The remuneration system of company directors is one of the most discussed issues in corporate matters within the legal community. One of the dilemmas that many companies encounter in the context of this matter is whether the remuneration paid to company directors is deductible for Corporate Income Tax purposes. This question has been analysed by the Supreme Court in judgment 875/2023, of 27th June 2023.
The question at issue in the case examined by the High Court was essentially whether compliance with the corporate formalities relating to the remuneration of company directors constitutes a requirement for the remuneration received by the latter to be considered to be deductible. In accordance with the Tax Administration, the non-compliance of such formalities would cause such remuneration to be classified as “liberalities” and, consequently, they would not be deductible.
The debate revolved around the remuneration received by a number of top executives in their condition as employees, to whom, as members of the board of directors, the so-called “the relationship theory” was also applicable. Generally, this theory, created by case law, sustains that when an employee is regarded as a top executive and parallelly belongs to the management body of the company, the commercial relationship (director) prevails over the labour relationship (top executive), which is absorbed by the former.
When applying this theory, the Tax Administration understands that the remuneration paid to a person in this situation is done so in their condition as director (even if it arises from the duties as an executive) and, therefore, must comply with the requirements in terms of the remuneration of the directors as established by the Spanish Companies Act. These requirements are, principally, (i) the statutory provision – namely, that the company bylaws provide for the paid nature of the post of director (article 217.1) -, and that (ii) the maximum amount of annual remuneration has been approved by the General Meeting (article 217.3).
For the Supreme Court, said requirements operate as a kind of control mechanism for the benefit of the minority partner, at the same time that they favour the latter being informed about the remuneration received by directors, thus avoiding possible situations of abuse on their part or by the rest of the partners. With regard to the second requirement, this objective is fruitless when the company has a sole partner who (i) approves the bylaws which provide for the paid nature of the post, (ii) appoints the directors, and (iii) approves the annual accounts of the company, so therefore it cannot be argued that the sole partner is unaware of the amount of the remuneration.
For this reason, the court deems it futile to require the sole partner to pass a resolution approving the specific remuneration of the directors. Therefore, from a commercial point of view, it is only required that the bylaws determine the paid nature of the post where sole partner companies are concerned.
Moreover, the court clarifies that the non-compliance of the company formalities (whether they are sole partner companies or companies with various partners) does not per se cause the remuneration to be considered as a liberality. If so, this would be an interpretation in malem partem of the tax legislation that is not justified by any legal provision.
Thus, remuneration that is duly accounted for, accredited and provided for in the bylaws must be considered tax deductible, regardless of whether the General Meeting has approved the specific amount of the remuneration (a formality that is not even required in the case of sole partner companies).
However, what happens when the bylaws establish the unpaid nature of the post? Although this case falls outside the factual scenario under consideration, the Supreme Court examines the question to conclude that, in such a case, the part of the remuneration received by the director in his condition as an employee would also be deductible. This is so because the relationship theory, which operates in an intra-corporate sphere, is difficult to accommodate in the tax sphere, so its application in this matter must be carried out with caution. In support of this argument, the court calls upon the case law of the Court of Justice of the European Union (Judgment of 5th May 2022, case HJ, C-101/21), and states that, even if the relationship theory were applicable for commercial purposes, “the deductibility of remuneration paid to an employee cannot be denied, nor can the employee or his employer be made worse off simply because he is a member of the management body“.
In summary, the court makes it clear that the deductibility of the remuneration received by the directors is not subject to compliance with commercial formalities. There are, therefore, two different systems operating on parallel planes: that of directors’ remuneration, on the one hand, and that of the deductibility of expenses, on the other. Only a forced and self-serving interpretation of corporate or tax legislation would justify an integration of the two systems, something which the Supreme Court rightly rejects. Likewise, it is noteworthy that the court has opted for a simplification of the requirements set forth in the corporate regulations, thus avoiding excessive formality, which is contrary to current corporate practice.
Joan Lluis Rubio
Vilá Abogados
For more information, please contact:
22nd September 2023
