Holding companies and the FEAC regime: the treatment of dividends takes on greater significance

Four recent rulings by the TEAC, issued in May, and a February advisory from the DGT, published recently, provide new insights for assessing the application of the FEAC regime when, following a restructuring, the holding company receives dividends and may apply the exemption under Article 21 of the Corporate Income Tax Law (LIS).

The creation of holding companies by individuals has long raised a particularly controversial question: whether the ability to apply the exemption under Article 21 of the Corporate Income Tax Law (LIS) to dividends received by the holding company constitutes, in and of itself, a tax advantage that precludes the application of the tax neutrality regime for mergers, spin-offs, asset contributions, and securities exchanges (FEAC).

If the shareholder held the equity interest directly as an individual, the dividends would be taxed under personal income tax. After contributing that equity interest to a holding company, the holding company may apply Article 21 of the LIS. The question is whether that tax difference is sufficient to establish abuse or whether one must consider the business purpose of the transaction and the actual use of the funds.

Recent rulings by the TEAC and the DGT shed light on this debate. Their significance lies not only in the specific cases analyzed but also in the legal context they reveal: the existence of a tax advantage does not, by itself, preclude the application of the FEAC regime, and the subsequent use of the dividends can become a decisive factor in assessing whether the tax advantage was obtained in an abusive manner.

Below, we explain the conclusions of this recent administrative doctrine.

A tax advantage does not, in and of itself, preclude the FEAC regime

The anti-abuse clause in Article 89.2 of the Corporate Income Tax Law (LIS) prevents the application of the FEAC regime when the primary objective of the transaction is tax fraud or evasion. In particular, the provision refers to transactions that are not carried out for valid economic reasons—such as the restructuring or rationalization of the participating entities’ activities—but rather for the sole purpose of obtaining a tax advantage.

A restructuring may result in tax savings while also serving a genuine business purpose. The analysis must consider the intended motives, the economic function of the holding company, subsequent actions, and the use of the funds.

Therefore, the fact that the holding company allows for the application of Article 21 of the LIS, thereby avoiding direct taxation of the shareholder under the Personal Income Tax (IRPF), does not in itself constitute an automatic impediment to applying the FEAC regime. However, it is also not sufficient to simply cite general economic reasons. Subsequent actions must be consistent with the business purposes claimed when the transaction was carried out.

The Use of Dividends as a Central Element

The distribution of dividends following a contribution under the FEAC regime takes on special significance when the dividends come from reserves generated prior to the restructuring. In this context, it must be analyzed what happens to the funds once they reach the holding company.

If the funds remain in the holding company without evidence that they have been applied to a business purpose, the tax benefit may be deemed to have materialized. The structure would have allowed profits to be placed in a company subject to Article 21 of the Corporate Income Tax Law (LIS), thereby preventing the individual from being taxed directly under personal income tax (IRPF), without the funds subsequently fulfilling an economic function within the business cycle.

The conclusion is different when dividends are effectively reinvested in economic activities. If the holding company uses the funds to acquire assets related to a business activity or equity interests in operating companies, the funds remain within the economic cycle and the company acts as a genuine investment vehicle. In such cases, the reinvestment may prevent the initially identified abuse from being consummated with respect to the reinvested amounts. The adjustment may be limited to the portion for which the tax advantage is deemed to have materialized.

Four guidelines for assessing reinvestment according to the TEAC.

The new administrative criteria allow for the identification of four relevant elements in determining when the reinvestment of dividends can prevent the abuse from being considered consummated.

Burden of proof. Once the abuse has been identified and the holding company’s availability of funds has been established, it is up to the taxpayer to prove that the funds have been reintegrated into the business cycle.
However, as we previously noted in our assessment of the criterion, the existence of tax abuse must be proven by the tax authorities and supported by a comprehensive analysis of the transaction.
Concept of investment. The reinvestment must be made in assets used in an economic activity or in operating companies. Merely making equity investments unrelated to a business activity is not considered sufficient.
In our opinion, this criterion should be qualified, since the fact that certain assets remain within a company does not mean that the shareholder personally has them at their disposal.
Identification and causality. It must be possible to link the receipt of dividends to their subsequent reinvestment. When the holding company has resources from different sources, the first business reinvestments made after receiving the funds may be attributed to the resources subject to the potential adjustment. If funds were received in multiple fiscal years, the chronological order of their receipt is taken into account.
Timing of the reinvestment. There is no fixed legal deadline, but the investment must be made within a reasonable period or be in the process of being reinvested, as sufficiently demonstrated. Generally, investments made before the start of the audit procedure are taken into consideration, although exceptional circumstances may be accepted.
In our opinion, this criterion requires caution and significant nuance. Investments are made when opportunities arise and economic circumstances warrant it, and dividends are not always controllable or predictable. Therefore, the time elapsed should be assessed in conjunction with the circumstances of the case.

The economic function of the holding company must be demonstrable

Application of the FEAC regime requires consistency between the alleged economic reasons and the actual operation of the structure. If it is claimed that the holding company is created to channel new investments, centralize resources, or strengthen business activity, subsequent decisions must be consistent with that purpose.

This consistency requires adequate traceability of funds. It must be possible to identify the origin of the dividends, their receipt by the holding company, the decisions made regarding them, and their actual application to business investments. If the reinvestment is ongoing, it will be particularly important to document the actions taken before an administrative audit begins.

Greater interpretive certainty, but with questions still unresolved

Recent rulings provide a stronger basis for arguing that Article 21 of the Corporate Income Tax Law (LIS) is not an automatic obstacle to applying the FEAC regime. The key factor is not the mere existence of a tax advantage, but rather the business purpose of the transaction and, in particular, the actual use of the dividends distributed following the restructuring.

The creation of a holding company by an individual may be covered by the special regime when the individual acts as a vehicle for genuine and effective business investment. To this end, it must be possible to demonstrate the investment, its business nature, its relationship to the dividends received, and its execution within a reasonable timeframe.

However, debatable issues remain, such as the type of eligible investments, the reinvestment period, the criteria for allocating dividends derived from reserves prior to the transaction, etc. These aspects make it advisable to analyze each structure based on its specific circumstances and to avoid jumping to conclusions.

In short, the new criteria do not automatically cover the creation of any holding company. They do, however, provide a stronger basis for defending these structures when there is a genuine business plan and cash flows are effectively reintroduced into the economic cycle. It is not enough to merely declare a future intention to reinvest; there must be business actions and decisions that demonstrate that purpose.

Before carrying out the transaction, one must analyze not only the existence of valid economic reasons but also the foreseeable use of subsequent dividends. Proper documentation of funds and investments will be essential to demonstrate that the holding company performs an effective economic function. Caution remains necessary, because a reinvestment that is announced but never carried out may reinforce the perception of abuse.