The fact that the Canaries have one of the most attractive fiscal systems will probably come as nothing new to you. These tax benefits have been around since medieval times and have gradually evolved over the years. Nevertheless, in order to take advantage of these tax benefits, companies must first comply with a number of essential requirements.

The Canary Island Government’s attention has been drawn to the incorrect application of tax benefits by many companies created in the Canaries, both currently and in years gone by, perhaps due to a lack of knowledge of the investors, perhaps due to poor assessment, etc. Consequently, during the past few months, inspectors of the Canary Island Government have been carrying out thorough tax inspections on companies created in the Canary Islands in order to verify whether such tax benefits have been applied correctly or not.

An incorrect application of the benefits could now prove to be a set back for many companies, that may now have to face an obligation to reimburse the benefit and pay a fine of up to 150% of the exemption as well as the corresponding interest for default in payment.

When a company domiciled in the Canary Islands invests in the purchase of a property to carry out its activities (whether trading, industrial, services, management letting, etc.) it may take advantage of a saving on transfer tax (6% of the property value). The objective of the Canary Island Government with these benefits is to achieve more productive and profitable investments within the Canary Islands. The objective of the “REF” Law (a special law of the Canary Islands regulating the economical and social aspects of the Canaries) is to promote the economical and social development of the Canary Islands. For this reason, a requirement for these benefits is for the investment to be profitable, although it has been proved that in many cases this condition is not fulfilled.

The basic problem is that many property purchases done through companies created in the Canary Islands take advantage of these exemptions on Transfer Tax (6% of the property value) or on I.G.I.C. tax (General Indirect Tax of the Canary Islands, equivalent to VAT levied at 5% of the property value) without fulfilling the necessary requirements.

These requirements, among others, are:

1. For the purchase date of the property to be within three years of the date of incorporation of the company, or capital increase of the company in question.

2. For the property effectively to be used by the company, which is to say, the company must make productive use of the investment. To give an example; if an apartment is purchased through the company, this should be let on a short or long term basis (and not used by the partners of the company simply for holidays, without declaring any income in exchange.)

3. For the investment to be kept for a minimum of five years by the company without being sold.

4. For the investment to be correctly recorded in the company accounts in accordance with the requirements established in the General Spanish Accountancy Plan.

5. For the company to have the corresponding letting agreements or contracts (always requested during a tax inspection). Many proprietors let their properties through internet, receiving the rents abroad, totally unaware that this can easily be discovered in a tax inspection simply by checking on water and electricity consumption of the properties in question. In this case, the problem is more serious because neither the rents (in accordance with international tax treaties signed between Spain and most European countries) nor the government IGIC tax (local VAT – 5%) paid over the letting of the apartment to tourists, have been declared in Spain.

To give you a clearer picture, for example:

A Company is incorporated within the Canary Islands with non-resident partners. This company buys two properties (saving on the transfer tax). One of the properties is then used for the partners’ holidays and the other is used for short-term lets to tourists through a management-letting agency based in the Canaries, or abroad. In this case, a tax inspection would verify the use of the properties (if the rents obtained are being declared in Spain, whether the corresponding IGIC (5% VAT) has been paid, whether the properties have been correctly recorded in the accountancy, etc.)

The problem would become even more serious if either one of the properties is sold without respecting the obligation to keep the property for a minimum of five years (essential requirement for any tax exemption) and, of course, even more so in those cases where a property is sold without declaring in Spain the corresponding profit generated (Capital Gains).