them are labelled by many countries as tax havens and thus give raise to adverse tax consequences.

It is also important in this changing and challenging world we live in to count with as much certainty as possible. It is public knowledge that the European Commission considers that many companies in Ireland should pay billions of Euros because of an abuse of the attractive Irish trading regime. So, counting with the blessing of the Brussels authorities avoids unexpected huge tax bills and it is a must for EU based solutions which are more convenient than trading regimes in non-EU countries such as the Fribourg or Zug canton based Swiss companies.

Moreover, a sharp tax planning does not only represent a spreadsheet with a low outcoming tax burden, but also to think of substance BEPS wise, to care for quality of services and infrastructures and to have the employees motivated.

So, if a company seeks an attractive trading regime but not in a tax haven island, a stable and reliable EU jurisdiction approved by the European Commission and a wonderful place to work in, (e.g. oil, gas, mining companies, etc.) there is one suitable solution: Canary ZEC regime.

ZEC stands for “Zona Especial Canaria” and the Canaries are a group of seven extremely beautiful islands[1] with mild weather the full year-round that belong to Spain (and thus can claim all Spanish tax treaties[2] (96 at the moment) and all the European Directives) that are geographically located west of the north of Africa.

Advantages of Canaries ZEC in a Nutshell

The remarkable thing about the Canaries -besides the aforementioned climate and let alone its beautiful cities and wonderful beaches- is that said islands are well connected to Spain and the rest of continental Europe by plane (e.g. 4 daily flights to London) but also to Africa.

And tax wise, subject to fulfil certain requirements later addressed in this article, a company operating under the ZEC regime can benefit until 2026[3] from a 4% tax rate and a 90% reduction of the tax base.

But moreover, unless the shareholder is resident in a country or territory statutorily classified by Spain as tax haven, as long as a simple threshold is met consisting on a 5% and one year shareholding over the company in the Canaries, no dividend withholding tax applies upon profits distributed to the shareholder.

Brief Summary of the Applicable Requirements

In order to qualify for the ZEC regime, two groups of requirements must be met: (i) Formal requirements, and, (ii) Substance requirements.

Formal Requirements

In order to qualify as a ZEC company, there is a mandatory registration process to go thru which starts by qualifying the business activity intended to be carried out in the Canaries. To that purpose there is a long list of approved business activities which basically only excludes those that do not really require a geographical link to the Canaries.

Once cleared the business purpose, it is necessary to register the ZEC company in a special registry[4], which requires the prior formal approval of the so-called Consejo Rector (Governing Council).

To proceed with said registration an application must be filed together with a brief memory of the aimed business activities, in proof of solvency, feasibility, international competitiveness and contribution to the economic and social development of the Canaries.

Finally, in order for a company to qualify for the ZEC regime, it must have both its business domicile and its seat of effective management in the geographical area of the ZEC. Moreover, it must have at least one local (i.e. Canaries resident) director and its business purpose must be the carry out of one of the numerous qualifying for the ZEC regime.

Substance Requirements 

A certain degree of substance is required to qualify for the ZEC regime, although substance is mandatory BEPS wise anyway when setting up companies abroad, should one intend to invoke local tax incentives.

Regarding the substance requirements, within the first two years from the registration date, the ZEC entity must invest in tangible or intangible fixed assets[5] an amount of at least EUR 100,000 for the two big islands (Gran Canaria and Tenerife) or of EUR 50,000 for the remaining islands. In the computation of said amount of investment, any contributions made under the roll-over relief regime shall be disregarded.

Finally, the substance requirement varies depending on the type of island as there are two groups. For the two largest islands (being Gran Canaria and Tenerife) it is mandatory to count with at least 5 employees within the first six months after the foregoing registration or 3 employees in the remaining islands.

Tax Regime

ZEC Company’s Taxation

A ZEC company is a regular Spanish company subject thus to the regular corporate income tax rate applicable in Spain, currently being 25%.

Having said that, should a company meet the aforementioned requirements it can benefit from a 4% tax rate on a tax base of at least EUR 1,800,000 plus EUR 500,000 of additional tax base at said low rate per each employment work created with a cap of EUR 25,000,000 of tax base.

There is also another limitation to the application of the 4% tax rate, which is indexed to the turnover and that has been recently amended to improve the former legislation. Said second limitation is that the reduction of the gross tax due of a ZEC company cannot exceed a certain percentage of the said company’s turnover. This limitation used to be 10% in case of service companies and 17,5% in case of industrial companies, but as a result of recently passed legislation it has been improved and unified to 30%.

Moreover, the ZEC regime is compatible with another attractive local tax incentive known as RIC (Reserva para Inversiones en Canarias or Canaries Investments Reserve) which subject to certain requirements allows a 90% reduction of the tax base. Nevertheless, this tax incentive could only apply on the remaining part of tax base, if any, that does not benefit from the ZEC regime and thus from the 4% rate. However, a joint combination of the two tax incentives can lead to a negligible rate of effective tax burden, much lower than other jurisdictions frequently used for trading purposes.

Shareholders’ Taxation

An additional advantage derived from the ZEC regime is the possibility to pay dividends to resident and non-resident shareholders under a full exemption of withholding tax with the sole requirement of a 5% shareholding uninterruptedly held for at least 1 year. Regarding non-resident shareholders, it is additionally required that it is not resident in a country or territory statutorily considered by Spain as a tax haven[6].

As far as interest from loans granted to the ZEC entity by its shareholder, should the latter be resident in another EU member state, an exemption of interest withholding tax would apply and in case a tax treaty exists, non-EU resident shareholders could claim the treaty rate.

Finally, regarding capital gains realised upon disinvestment in the ZEC entity, should a non-resident but a treaty resident shareholder realize a gain upon transfer of its prorated share of the ZEC entity, the treaty could apply and if the substantial shareholding or real estate company clause apply a 19% taxation would accrue but otherwise an exemption could be claimed.

A Great Alternative for African Business

Without prejudice of other issues as the risk of a permanent establishment and the tax consequences derived therefrom, the ZEC regime is being used by many large multinational groups with business interests in Africa for many reasons.

On the one hand, because Spain has income tax treaties with 9 African countries[7]. Moreover, because Spain is in the European Union and that allows the ZEC entity to claim all the benefits of the applicable EU Directives. Additionally, because the Canaries are well connected with 3 continents (Europe, Africa and America) and do count with the necessary infrastructure including an American School. And needless to say, because the Canaries do provide a degree of safety, let alone a standard of living, which cannot be achieved in general in the African continent.

Therefore, the ZEC is a great and suitable option for and it is being used by companies in the business of oil, gas, shipping, mining, etc. as the Canaries provide the aforementioned advantages thanks, in most cases, to its convenient geographical location, especially with respect to north western Africa.

Numerical Examples

A US group decides to set up a Spanish limited liability company (S.L., which is a foreign eligible entity for US tax the box purposes as opposed to the S.A. which ranks as per se corporation) in the Canaries and meets all the applicable requirements to claim both the ZEC and the RIC regime.

The ZEC SL has a turnover of EUR 50,000,000 and a profit of EUR 7,500,000.

Case A. ZEC SL has 10 employees and is not keen on reinvesting in local assets.

ZEC SL’s Turnover

50,000,000

ZEC SL’s Profit of the Year

7,500,000

Tax Base Subject to 4% CIT rate

6,800,000

Limitation Applicable to Tax Base at 4%

12,000,000

Final Applicable Tax Base at 4%

6,800,000

Resulting Gross Tax Due on EUR 6,800,000 tax base

272,000

Remaining Tax Base Subject to Spanish General CIT Rate

700,000

Gross Tax Due on Remaining Tax Base (25% of EUR 700,000)

175,000

Overall Tax Due by ZEC SL (272,000 + 175,000)

447,000

Effective Tax Burden of ZEC SL

5.96%

 

Case B. ZEC SL has 10 employees and is keen to reinvest EUR 500,000 in local assets.

ZEC SL’s Turnover

50,000,000

ZEC SL’s Profit of the Year

7,500,000

Tax Base Subject to 4% CIT rate

6,800,000

Limitation Applicable to Tax Base at 4%

12,000,000

Final Applicable Tax Base at 4%

6,800,000

Resulting Gross Tax Due on EUR 6,800,000 tax base

272,000

Remaining Tax Base (7,500,000 – 6,800,000) eligible to RIC

700,000

Tax Base Adjustment upon RIC (90% of 500,000)

450,000

Remaining Tax Base Subject to Spanish General CIT Rate

250,000

Gross Tax Due on Remaining Tax Base (25% of EUR 250,000)

62,500

Overall Tax Due by ZEC SL (272,000 + 62,500)

334,500

Effective Tax Burden of ZEC SL

4.46%

 

[1] Gran Canaria, Tenerife, Lanzarote, Fuerteventura, El Hierro, La Gomera y La Palma

[2] Spain has currently treaties in force with the following countries: Albania, Algeria, Andorra, Argentina, Armenia, Australia, Austria, Azerbaijan, Barbados, Belgium, Bolivia, Bosnia and Herzegovina, Brazil, Bulgaria, Canada, Chile, China, Colombia, Costa Rica, Croatia, Cuba, Cyprus, Czech Republic, Denmark, Dominican Republic, Ecuador, Egypt, El Salvador, Estonia, Finland, France, Georgia, Germany, Greece, Hong Kong, Hungary, Iceland, India, Indonesia, Iran, Ireland, Israel, Italy, Jamaica, Japan, Kazakhstan, Kuwait, Kyrgyzstan, Latvia, Lithuania, Luxembourg, Macedonia, Malaysia, Malta, Mexico, Moldova, Morocco, Netherlands, New Zealand, Nigeria, Norway, Oman, Pakistan, Panama, Peru, Philippines, Poland, Portugal, Romania, Russia, Saudi Arabia, Senegal, Serbia, Singapore, Slovakia, Slovenia, South Africa, South Korea, Sweden, Tajikistan, Thailand, Indonesia, Trinidad And Tobago, Tunisia, Turkey, Turkmenistan, Russia, Ukraine, United Arab Emirates, United Kingdom, United States, Uruguay, Uzbekistan, Venezuela, Vietnam.

[3] However, an extension of this regime by the European Commission is foreseeable as it has happened in the past.

[4] The so-called Registro Oficial de Entidades de la Zona Especial Canaria.

[5] These assets are subject to certain holding period requirements.

[6] Spain has a closed list concept of tax haven being said list elaborated and approved by Spanish Royal Decree 1080/1991. However, since 2003 any jurisdiction that enters into an exchange of information agreement or subscribes an income tax treaty including the exchange of information clause shall be automatically removed from the referred black list and that shall no longer be considered as a tax haven.

[7] Those countries being: Algeria, Cape Verde (about to enter into force), Egypt, Morocco, Namibia (about to enter into force), Nigeria, Senegal, South Africa and Tunisia. 

 

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