SPAIN - Pension funds in EU member states outside Spain can now reclaim withholding tax on dividends from Spanish companies, following a change in the country's tax law last month.

Under the new law, dividends paid to EU pension funds are exempt from taxation in Spain, provided the funds are located in other EU member states and satisfy certain requirements which basically act as a comparability test with Spanish pension funds.

However, the tax will still be deducted in the first instance.

"Withholding tax is to be applied at source by the Spanish paying agent or custodian, and the new tax exemption must be claimed by the pension fund or UCITS," says Victor Mendoza, partner and head of tax in financial services, KPMG in Spain. "But because no specific procedure has been approved for making the claim, it appears that the general tax filing rules for non-residents would apply."

There are, in addition, concerns that the claims procedure may take some time - longer even than for the standard treaty claim refunds, according to Mendoza.

The tax exemption for dividends and other distributions of profits paid to UCITS in other EU countries applies only to the extent that these UCITS are taxed at a lower rate than if they had been a Spanish resident UCITS.

"The intention is to tax Spanish dividends received by EU UCITs and Spanish-resident UCITS on an equal basis," says Mendoza. "Although the language concerning this limitation is not completely clear, it appears that EU UCITS would in principle be subject to final taxation in Spain at a rate of 1%, which is the current corporate income tax rate applicable to Spanish UCITS."

But EU pension funds and UCITS may also be able to reclaim tax on dividends paid by Spanish companies before 1 January 2010. A series of European Court of Justice rulings over recent years has required tax authorities in some member states to refund withholding tax on dividends paid to tax-exempt foreign investors.

The changes are effective retroactively and apply for income obtained or realised from 1 January 2010.

The current rate of withholding tax is 19%, or possibly lower if there is an income tax treaty between Spain and the country concerned.

The change in Spanish law is another step towards the European Commission's goal of a more effective internal market for cross-border investments. Infringement proceedings taken by the EC against several other member states are at various stages of progress.

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