date | theme

08. October 2021 | Establishment in Spain: only 25% tax for German partnerships

30. December 2021 | Spain and its tax law: An overview of tax types

17. February 2022 | Special Economic Zone ZEC in the Canary Islands (this contribution)

In the Canary Islands, there are sometimes special rules regarding taxes. In particular, the creation of a special economic zone which includes all the Canary Islands is interesting. Under certain conditions, corporation tax can be reduced to up to 4%. This should encourage investors to locate companies in the Canary Islands. Indeed, the EU has also approved these economic support measures, which have been in force since 2000. At the end of 2021, the Canary Islands Regional Government extended these tax measures at least until 31.12.2027. All that remains is the EU's renewed agreement on this. In addition, ZEC companies can even take advantage of some other general tax advantages in combination with the benefits of the Special Economic Zone. But to start and run a ZEC company you have to meet certain conditions.

The Canary Islands have long been a remote region. Since the Canary Islands could not develop large alternative economic sectors other than tourism, their socio-economic development lagged behind in comparison with other European regions. This has led, among other things, to a sharpening of the labour market in the past. The unemployment rate in the Canary Islands is among the highest in both Spain and the EU.

Therefore, it was decided to introduce a special economic zone in this autonomously administered region. The legal basis for this was Law 19/1994 enacted by the Regional Government. When this special economic zone was officially introduced in early 2000, it was called Zona Especial Canarias, or ZEC for short. It also received approval from the European Union for its special tax arrangements. In fact, the EU has so far approved all extensions for these special arrangements.

Since 2022, a further extension of the ZEC has come into force. One can assume that this time, too, the EU will give its further approval. Finally, the promotion of peripheral areas of the EU is an integral part of EU policy. Only if such an EU peripheral area is considered as a net contributor, one should probably question the further support. But this is still a long way off in the Canary Islands.

The ZEC is a special economic zone that offers opportunities for entrepreneurs in the administrative area of the Canary Islands to obtain tax advantages under certain conditions. In return, tax support is expected to stimulate the labour market and diversify the economic base. After all, the heavy dependence on tourism also has its downsides. That is why a more fragmented economy based on both different industries and a correspondingly diverse service sector is a useful enlargement.

For this purpose, the Spanish state and the regional government of the Canary Islands have jointly set up a consortium. It is responsible for managing the approval procedures of applications related to the ZEC. If entrepreneurs undertake to meet the legally prescribed conditions, they can set up a so-called ZEC company in the Canary Islands. For this purpose, after approval of the application, a registration in the public ZEC register (ROEZEC), which acts as a kind of commercial register for ZEC companies. However, this ZEC register does not replace the regular business register in its function.

But only certain business activities are eligible for such a ZEC company. These include manufacturing, business and service industries. In particular, various industrial enterprises are provided here. But also research and development tasks as well as facilities for training come into consideration. And in the service sector, companies that deal, for example, with repairs – including crafts – and the provision of home care services can benefit from the tax benefits. In addition, however, there are many other eligible business sectors. On the other hand, companies in the hotel and catering sector, as well as financial, insurance and securities trading companies and the construction sector, with the exception of refurbishment, are excluded from the support.

To benefit from favorable taxes in the Canary Islands, ZEC companies must meet a number of conditions. The conditions for granting the tax advantages are more favourable in certain islands than in others. Because on the two main islands Gran Canaria and Tenerife higher minimum requirements apply than on the other islands.

On the one hand, as an entrepreneur you have to invest a certain minimum amount in a new company. If you want to base it on Gran Canaria or Tenerife, then an investment of at least EUR 100,000 is required. Elsewhere in the Canaries, on the other hand, half of this investment amount is sufficient. The investment must take place in the first two years after the company is founded. In addition, the investment amount must go to the fixed assets of the ZEC company.

This also allows an investment in real estate. However, this should not be used for rental, residential or staff accommodation. Instead, only a purely economic operating purpose of such a property can find recognition. Should a sale of the property take place, then a reinvestment in another property is required within one year.

Furthermore, you have to create jobs with the ZEC company, which is the main purpose of these measures. Within the first six months of the establishment of the company, at least five new jobs must be created in Gran Canaria and Tenerife, while for other islands, three new jobs already meet this condition. A ZEC company must maintain this number of jobs on an annual average in the future. In addition, at least one of the directors must have a residence in the Canary Islands.

Of course, both the company headquarters and the management should be located in the area of the Special Economic Zone of the Canary Islands.

In order to set up a tax-beneficial ZEC company in the Canary Islands, you have to submit an application to the ZEC consortium. Some documents are submitted for this purpose. This includes a report on the company’s planned economic direction, its technical and financial solvency and the contribution it can make to the socio-economic development of the Canary Islands.

Subsequently, the application is processed in the ZEC consortium. The processing time shall not exceed two months. With the approval and a copy of the company’s registration in the Spanish company register and the submission of the Spanish tax identification number (CIF’), this hurdle has also been overcome.

If you have met all the requirements for the establishment and continuation of a ZEC company, you can look forward to particularly favorable tax privileges. First and foremost, this includes the reduction of corporate tax from the usual 30% in the country to only 4%. However, this tax rate applies only up to a certain amount of the taxable profit. In addition, there is again a distinction between the two main islands and the other areas.

For ZEC companies based in Gran Canaria or Tenerife, which employ only the minimum number of five employees, this tax rate can only be applied to a taxable profit of EUR 1.800,000. Profits beyond this are therefore subject to standard taxation. However, if a ZEC company based in the two main islands employs between six and 50 people, then the favourable tax rate of 4% is applicable to a further EUR 500,000 of the profit per additional job created. For six employees, the tax base for the favorable tax rate increases to EUR 2,300,000. The maximum amount covered by this condition is EUR 24,300,000. However, if you employ more than 50 employees, then the preferred tax rate applies even to the entire profit. However, the reduction in gross taxes shall in no case exceed 30 % of the turnover generated by the undertaking.

The same rules apply on the other islands, except that only three employees are required in the entry level instead of five.

3.4.2. No real estate transfer tax for ZEC companies

In addition, the acquisition of real estate by a ZEC company does not incur any real estate transfer tax or stamp duty if the real estate is located in the Canary Islands. Other comparable transactions also remain tax-free. However, the condition for the tax exemptions is that the acquired assets and rights serve the business activity.

3.4.3.

Tax exemptions also apply to indirect taxes. This means the special island tax (IGIC), which is to be understood as a local variation of the VAT otherwise incurred in Spain. This tax exemption applies if two ZEC companies provide supplies and services between each other. It also applies to goods imported into the Canary Islands.

3.4.4. No withholding tax on profit distributions abroad

Tax advantages are also provided at other levels. This concerns the taxation of capital gains in connection with a ZEC shareholding. On the one hand, dividends distributed by a ZEC subsidiary to its domestic or foreign parent company are exempt from withholding tax. On the other hand, this also applies to interest on loans to third parties and capital gains from movable assets that have arisen without a permanent establishment being involved.

3.4.5. Combination with other general tax benefits

In addition, a ZEC company can receive further tax privileges granted by the Regional Government of the Canary Islands under the general tax promotion and which also bear the blessing of the EU. However, these tax advantages are only limited to some aspects. This includes, in particular, the granting of generous depreciation opportunities, of certain reserves and of tax concessions in free trade zones.

Since the tax base for calculating taxes in the Canary Islands is determined according to special specifications, a ZEC company must also comply with special accounting regulations. Therefore, a separate accounting is also required for all branches in Spain.

By extending the measures of the Regional Government in relation to the ZEC, companies set up under these provisions until the end of 2022 can claim the tax benefits as a ZEC company at least until 31.12.2027. There may even be an extension until the end of 2029 in sight. However, this also depends on the EU approval procedure.

Registration as a ZEC company, however, entails costs. There is a fee of EUR 884,52. Furthermore, there are also annual costs associated with maintaining the status as a ZEC company. For ZEC companies based in the two main islands, this is EUR 1,560.90. Elsewhere in the special zone ZEC, however, the fees are EUR 1,352.78.

The biggest advantage of the ZEC Special Economic Zone in the Canary Islands is, of course, the reduction of corporate tax. A tax rate of only 4% is certainly a very low approach by international standards. And if you compare the other EU member states with this, this is even the lowest regular corporate tax rate. At the same time, however, other factors must also be taken into account. Finally, there is a good reason why such a special zone has been established in the Canary Islands. Because as a recognised peripheral area of the EU, it is much harder for entrepreneurs to position themselves on the general market than if they manage a company in Central Europe. However, step by step, globalization brings about an interdependence in which the geographical location of a company increasingly loses importance.

Apart from that, the geographical location of the Canary Islands can also offer opportunities. Companies active in the energy sector, which are also eligible for funding in the ZEC, can greatly benefit from this when operating wind power and photovoltaic systems. In fact, the regional government of the Canary Islands has set itself ambitious targets for this, because it intends to switch energy production completely to renewable energies within the next few years. Thanks to the generous reduction in corporation tax and the great depreciation possibilities, there are therefore the best conditions for establishing a ZEC company in the energy sector. The fulfilment of the conditions is also quite realistic due to the level of investment and the number of employees required for this. In addition, another tax advantage is the exemption from the real estate transfer tax. This also greatly facilitates the construction of a power generation plant. All in all, one can therefore expect that the initial investments will pay off after only a few years.

Nevertheless, one question remains unanswered: How long will you be able to benefit from ZEC’s generous tax benefits in the Canary Islands? Although the ZEC already exists since 2000 and has been extended so far. Similarly, the current unstable general economic situation due to the Corona pandemic has certainly not helped to improve the situation in the Canary Islands; On the contrary. However, this could change in the future. The EU would then have no reason to continue to tolerate this exceptional special economic zone. But at least until 2027, the situation seems to remain predictable.