The judgment of the High Court of 26th February 2018 outlined the retribution system of company directors provided under the Spanish Companies Act (Ley de Sociedades de Capital – LSC) as a “cumulative” system of conditions to be complied with in order to deem that the remuneration is in accordance with the law, that is to say, those conditions set forth in articles 217 and 249 of the LSC. The requirements are:
a) The company bylaws must expressly determine whether the post is unpaid or remunerated, and in the latter case, the concept of remuneration must be specified (article 217 LSC).
b) An agreement made by the general meeting must exist, which determines the maximum amount of annual remuneration of the directors (article 217.3 LSC).
c) The agreement of the directors themselves (as a collective body) shall establish the distribution between them of the amount of remuneration established in the bylaws and approved by the general meeting. Likewise, the approval and entering into of a service agreement with the executive directors or managing directors shall be necessary when there is a board of directors.
From a legal standpoint, said judgment dismissed the criteria sustained up until now by the Directorate General for Registers and Notaries (DGRN) that although the bylaws do not provide for the remuneration of directors, it may be established by the board, even without the agreement of the general meeting. It also made clear that it is essential that the bylaws contain a remuneration system for directors.
Bearing in mind the above, the point of view of the Spanish Tax Administration remained unknown regarding the necessary conditions for the deductibility of the remuneration of company directors.
A judgment from the National High Court dated 29th February 2019 highlighted various issues:
1) The remuneration of directors are a deductible expense when they fulfil the legal requirements for such deduction. The deduction shall not apply if there is no legal framework.
2) The legality of the remuneration shall be analysed in light of the requirements established in the Spanish Companies Act (LSC), that is to say, it shall only be deductible if commercial legality is strictly complied with.
3) In the same way, director remuneration shall not be deductible as expenses if the bylaws do not provide for the remuneration, in accordance with article 217 of the LSC.
4) Remuneration which passes the deductibility test of the Spanish Tax Administration shall be deductible. This consists of examining whether two requirements have been fulfilled: (i) there is a statutory provision which explicitly establishes the remuneration of the post; and (ii) that the remuneration does not constitute a handout.
With regard to the requirement that the remuneration does not constitute a handout in order for it to be deductible, we must say that the Spanish Tax Administration does not consider deductible the remuneration of a director, which exceeds the threshold of the maximum remuneration set forth in the bylaws, so the decision of the meeting for increasing the amount becomes completely irrelevant. Thus, the part of the remuneration, which exceeds this limit shall be considered a handout, and therefore, is not deductible. That said, the situation is not so clear when the quantity of maximum remuneration is authorised by the general meeting -and therefore fulfils the required legal formality-, and nevertheless the “reasonableness” of the remuneration is questioned. In our opinion, when remuneration is not proportional to the importance of the company, the financial situation at any given time and the comparable market standards, in the sense that it is greater than what it should be in accordance with these parameters, it would contravene article 217.4 of the LSC, in such a way that it is plausible that the Spanish Tax Administration may deem the amount, which exceeds the quantity of a “reasonable” remuneration, as a handout. What is and is not reasonable shall have to be examined on a case by case basis, taking into account the particularities of the company in question and its current situation.
The premise of the dual office of top manager and director.
In cases where the director of the company also carries out management functions as an employee, the duality of commercial and labour relations operating simultaneously shall not be appreciated. Taking into account the theory of the link, the commercial relationship absorbs the labour relationship when the person who is manager under a labour relationship is also the director of the company. Consequently, it must be understood that the remuneration received by directors is due to their functions within the management body, and if it turns out that such functions are exercised without obligation on the part of the company to remunerate them (that is to say that the bylaws do not provide for their remuneration), it is understood that the payment is a handout and therefore this amount is not a deductible expense. In this case, the paradox would be that even if a real management and administration service is provided (and it is remunerated), the paid remuneration would not be a deductible expense as the legal formalities required by the Spanish Tax Administration are not complied with.
Remuneration of executive directors and managing directors.
The LSC provides for a specific mechanism in article 249.3 LSC, establishing the obligation to enter into a service agreement between the board of directors and the executive directors or the managing director. However, even if this formal requirement is complied with, in order to achieve the scrupulous compliance level of commercial legislation required by the Spanish Tax Administration and for the remuneration to be accepted as deductible expenses, we understand that in addition to the agreement, the general meeting must approve the maximum annual remuneration of said directors, which must be an amount equal to or less than what is set forth in the agreement; this approval shall remain in force while the remuneration for subsequent years does not exceed the approved amount, (article 217.3 LSC in fine). And in any case, the established remuneration must be compatible with the “remuneration policy” approved by the general meeting, although this document is not obligatory for non-listed companies; if the contractual remuneration were an amount exceeding the amount defined in the remuneration policy, the excess must be considered a handout and therefore, not a deductible expense.
The sole administrator.
We understand that in such cases the entering into of service agreement may not be required because the LSC does not expressly stipulate it and neither may the rules of article 249.3 of the LSC apply as they are only relevant to a board of directors. In the absence thereof, and in order to comply with the requirement of legality and tax deductibility, the bylaws must reflect the remunerated nature of the post and the partners meeting must approve the maximum annual remuneration of the post for the rendering of company management services (217.3 LSC).
Ultimately, the Technical Office of the Spanish Tax Administration analyses the tax deductibility of the remuneration of directors under a rigorous criteria, in such a way that amounts shall only be deductible if the company has performed a “scrupulous compliance with commercial legislation”, under Spanish Supreme Court judgments of 2nd January 2014 and 5th May 2015. The legal requirements are those derived from the legal order and also from company bylaws, the latter configured as a set of regulations governing the company; non-compliance with those regulations and remunerating directors when it is not so provided for is interpreted as “betrayal”.
Therefore, the aforementioned judgment of the National High Court adopts as its own the argument of the Spanish Tax Authorities: the refusal of the tax deductibility of the remuneration of company directors is a consequence of the failure to comply with the commercial regulations on this matter. Hence the importance of analysing the situation of the directors receiving remuneration in each company, especially in those cases wherein the director simultaneously performs those tasks inherent to a manager, pursuant to a top management contract entered into prior to the date upon which the same person was appointed director of the company.
Eduardo Vilá
Vilá Abogados
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24th April 2020
