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

15. February 2022 | Taxes on the Canary Islands (this contribution)

In the Canary Islands, there are sometimes special rules regarding taxes. In particular, the creation of the ZEC Special Economic Zone, which includes all the Canary Islands, is interesting. Under certain conditions, corporation tax can be reduced to up to 4%. But in other areas too, the tax regime of the Canary Islands offers tax advantages. For example, there are special rules for depreciation and investment reserves. This should encourage investors to start companies in the Canary Islands. In fact, this is done with the blessing of the EU, which allows tax exemptions to promote its peripheral regions. Therefore, other rules apply in the Canary Islands regarding taxes paid by consumers. Although the Canary Islands are part of the EU, they can make derogations from the EU VAT directives for their territory.

Many natural paradises in the world are islands. Many are also tax havens. Indeed, an isolated situation seems to have some influence on the granting of tax benefits. After all, this is also expressed in the synonym tax haven. In this context, if we were to take as a starting point the numerical ratio of the tax-advantaged islands to the mainland tax havens, we would have to speak of tax islands at least as often. But this is an etymological and thus purely academic question.

Because the details of how a tax regime actually deals with its tax jurisdiction are even more interesting. Even among these exotics, the Canary Islands stand out for several reasons. Therefore, in this article we describe details of the extensive range of measures with which the Canary Islands conduct tax policy.

The Canary Islands are located in the Atlantic Ocean and politically belong to the Kingdom of Spain. Gran Canaria, La Palma, El Hierro, Fuerteventura, Tenerife, La Gomera, La Graciosa and Lanzarote are the most famous islands in this archipelago, commonly known as the Canary Islands. Geographically, they lie off the west coast of Africa, approximately at the border between Morocco and Mauritania. But as Spanish islands, they are also part of the EU.

Since the Canary Islands have not developed large alternative economic sectors other than tourism, this has had both economic and social consequences in the past. For example, the labour market has deteriorated. The unemployment rate in the Canary Islands is among the highest in both Spain and the EU. Therefore, in this autonomously managed region, an independent tax regime has been opted for (regime Fiscal de las Canarias, REF for short). In fact, the autonomous legislation of the Canary Islands in the field of taxes dates back to 1972.

Later, when Spain was accepted into the EU, it was decided to create a special economic zone in the Canary Islands. The legal basis for this was Law 19/1994 enacted by the Regional Government. When it 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 addition, special rules apply to the Canary Islands for the taxation of transactions, which differ greatly from other requirements in the EU. As an EU peripheral area, the Canary Islands are outside the scope of the EU VAT system directive. In fact, the EU, in cooperation with the Spanish legislature, has created its own regulation, which grants special freedoms for the legal design of the local tax regime. These are set out in Council Decision (EU) 2020/1792 of 16. November 2020 on the application of the AIEM tax in the Canary Islands included. In addition to the island tax, which is aimed at general sales to consumers, there is also the AIEM tax, which is considered an excise duty on certain locally produced goods. This means that two different excise taxes apply in the Canary Islands, which differ significantly from the general regulations of the EU.

As in the rest of the Kingdom, the Canary Islands also regularly pay taxes on income. The income tax is progressively staggered in Spain, as well as in Germany. Furthermore, in Spain, the world income principle is also decisive for the determination of taxable income. You are considered unlimited taxable if you are present in Spain for at least 183 days per year. On the other hand, in Spain, too, the approach of the center of life is recognised as justifying an unlimited tax liability. This is therefore of particular interest to those who continue to reside in Germany, but who spend most of the year in the Canary Islands or elsewhere in Spain.

Furthermore, this is also of great importance with regard to social security obligations. This is especially true when working locally. After all, Spain has concluded a double taxation agreement with many other countries in the world; This also applies to Germany, Austria and Switzerland.

In the field of income tax, however, there are exceptions that apply only in the Canary Islands. Because if you have a limited tax liability for natural persons who earn income in the Canary Islands, you pay a flat rate of only 24% in taxes. This also applies to managers.

An annual property tax in Spain is also payable nationwide. This applies in particular to real estate assets. It also occurs if you are only limited taxable. In addition, worldwide assets are considered as a requirement. There are special rules for limited taxpayers. In contrast, locally varying allowances apply to unlimited taxpayers. In principle, EUR 700,000 is planned. For assets that go beyond this, a progressive tax rate of 0.5% to 2.5% applies. There are also tax exemptions, for example in the case of investments in family businesses or intellectual property.

Unlike property tax, where the state is entitled to collect, real estate property tax goes to the local communities. Various factors influence the level of taxes on the Canary Islands. Thus, the area and location of a property are just as decisive as the presence of certain add-ons (for example, a garage).

Another type of tax that is known both in the Canary Islands and in other parts of Spain and that is also familiar to us is inheritance tax and gift tax. However, since no DTA with Germany regulates the avoidance of double taxation in detail in this context, it is necessary to take forward-looking action in order to avoid excessive double taxation.

3.4.1. Corporate tax in the Canary Islands

The general corporate tax also applies in the territory of the Canary Islands. In most cases, the tax rate is 25 % of the net profit. However, the tax rate may increase to up to 30%. But there are also tax benefits for newly founded companies. It depends on the company form. For example, corporations pay only 15% in taxes in the first two years of making a profit. In the other applications as well, this tax advantage is limited to the first two profit-making assessment periods.

In other areas, too, special tax concessions are available for companies located in the Canary Islands. In this way, most of the tax breaks available in the rest of Spain (for example, for expenditure related to research and development) can be obtained at a significantly higher level in the Canary Islands. The difference can be up to 80%. For example, a 50% reduction in taxes is envisaged if a company based in the Canary Islands generates its profits through industrial or agricultural production or fisheries. In addition, companies that make a profit on ships registered in the Canary Islands receive a tax reduction of up to 90 %.

In addition, there are other special exceptions for companies located in the Canary Islands that meet certain conditions. If a corporation establishes itself there as a so-called ZEC company, then its corporate tax is significantly lower with only 4 % of the net profit.

3.4.2. Tax benefits through special depreciation possibilities

Another tax deduction designed to provide tax incentives specifically in the Canary Islands concerns the depreciation of assets and the tax treatment of costs incurred. For this purpose, a quota of 25 % to 50 % is generally applicable in Spain. In the Canary Islands, on the other hand, 60 % to 90 % can be associated with a favourable tax. For example, expenditure on research and development and technological innovation can be expected to be tax-depreciated by 45%. This is up to 33 percentage points cheaper than the tax options in general Spanish corporate tax law.

3.4.3. Tax investment reserves for companies in the Canary Islands

In parallel, the tax regime of the Canary Islands grants an exclusion of up to 90% in taxes if the profit goes to local reinvestments. Of course, there are also certain framework conditions. The reinvestment must take place within three years of the end of the investment period. Only certain assets are eligible. Alternatively, the investment reserve can also be invested in public projects or in other companies based in the Canary Islands, which themselves invest in qualifying assets.

3.4.4. Business tax in the Canary Islands

There are only a few countries in the world where there is a tax comparable to the German trade tax. However, Spain is one of these few exceptions. Indeed, in Spain too, the trade tax is a tax which the municipalities levy on their own and which they are entitled to. However, since the corporation tax in Spain is relatively high, the rate of business tax is generally low.

3.5.1 Capital gains tax on the sale of real estate

Taxes on capital income in Spain, and thus also on the Canary Islands, also apply to the profit from the sale of landed property. These taxes are called Impuesto sobre Incremento de Patrimonio de la Venta de un Bien Inmeuble. The seller is liable for this tax.

3.5.1.1. Sale by limited taxpayers

However, there is a special arrangement for limited taxpayers. Because the sale of a property in the Canary Islands is accompanied by a flat tax rate of 19% on the sales profit less certain costs if you are based in the EU. Otherwise it is 24%. A tax withholding on the purchase price takes place. For this purpose, the buyer retains 3% of the purchase price and pays it to the tax office. The limited taxable seller now has three months to file the associated tax return. If the tax amount is less than the withholding, the seller receives a tax refund. Otherwise, an additional payment follows.

3.5.1.2. Sale by unlimited taxable persons

For unlimited taxpayers, however, no tax retention is provided. They also benefit from a progressive tax rate. For taxable profits up to EUR 6,000, 19% of taxes are provided. The additional amount up to a taxable profit of EUR 50,000 is subject to a tax rate of 21 %. Every additional euro is associated with a tax of EUR 0.23.

For unlimited taxpayers who have linked their residence to the sold property for at least three years, however, there is the possibility of a tax refund. This requires a reinvestment in a new property within two years. However, if the acquisition costs are below the previously achieved selling price, then the tax refund is only possible proportionally. But you can possibly count back paid mortgages. However, already when selling the property to the tax office you have to declare the intention to reinvest in order to receive the tax refund.

On the other hand, unlimited taxpayers who are at least 65 years old enjoy a tax privilege. Because they are completely exempt from this taxation.

3.5.2. Capital gains tax on other capital income

What applies to the sale of real estate for tax purposes applies generally to other capital income in Spain. This means, among other things, sales of corporate shares, shares and other securities, cryptocurrencies and precious metals. However, special features can be considered if the acquisition took place before 01.01.1995 and the capital investments were worth at most EUR 400,000 at the time of the sale. In this case, a reduced tax rate applies. In the case of real estate, the tax rate is 11,11 %, in the case of company shares 25 % and in the case of all other investments 14,28 % of the value that can be ascertained on 20.01.2006.

In addition, there is another tax that arises when selling land. But this applies only to the value of land; Buildings are excluded. In addition, the seller is liable for that tax. It goes to the communities where the properties are located. However, instead of the profit achieved, this real estate transfer tax is due to a hypothetical increase in value calculated over time. This is why it is called a plus Valia tax. The same tax bases are used to determine the property tax. The tax is due 30 days after the notarized sale.

Furthermore, companies must pay a stamp duty when acquiring real estate. These taxes are in the order of 0.5%. However, ZEC companies in the Canary Islands are exempt from these taxes.

In ZEC you can set up corporations that successfully apply to the ZEC consortium as ZEC companies. The ZEC consortium is an agency co-founded by the Spanish State and the Regional Government of the Canary Islands in order to realize economic development through this special economic zone.

However, to qualify as a ZEC company, you have to meet a number of conditions. The most important concerns the level of investment and the creation of a certain number of jobs on the ground. There are local variations, with stricter requirements for the two main islands Gran Canaria and Tenerife. However, only certain business areas are considered for ZEC companies. For example, the tourism industry in the Canary Islands is completely excluded from ZEC funding.

However, if you meet all the requirements that affect a ZEC company, then considerable tax advantages beckon. In particular, the corporate tax, which stands out with a tax rate of only 4 %, is likely to be tempting. The tax advantages of the ZEC can also be combined with a number of other general benefits.

Another peculiarity in terms of taxes, the Canary Islands claim for themselves in the field of sales taxation. Here, with the permission of the EU, the principles of the EU VAT Directive are deviated from. Indeed, in the Canary Islands, there is no collection of VAT in the classical sense or in the sense of Spanish VAT law. Once again, this has to do with the fact that the Canary Islands are entitled to special support because of their status as EU peripheral regions. In fact, the mainland taxation of turnover in the Canary Islands dates back to 1972, long before Spain became a member of the EU.

5.2.1. General rules for IGIC

Nevertheless, the tax regime of the Canary Islands also knows an indirect taxation of transactions. This is particularly relevant for imports into the islands. The so-called island tax (Impuesto General Indirecto Canario, IGIC for short) applies differently to different transactions. According to the latest amended regulations in 2020, the following tax rates and regulations are provided for:

The lowest tax rate of 0% is applied to unprocessed foodstuffs (mainly fish, meat, milk, eggs, vegetables and other crops and fruit). In addition, you do not pay IGIC when buying bread, pasta and vegetable cooking oils. In addition, there is also no IGIC for work in social housing, sea and air transport between the islands. Medications used in human medicine as well as books and press products are also exempt from tax.

An IGIC of 3% is generated by various industrial products (chemical, paper and wood industries) and extracted mineral resources. In addition, 3% IGIC is also mandatory for all types of road transport. With a VAT of 3%, vehicle repairs are also tax-advantageous.

The regular IGIC tax rate is 7%. It shall apply to all supplies and services not covered by any of the derogations in this context. For example, this applies to industrially processed foods.

An increased tax rate of 9.5% is charged in the Canary Islands for the supply of certain vehicles for road transport.

For certain luxury items, the Canary Islands levy taxes at a tax rate of 15%. These include cigars that cost more than EUR 1.80 per piece, watches and jewellery.

Tobacco products are otherwise generally accompanied by a tax of 20%.

5.2.2. Special features to repair damage caused by volcanic eruption

In addition, a derogation is in force until 31.12.2022 related to the recent volcanic eruption on La Palma in 2021. IGIC does not apply to imports or other supplies and services if they are used to repair damage caused by the volcanic eruption of the Cumbre Vieja. However, this is only intended for businesses and professional goods, as well as medical, cultural, sporting, social and religious institutions. It also includes educational institutions and farming, forestry and fishing enterprises.

In addition to the local island tax IGIC, there is another excise tax on the Canary Islands. The Arbitrio sobre Importaciones y Entregas de Mercancías en las Islas Canarias (AIEM for short) concerns only certain locally produced products. The Council of the EU has set out in a list the selection of products for which Spain may allow a derogation for the collection of AIEM. These are products from agriculture, forestry, livestock and fisheries, production of building materials and raw materials extracted from mining, products from the chemical, metal, food, beverage and graphic industries. Furthermore, paper, tobacco products, clothing, shoes and other textile and leather products are included.

In order to promote local production, the Canary Islands are allowed to keep taxes particularly favorable in this context. Because either a reduction or even a complete exemption is possible at the AIEM. However, there are also certain borders that Spain is supposed to monitor. For example, the difference may not exceed 15 %. In addition, the total amount of exemptions may not exceed EUR 150 million per year. In special exceptional situations, however, a departure from this limit is possible. There is also a condition that the tax relief granted thereby promotes the socio-economic development of the Canary Islands. These exceptions only apply until 31.12.2027. At the same time, the Spanish Government is obliged to submit an interim report to the EU by 30 September 2025. This report should then indicate whether the conditions for the continuation of the measures are met.

The great advantage of the Canary Islands in terms of taxes is less due to their favourable conditions for companies alone. Rather, it is the combination with their membership of the EU that contributes to the particular attractiveness of the Canary Islands as a holistic framework. If the Canary Islands were to incentivise the establishment of companies elsewhere with this tax regime, it would very quickly have found itself on a blacklist of tax havens. However, since the EU has included the promotion of its peripheral regions in its Statute, the inclusion of the Canary Islands in the EU blacklist is excluded. Of course, the agreement of the EU Commission is always required. But as long as the Canary Islands are far from being a net contributor, there should be no change in this regard for the foreseeable future.