The aim of this article is to provide a brief overview of how income tax applies to the different insurance policies under Spanish tax law.
Broadly, there are 'tax compliant' contracts issued by domestic, Freedom of Establishment (FoE) branches, Freedom of Services (FoS) providers and 'foreign' contracts issued by third country insurers as well as non-tax compliant FoS providers in Spain.
There are generally two types of tax compliant insurance policies Type A and Type B policies.
Type A policies do not allow the policyholder to choose investments - such as with profits policies. The insurer is able to choose any assets it wishes for its life fund so long as they are permitted by its own Regulator. If the policyholder does not want to invest in the assets then their only choice is to surrender the policy.
Type B policies are policies that allow the policyholder to switch investments and can be broken down into two categories B(a) and B(b).
Type B(a) policies are able to invest in shares or participations in collective investment institutions by Spanish Law 35/2003 dated 4 November or by Council Directive 85/611/CEE
Broadly, this means that for Type B(a) policies, investments are restricted to Funds which are EU domiciled with UCITS status and this does not include Bank Deposits.
Type B(b) policies are able to invest in ‘baskets’ of assets, these policies have to fulfill a number of requirements, some examples are to:
- adhere to the diversification and dispersion of investment rules; and
- the requirement for the assets within the basket to be accepted as valid by the Spanish Insurance Supervisory Regulations, excluding funds which directly invest in real estate.
For example, in accordance with the diversification and dispersion of investment rules, all funds holding deposits must not have more than 40% of their total investment in any one company at any time. No additional diversification or dispersion requirements will need to be met for investment funds or debt securities issued by insurance companies or credit entities.
Broadly, this means that for Type B(b) policies investments are restricted to internal funds (including cash funds) meeting the B(b) requirements.
An additional requirement of Type B policies is that the individual internal funds or other assets the policyholder can choose from must be stated within the policy Terms and Conditions. So if funds are not specified in the policy and the policyholder is free to choose the funds then it will not be a Spanish tax complaint policy and instead it will be a foreign policy.
The Old Mutual International Ireland Spanish Collective Investment Bond falls under B(a) category and the Old Mutual International Ireland European Capital Account falls under B(b) category.
If a policy does not fall within the requirements stated above for Type A and Type B policies then they will not be Spanish tax compliant policies and would instead be taxed as foreign policies.
Whilst Domestic and FoE branches account direct to the tax authorities, FoS providers (offering either tax compliant or foreign policies) have to appoint a Fiscal Representative* at the time they start writing business and to whom they send any tax withheld.
All gains on policy payments from 1 January 2016 will be taxed at a flat rate of 19% which is withheld by the insurer. There will be no further personal income tax liability for the policyholder on the first €6000 savings income received in a tax year. This also includes interest on savings accounts and dividends received in the same tax year. There will be a further 2% personal income tax liability which the policyholder will need to account for on the next €44000 savings income and a further 2% personalincome tax liability on savings income above €50000. Should there be a loss rather than a gain then the loss can be off set against other income tax liabilities.
Penalties for non-reporting range from 50-150% of the tax due and will be payable by the policyholder.
Tax compliant policies are subject to withholding tax in the tax period when the policy proceeds are paid out i.e. on surrender, death of the relevant life assured.
Foreign policies will be subject to income tax and can offset losses on an annual basis.
So for example, if an Irish FoS insurer was conducting tax compliant business in Spain then they would need to appoint a Fiscal Representative who would withhold tax when the policy proceeds are paid out for Spanish tax compliant policy and pay this to the Tax Authorities on behalf of the policyholder. There will be no further personal income tax liability on the first €6000. The policyholder would then only need to account for the additional 2% income tax liability for savings income on the next €44000 and an additional 2% income tax liability for savings income above €50000.
If the Irish FoS insurer has not appointed a Fiscal Representative and has not been withholding tax in accordance with the above requirements then the non-reporting penalties could be imposed on the policyholder as well as the insurer and its Fiscal Representative.
Example of how a tax compliant product is taxed.
Mr John Smith took out an insurance policy on 1 November 2014 with a premium of €100000. The surrender value as at 31 December 2015 is €120000 and on 31st December 2016 it is €140000. No withdrawals have been made.
As Mr Smith took out a tax compliant policy withholding tax will be payable when the proceeds are paid out and will be the difference between the surrender value (for total surrender payments) or the benefits received (for death benefit payments) less the premiums paid. Part surrenders will be calculated in the same way as for total surrenders but the part surrender amount will need to be apportioned between redemption of capital (part of the premium) and profit which will affect future calculations. As none of these events have occurred in the above example. No withholding tax will need to be paid on a tax compliant policy in 2016.
Compare this to Mr Jones who took out a foreign policy instead. Income tax is payable on an annual basis and will generally be the difference between the surrender value as at 31 December of the current year added to any withdrawals taken during the year less the surrender value as at 31 December of the previous year.
Therefore, where Mr Jones holds a foreign policy the gains of (€140000 + €0) - €120000 = €20000 would be subject to income tax. The first €6000 will be subject to tax at 19% and the next €14000 would be subject to tax at 21% (Assuming he has no other savings income). So a FoS insurer offering a foreign policy would withhold 19% of the gain and the policyholder would need to account for the additional tax due. The Fiscal Representative will provide a record to the Spanish tax authorities confirming the tax that has already been paid.
What things should be considered when choosing a FoS provider?
The things to consider when choosing a FoS provider include:
- Do they offer a tax compliant product?
- Do they automatically withhold tax as required by Spanish law?
- Have they appointed a local tax representative as required by local law?
- Do they regularly review the funds that are offered to ensure on going tax compliance?
Some additional points to consider
Spanish withholding tax is not payable on tax compliant policies if the policyholder is tax resident in another country before the policy proceeds are paid out. However, Spanish income tax is payable and losses can be offset on an annual basis whilst the policyholder is Spanish Tax resident on foreign policies.
This article does not in any way infer that foreign policies should not be retained, that is a matter for the policyholder and their adviser to decide. There may be valid reasons formaintaining such policies, for example proof of source of funds within Spain and the intention for only short term residence.
*As per Article 86 of the Spanish Law on Ordination and Supervision of Private Insurance and Royal Decree 1065/2007.