13 Mar The new Supreme Court criterion on Real Estate leasing subsidiaries in family business groups

In the realm of family business groups, it is common practice to structure activities by separating ownership of real estate into a specific company. As we explain in another article on our blog about holding companies, this company usually acts as the owner of the group’s real estate assets, leasing them either to other companies within the group itself or to third-party clients.

However, from a tax perspective, this organization poses an important problem: it is not always considered that the leasing company carries out an economic activity.

This is especially relevant in Inheritance and Gift Tax, since the transfer of a family business may benefit from a 95% reduction, provided that certain requirements are met.

One of the most debated is that established in the Personal Income Tax regulations:

for real estate leasing to be considered an economic activity, there must be at least one person employed full-time dedicated to leasing management.

But what happens when that management is carried out by employees of another company in the group?

A recent Supreme Court ruling has addressed precisely this issue.

The case analyzed by the Supreme Court

• The shareholders of the Parent Company (ABM Corporación Empresarial S.L.) choose to make a gift of shares in this company to their children.
• One of the companies owned by the parent company is a company dedicated to real estate leasing without its own employees (MICROBELL S.L.).
• When filing the Self-Assessment, the donees (the children) chose to apply the reduction provided for in article 20.6 of the LISD.
• Given that the real estate subsidiary did not have its own employees for leasing management, the tax authority considered that its activity did not constitute an economic activity, and consequently partially denied the application of the reduction.

The key question: Is an employee in the subsidiary inevitable?

The court had to resolve whether, in order to apply the tax reduction in the transfer of the family business, the worker must necessarily be employed by the leasing company, or whether they can belong to another company in the group, taking into account what is provided for in the definition of economic activity given by the Corporate Income Tax Law.

The criterion given by the Court

The chamber adopts a less formalistic interpretation than that applied by the Tax Administration. According to the ruling, it cannot be automatically and inexcusably required that the worker appear on the subsidiary’s payroll. It is possible for the employee to be in other companies in the group if there is a genuine activity provided by the group jointly, in which the leasing is integrated.

But this flexibility will not apply to any situation:

The activity must actually be integrated into the group.

It will not be sufficient for the leasing company to belong to a group. The leasing must form part of a broader business activity, coordinated with other companies.

What will be relevant is not whether the employee is in the subsidiary or not, or whether it can be understood that an economic leasing activity is being carried out, but whether together with the rest of the provision of goods and services carried out by the other companies, the subsidiary’s activity transcends mere real estate leasing. Attention must therefore be paid to whether the subsidiary’s activity can be analyzed exclusively from the lessor’s perspective, or whether it should be analyzed considering its contribution to the group as a whole.

The interpretation for the continuity of the family business.

The Supreme Court also recalls that the tax regime for family businesses has a clear purpose: to facilitate their generational transfer.
Therefore, it considers it necessary to interpret the regulations avoiding formalisms that may hinder the continuity of family businesses, relying on the recommendation of the European Commission of December 7, 1994 and the Resolution of the European Parliament of September 8, 2015. These urged States to seek the survival of family businesses, with an adequate treatment of inheritances and gifts, as well as not to obstruct generational succession with formalisms and bureaucracy.

What this ruling implies

It is true that the ruling opens the door to a more flexible interpretation:

It will not always be mandatory for the real estate subsidiary to have its own employees, or rather, it will be possible to demonstrate the existence of real economic activity despite their absence.

However, the impossibility of applying this interpretation to any leasing company integrated into a business group is more than clear:

“On the contrary, and as a negative delimitation, the mere membership of the real estate leasing company to a group of companies, when the real estate leasing activity is not articulated and functionally integrated with the economic activity of the set of other companies in the group, requires that compliance with the economic activity requirements provided for in art. 27.2 LIRPF be verified in isolation at the company dedicated to real estate leasing.”

That said, although the resolution represents a small advance towards a purposive interpretation that prevents the Tax Administration from inexcusably requiring the existence of workers in the subsidiary, it leaves several questions open:

What does it exactly mean that the subsidiary’s activity transcends mere real estate rental?

Will we be able to apply this interpretation outside the scope of family business?

To what extent can this criterion be extended to other tax areas related to leasing subsidiaries?

We will have to see how the Administration’s and the Courts’ criteria evolve in the coming years. Certainly, we are studying the possibilities to understand how we can benefit our clients.