The family business exemption is by far the most valuable piece of Spanish wealth tax (the tax known locally as Patrimonio). It removes from the base the entire value of a company that, in many family fortunes, accounts for half of everything. It is also the most fragile. It depends on four conditions measured against objective data, and it is lost through administrative details, a salary set badly or a directorship that has lapsed at the Registro Mercantil (the Companies Registry), without anyone noticing until a tax review arrives.
There are really two exemptions
Article 4.Ocho of Ley 19/1991, the Wealth Tax Act, contains two cases that should not be confused:
- The individual business owner or professional. The assets and rights needed to carry on the activity are exempt, provided it is carried on habitually, personally and directly and that it is the person's main source of income. The premises, the machinery, the stock, the vehicle used in the business.
- Shares in companies. Shares are exempt when the four conditions set out below are all met at the same time. This is the case that affects almost any shareholder of a family company.
This guide concentrates on the second, which is the one that generates the tax files.
Condition one: the company has to actually do something
The company's main activity may not be the management of a portfolio of securities or real estate. The law defines this in the negative: asset management is taken to exist when, for more than ninety days of the financial year, more than half of the company's assets consist of securities or are not used in economic activities. A company that simply holds let flats with no business structure behind it, or one that is a portfolio of funds with a director, does not get through this door.
Holdings that carry at least 5 % of the voting rights and are held in order to direct and manage the investee do not count as securities, provided there is a proper organisation of material and human resources to do so. And for the letting of property, whether it counts as an economic activity depends on having at least one person employed under an employment contract and full time, following the test in the IRPF Act (the Spanish income tax law). A property-holding company that hires someone by the hour to dress up the requirement does not meet it, and that is the point argued over most.
Condition two: the size of the holding
| Option | Percentage | Who is added together |
|---|---|---|
| Individual | At least 5 % | The taxpayer alone |
| Jointly with the family group | At least 20 % | Spouse, ascendants, descendants or relatives in the second degree of the collateral line, by blood, by marriage or by adoption |
The family group reaches as far as the second collateral degree: brothers and sisters yes, cousins no. Someone holding 3 % whose close family does not add up to 20 % cannot apply the exemption, however much the company is a family business in the everyday sense of the phrase.
Condition three: genuine management functions
The taxpayer, or in the joint option at least one person in the family group, must actually perform management functions in the company. Appearing as a director in the deed is not enough. The point is to take part in the decisions, and that is shown with minutes, signed contracts, powers of attorney still in force, correspondence and, above all, with a directorship that is registered and has not expired.
Directors appointed for a fixed term see their appointment lapse, and the company carries on as if nothing had happened. When a review comes five years later, the Registro Mercantil shows the appointment expired, and the fact that management was genuinely exercised has to be rebuilt by other means. It can be done, but it is an avoidable fight: checking the directorship once a year costs one search at the Registry.
Condition four: more than half of your earnings
The pay received for those management functions must represent more than 50 % of the person's total business, professional and employment income. Investment income and capital gains do not go into the denominator: dividends from the company itself, rents received personally or the sale of a property do not spoil the calculation. Nor, for this purpose, does income from a business activity that already enjoys the individual business owner's exemption.
| Shareholder's income | Case A | Case B |
|---|---|---|
| Salary as the company's managing director | 62,000 | 31,000 |
| Salary from another job as an employee | 0 | 45,000 |
| Income from the person's own professional activity | 18,000 | 0 |
| Dividends and rents | 54,000 | 54,000 |
| Denominator of the calculation | 80,000 | 76,000 |
| Proportion | 77.5 % | 40.8 % |
| Is it met? | Yes | No |
In the joint option it is enough for the management and pay conditions to be met by at least one person in the family group, and the exemption then reaches everyone who satisfies the remaining conditions. That is why, in many families, the son or daughter who runs the business carries the exemption for the parents and for the siblings.
The shareholder who does not work in the business
In the joint option the exemption does not require every shareholder to manage or to be paid. It requires someone in the family group to do so. That allows a retired mother holding 40 % of the shares to be exempt because her daughter, with 15 %, is the managing director and receives from the company more than half of her earnings. What each shareholder does need, separately, is to meet the holding condition (5 % of their own or 20 % as a group) and for the company to pass the activity filter.
The consequence is that the exemption of an entire family can hang on one person, and that person leaving, retiring or taking a pay cut makes it disappear for all of them at once. When the risk is concentrated like that, it should be written into the family protocol (the agreement many Spanish families sign to govern the business) and reviewed before the financial year closes, not in the spring. It is also worth checking who remains inside the family group: nephews, nieces and cousins are not in it, and a handover between generations can break the joint 20 % without anyone noticing until the next return.
The exemption is almost never a hundred per cent
Even when all four conditions are met, the exemption only covers the value of the shares in the proportion that the assets used in the business (reduced by the debts of the business) bear to the company's net equity. Put another way: surplus cash the business does not need, the flat the company bought for the family to use, or the securities portfolio sleeping on the balance sheet all stay outside.
That split is where the money is decided. An operating company with fifteen years of retained profits sitting in term deposits can have half its balance sheet in assets not used in the business, and that half pays. The proportion should be worked out every year and kept on file, because the value of the holding is also calculated under the article 16 rules explained in how each asset is valued.
What happens when one fails
| Condition that fails | Consequence | Can it be fixed? |
|---|---|---|
| The company merely holds assets | No exemption of any kind | Only by changing the reality of the business, not the paperwork |
| Neither 5 % nor the family 20 % is reached | No exemption for that shareholder | Through a real reorganisation of ownership, with its own costs |
| No management functions are performed | No exemption | Yes, going forward: appoint, register and document |
| Pay does not exceed 50 % | No exemption | Yes, going forward: adjust the following year's remuneration |
| There are assets not used in the business | The exemption is reduced proportionally | Partly, by cleaning up the balance sheet on business grounds |
The conditions are measured on the accrual date, which for wealth tax is 31 December, with the financial year already closed. In the Impuesto sobre Sucesiones, Spain's inheritance tax, the accrual date is the date of death, and which year should serve as the reference for measuring pay has been a matter of dispute. It should be reviewed case by case rather than assuming that the approach taken for wealth tax holds. We warn you of the risk; we do not guarantee that the tax authorities will share one reading or the other in a particular file.
Why this matters far more than the wealth tax itself
The 95 % reduction in the Impuesto sobre Sucesiones y Donaciones, Spain's inheritance and gift tax, for passing on shares in a family business rests on this same exemption: if the shares are not exempt for wealth tax, the reduction does not apply. Many regions have improved that reduction, but all of them start from the same requirement. One lost year of exemption may cost almost nothing in the Modelo 714 and cost a fortune on an inheritance, which is why the annual review is not a formality.
If you would like us to go through the four conditions with your annual accounts, your payslip and the company's registry sheet, write to us through the wealth tax form. We will tell you what is met today, what is up in the air and what can be put in order before 31 December. What we will not do is assure you of a result: whether assets count as used in the business depends on facts, and the tax authorities may see them differently.