Tax effects of the Next Generation EU Funds
1. Tax effects of Next Generation funds on corporate income tax
1 The tax calculation of income
Regarding the calculation of income, neither the Royal Decree Law 36/2020, of 30 December, which approves urgent measures for the modernisation of the Public Administration and for the execution of the Recovery, Transformation and Resilience Plan, nor the Recovery, Transformation and Resilience Plan (summarised version) sent by the Government of Spain to the European Commission contemplate any type of tax exemption for these aids. Thus, at least for the moment, we can assume that your taxation will follow the general rules. In this sense, the Corporate Income Tax regulations provide an exemption, subject to certain limits and conditions, for the following subsidies:
- Subsidies granted to taxpayers who operate forest farms managed in accordance with technical plans for forest management, forest exploitation, forestry plans or reforestation plans approved by the competent forest administration, provided that the average production period, according to the species in question, determined in each case by the competent forest administration, is equal to or greater than 20 years.
- The subsidies contemplated in the Third Additional Provision of the Corporate Income Tax Law. These are certain aids from the community agricultural policy and the community fisheries policy, to repair the destruction of heritage elements, for the abandonment of the road transport activity and for the compulsory slaughter of cattle, within the framework of actions aimed at the eradication of epidemics or diseases.
Aside from the cases in which an exemption may apply, what is usually relevant will be the moment when the corresponding subsidy should be considered taxable income. The accounting treatment that is envisaged for these subsidies will determine this, since the accounting result is the starting point to determine the tax base of the Corporate Income Tax. Here, unlike what happens with lucrative acquisitions (donations and bequests), the tax treatment fully coincides with the accounting treatment of non-exempt subsidies.
So, the Registration and Valuation Standard (NRV) 18 of the General Accounting Plan (PGC) “Subsidies, donations and bequests received” distinguishes between non-repayable and repayable subsidies, and grants each of them the corresponding treatment. For our purposes here, we can identify the non-repayable subsidies as non-repayable aid, and the repayable subsidies as loans.
1.a) The calculation of income in non-repayable subsidies
Non-repayable subsidies granted by public entities constitute an income for the company that is initially recognised as part of its net worth, taking into account its tax effect. Its allocation to the income statement, and therefore its recognition as taxable income, depends fundamentally on its purpose, and it must be carried out in accordance with the rules established in NRV 18, which we briefly explain below. Specifically, the allocation of subsidies must be carried out as follows:
- When granted to ensure a minimum profitability or to compensate for operating deficits: They will be charged as income for the year in which they are granted, except if they are used to finance the operating deficit in future years, in which case they will be charged in those years.
- When granted to finance specific expenses: they will be charged as income in the same fiscal year in which the expenses they are financing are accrued.
- When granted to acquire assets or cancel liabilities, there are certain rules that apply depending on the corresponding type of asset or liability. The common characteristic is that the subsidy is allocated based on the expenses generated in the company by the corresponding asset (amortisation, impairment and retirement). In the cancellation of debts, the subsidies will be charged as income for the year in which this cancellation occurs, except when they are granted in relation to a specific financing, in which case the allocation will be made based on the element financed.
- Subsidies received without assignment to a specific purpose will be charged as income for the year in which they are recognised. Since all public subsidies are awarded for a specific purpose, the latter rule can be interpreted as a “catch-all” that would apply in the event that none of the above specific purposes is identified.
1.b) The calculation of income in reimbursable subsidies
NRV 18 considers that this type of subsidy must be recognised as a liability, which opens the door to the application of the NRV 9 “Financial instruments”, of the PGC, as well as the NRV 9 “Financial liabilities” of the General Accounting Plan for Small- and Medium-sized Enterprises (PGC SMEs) as explained below.
The key to this matter is that repayable subsidies (loans) actually represent a grant in relation to the applied interest rate, which will normally be lower than usual in the market, or even zero. In application of the corresponding NRV 9, this loan must be initially recognised at its fair value, adjusted for transaction costs. Subsequently, the liability will be recorded at amortised cost, applying the effective interest rate method. This way of accounting for the loan will cause the initial amount to not match the amount received.
Indeed, according to query 1/81 of the Accounting and Audit Institute (BOICAC 81/2010), to calculate the fair value, a valuation technique must be used, such as the present value of all discounted future cash flows, and applying the market rate as interest rate.
This implies that it will be necessary to recognise the financial expense derived from the loan, even if the interest rate is zero. This financial expense is identified with the difference between the fair value of the loan and the amount received (at zero interest rate) or that must be repaid (when the interest rate is lower than the market rate).
In terms of income, this amount qualifies as an interest rate subsidy. According to the ICAC, applying the treatment provided for non-repayable subsidies that we have seen before, the interest rate subsidy has to be initially recognised as an equity income, which will be charged to the income statement in accordance with financial criteria. However, in accordance with this rule, if the granting of the loan at a zero interest rate or a rate below the market rate is for the performance of specific activities, such as research and development expenses, this will be the purpose that must be considered at when applying the criteria for allocating the subsidy (interest rate) to the income statement. Thus, in our example, the interest rate subsidy will be considered income for the year as research and development expenses are incurred.
As we can see, this type of subsidies (interest rate subsidies) give rise to an expense and an income of the same amount. The logical consequence of this is that they do not generate any type of taxation for this tax. However, if the expense must be recognised according to financial criteria, but the income is allocated as the expense is incurred in the subsidised activity, there may not be a temporal correlation between them.
It must also be taken into account that public subsidies typically reduce the base of the incentives (deductions) that are granted in this tax for the performance of certain activities. We will address this below.
The effects of subsidies on the basis of deductions for the performance of certain activities
The Corporate Income Tax regulations provide for certain deductions for carrying out certain activities, such as research and development and technological innovation or investment in film productions. These deductions reduce the tax debt for this tax, with certain limits and conditions. However, in all cases, the amount that the deduction rate established in the regulation is applied to (the deduction base) is reduced by the public subsidies received, whether they are non-repayable aid or interest rate subsidies. In fact, it is a matter of course that repayable subsidies, that is, interest rate subsidies, reduce the deduction base.
In any case, with respect to the general effect of public subsidies, it is common for controversies to arise, such as the correct temporary allocation of the subsidy or the calculation of the interest rate subsidy, since what is considered a market value may be subject to various interpretations. But, undoubtedly, the most recurrent issue is the effect of the granting of the aid once the activity has already been carried out and the corresponding Corporate Income Tax self-assessments have been submitted, implementing the deduction without taking this aid into account (which was subsequently granted).
The position that technically seems more correct in this situation, and which is the one indicated by the Spanish Tax Authority in its inquiries, is the one that requires submitting a complementary self-assessment or a request for rectification of the self-assessment submitted, which regularises the excess deduction declared. But since this excess comes from conduct that is not fraudulent, the applicable procedure should be that of article 125 of the Corporate Income Tax Act, which provides for the accrual of late payment interest, but excludes the application of surcharges.
Tax effects of the Next Generation EU funds on VAT
The effects of subsidies on VAT take place to the extent that they are directly linked to the price of the operations carried out by the recipient which are subject to this tax. What the VAT Law does is consider this type of subsidy as part of the tax base of the tax. In this sense, the subsidies established based on the number of units delivered or the volume of services provided are considered directly linked to the price of the operations subject to VAT, when they are determined before the operation is carried out.
What the VAT regulations aim to do is guarantee the neutrality of the tax, so that consumption is taxed in the same way, whether or not the product has received public aid. Therefore, if a subsidised good or service has a price for its consumers, the tax base that determines the VAT to be paid by these consumers is made up of both the price actually paid and the subsidy linked to the price.
However, what constitutes a price-linked subsidy has been a controversial issue for years. Since the last reform of the article that regulates this matter, issued in 2017, The existence of a direct link between the subsidy and the product or service that is the object of consumption is required to affect the VAT base. To appreciate when this occurs, one must turn to the jurisprudence of the Court of Justice of the European Union, which, in various judgements, has been outlining what requirements must be met for there to be a direct link between the product delivered or the service provided. and the counterpart obtained. Specifically, synthesising the doctrine on this subject, it must be understood that this direct link exists when the following requirements are met:
- That the subsidy has been paid to the subsidised operator in order to specifically carry out a delivery of goods or a specific provision of services
- That the purchasers of the good or the recipients of the service obtain an advantage from the subsidy granted to the beneficiary, and,
- That the consideration represented by the subsidy is at least determinable. Note that it is not necessary for the amounts received to be linked to a perfectly individualised provision of services.
That said, the VAT Law expressly excludes from the VAT tax base the monetary contributions, whatever their denomination, that the Public Administrations grant to finance:
- The management of public services or the promotion of culture in which there is no significant distortion of competition, whatever its form of management.
- Activities of general interest when their recipients are not identifiable and do not pay any consideration.
Finally, a question that is not fiscal in nature, but that should be clarified, is whether the VAT of the expenses and investments in which the aid is materialised can be part of the subsidy. In this regard, Law 38/2003, of November 17, General Subsidies, establishes in its article 31.8 that “Taxes are eligible expenses when the beneficiary of the subsidy actually pays them. In no case are indirect taxes considered eligible expenses when they are capable of recovery or compensation or personal income taxes”. However, article 6 declares that “The subsidies financed with funds from the European Union will be governed by the Community rules applicable in each case and by the national rules of their development or transposition”. In short, although the general rule is that VAT is not an eligible expense, It will be necessary to examine the specific regulations issued by the European Union, as well as the specific transposition regulations, to determine whether this general rule is followed in the case of the Next Generation EU funds.