Report for the Spanish Tax Reform: English Summary and Dissenting Opinion

On March the 13th 2014 the Report of the Commission of Experts for the Spanish Tax Reform (chaired by Professor Manuel Lagares) was presented to the Minister of Finance. You can read the official English executive summary as well as an unofficial translation of the Dissenting opinion on labor income and housing taxation.

Pedro Herrera

Dissenting opinion on someaspects of the Commission of Experts’Report on the Tax System Reform

(Housing tax and labour income)

Prof. Pedro M. Herrera Molina

Financial and TaxLawProfessor

Universidad Nacional de Educación a Distancia

(SpanishNationalUniversity of DistanceEducation)


I. Abstract

TheInforme de la Comisión de Expertos para la Reforma Tributaria(Report of the Commission of Experts for the Tax Reform) [appointed by the Spanish Government on July the 5th of 2014] and presided byProfessor Doctor Manuel Lagares provides reallyvaluableclueswith a view to guidingthecomingtaxreform. Amongthem,itisworthstressingthe idea of extending tax bases and of reducing the types of taxes of direct taxation, upon which I fully agree. What I also find appropriate is the proposal to increase indirect taxation – especially in environmental taxes that are based upon the principle he who pollutes, pays – in order to reduce tax burdens on the work factor(personal income tax and social contributions).

However, and verymuch to my regret, I shall express a dissenting opinion [as a member of the Commission] on two specific issues and their diverse implications throughout the Report: the approach to income imputed to the habitual residence and that to labour. As regards these two points and with all due respect to majority opinion, I disagree on the way the Report delimits tax exemptions or benefits which shall be suppressed with aim of obtaining additional collection allowing to compensate the reduction of the types of taxes and achieving tax neutrality[1].

II. Income imputed to the habitual residence

The Commission of Experts’ report puts special emphasis upon observations by international organisations recommending to increase real estate taxation – as it is a highly stable alternative – and reduce the Asset Transfer Tax(whose collection collapsed as a result of the real estate bubble).

As an immediate measure, the Commission of Experts suggests to subject income in kind from the use of a personal housing unit to taxation. It is not an absolute novelty, since our tax system already taxed such imputed income since its introduction by Act 44/1978[2] until its suppression by Act Ley 40/1998 (which restricted imputation of non-rented real estate other than the habitual residence). In the field of comparative law, taxation on income imputed to housing is really unusual and gradually disappearing[3].

Apparently, there are some reasons that could be taken into consideration when it comes to expressing the following suggestion: the use of an owned housing unit means a utilityin kind for the taxpayer and their family and prevents them from incurring in expenses for the rent payment. Therefore, one might think that the current system is unfair(the economic capacity derived from such use is not taxed). It is a perverse incentive(to be invested in the own housing instead of in other alternative assets), infringes tax neutrality(between the rent and the purchase of the housing) and implies a loss in collection(which forces to maintain higher types of taxes for taxpayers as a whole).

It must be admitted, though, that all these arguments have a theoretical value, but I am convinced that their weight vanishes when compared to three specific factors: a) the difficulty in assessing an income in kind dissociated from a compensation; b) the different taxation on each housing; and c) the structure of proprietorship regarding personal housing units in Spain(including the high indebtedness of many proprietors to finance purchase). These two factors are closely linked to each other.

Let us start with the problems in assessing: how shall the utility derived from the proprietorship of a personal housing unit be assessed? One might think that such utility is equal to the market price of the rent of an identical housing. Nevertheless, this apparent solution would entail two major disadvantages: a) it is unimplementable and b) it is false.

It is unimplementable as it is not possible to determine the market value of the rent in each case with a minimum of certainty and of real possibilities for taxpayers to contest. It is true that the Constitutional Court of Spain accepts the ‘potential’ income tax  on non-rented real estate other than thehabitual residence(SSTC 295/2006 of 11 October and 91/2007 of 7 May). However, that statement is just an extrafiscal measure aimed at promoting the rent of unoccupied housings and not at assessing a current utility in kind. Furthermore, the aforesaid Court is well-known for its laxness when it comes to interpreting the constitutional principles on tax fairness, so that the mere fact that a  measure does not infringe the constitution does not imply that it is fair, not even appropriate.

But, even if it were possible to determine the market price of the rent in each case(the ‘potential’ income), such amount would not mean anything as regards the utility of a personal housing unit for taxpayers for several reasons that cannot be reflected by law, owing todiversity of individual situations. I do not mean exceptional circumstances, since, diversity reigns in this matter.

Besides, do taxpayers actually save money by residing in an owned housing unit instead of in a rented one? This might be the case if the taxpayer has inherited the housing from their parents, thus enjoying a favourable treatment in theInheritance Tax. If they have inherited it from further relatives, they would have had to pay a very high amount for such tax. If they have purchased the housing, they will have paid the VAT(Value Added Tax) – currently 10% or the Impuesto sobre Transmisiones Patrimoniales Onerosas(Onerous Asset Transfer Tax)which can be fixed at around 6% and that many Autonomous Regions collect in practice over market price -[4]. Moreover, they are most likely paying the fees and interests for the loan they asked for to buy the housing. In a moment where bank mortgages are slowly being paid out, fixing an additional tax for the ‘enjoyment’ of a personal housing unit may lead to considerable injusticeand taxpayers might reach the point of not having all liquidity necessary to face the tax payment.

But getting back to the Commission of Experts’ proposal: to try and tax the real ‘utility’ derived from the enjoyment of a housing unit turns out to be unimplementable, that is why the Report suggests to subject a certain percentage of the rateable value to taxation, (as it is now the case of non-rented real estate other than thehabitual residence). Since it is a short percentage, such amount could be fictitiously thought to be already equal to ‘net’ income from the housing unit itself, so, expenses derived from its use will not be deducted(among them, those interests paid for the loan granted for its purchase or its repayment)[5].

In other words, in order to attain neutrality between personal housing units and rented housing units, it imputes an income that has no relation with the real utility of the housing unit, nor with the tax burden as a result of its purchase, not even with the expenses derived from it. In this regard, the specific amount of the income imputed to taxpayers is, actually, a fictitious income.

Moreover, as the Commission of Experts itself points out, the current situation of rateable values shows a huge dispersal depending on the moment of their update(before, during or after the real estate boom). This factor would lead to an additional inequality that could only be corrected in very rough way by fixing various imputation percentages(as it is now the case of income imputed to second and later housings).

As for the structure of real estate property in Spain, the data show that around 13 million taxpayers own their housing. So, the erratic effects – due to their inaccuracy – of the tax on a personal housing unit would affect an enormous number of taxpayers, many of them lower incomers. It is true that the Commission of Experts suggests establishing some specific tax-free minimums for imputed income (€20,000 of income and €90,000 of rateable value), but I do not consider it to be proven that such mechanism is enough to lessen the unfair effects of that measure. That tax will affect many middle incomers and it could affect lower incomers as well (let us think of pensioners or long-time unemployed people) [6].

In addition, the Commission of Experts’ proposal shall be assessed along with the other measures contained in the Report. So, following recommendations by international organisations, the Commission of Experts suggests the future suppression of the provisional housing deduction system. Although the Commission of Experts does not suggest the immediate suppression of such system, implementing this measure will notably increase the tax on many housing proprietors(particularly those who still have to repay most of the loan).

According to arguments in terms of economic efficiency, the provisional system implies a harmful incentive for loans not being repaid immediately. However, I do not know about any information proving such statement. In my view, in such a harsh economic crisis where bank mortgages are only slowly being paid out, the number of taxpayers who could repay their loans in advance will probably be very small.

Moreover, it must be taken into account that international organisations only recommend to increase taxation on real estate property in Spain in return for reducing taxation on asset transfer[7]. It is true that the Commission of Experts suggests both types of measures. Nevertheless, whereas the tax on imputed income is an easy decision to make immediately (in the sense that it depends unilaterally on the State), the reduction of the Asset Transfer and Documented Legal Acts Tax will be much harder to implement, as it will require a political negotiation with the Autonomous Regions which will claim any compensation for sure.

Besides these background reasons, I would like to mention some technical arguments that lead me to leave the majority approach to the Report aside. Indeed, according to the Commission of Experts, the current system – non-existence of income imputed to the personal housing unit – is an ‘exemption’ that shall be suppressed with the aim of covering a hole in the tax base.

In my opinion, the absence of taxation on utilities in kind regarding habitual income in current law is not an ‘exemption’, but a hypothesis outside the IRPF’s taxable event. The concept of income designed by lawmakers does not cover utilities in kind, except for the case that they are derived from a compensation. For this reason, housework is not subjected to taxation (even if it saves on domestic service costs), nor the utility derived from household (which in some cases might be highly valuable), nor that of cars, boats or private aircrafts (they could be considered as luxury items), nor that real estate capital[8].

Income imputed to non-rented real estate other than the habitual residence is the only exception. However, in this case the tax is not justified either by the obtention of utilities in kind, but by an extrafiscal measure with the aim of leasing or exploiting such real estate (the Constitutional Court of Spain considers that this tax is justified by the ‘potential’ income, that is, the one that could have been obtained if the real estate good would have been rented).

As an additional argument, we can stress that the reports of the two previous commissions for the Personal Income Tax reform suggested the complete suppression of imputed real estate income, as they considered it did not fit the concept of income in the Spanish Personal Income Tax [9].

It is true that the Report of the current commission suggests the complete suppression of imputed income in the mid term and its replacement by an increase in Real Estate Tax or any other similar tax.

Such increase would be derived from a new property assessment system which, in theory, would enable annual updates (upward or downward according to market fluctuations) with a high degree of accuracy.

So, I do not think that the IBI(Spanish Real Estate Tax)’s tax burden should be designed with a view to reducing the tax rates of the Personal Income Tax (through a state share in the Real Estate Tax). Indeed, the Real Estate Tax is justified by its direct connection with the services rendered by councils. State participation might turn out to be reasonable in that it contributes to financing of the so-called entidades locales(local bodies), but the IBI’s justification would be harmed if its amount were conditioned by the decisions on the tax revenue of the Personal Income Tax.

III. Restriction to reductions for labour income

The Commission also suggests to reduce current reductions for labour income and to replace them by a fixed amount, considerably smaller than the current maximums. As a complementary measure, the current tax credit ‘for the obtention of labour income or from economic activities’ [article 80 bis of the Income Tax Act] would be changed, so it would only include labour income and guarantee non-taxation on such income in the case of a scarce amount.

There is a theoretical argument in favour of turning the current reduction for labour income into a fixed and smaller amount: if the only justification for such reduction were to compensate for the limitation of tax-deductible expenses of labour income (unlike in the case of income from economic activities) it would make sense to establish a fixed price amount for all taxpayers and not higher amounts for people with lower income, as it is the case now.

In my opinion, what actually happens – as it can be inferred from the current law[10] – is that the aforementioned reduction, actually, aims at compensating labour incomers for the legal disadvantages regarding savings income (whose system is justified by capital mobility) and income from economic activities (by recognising tax-deductible expenses, the existence of various tax incentives, the lesser possibilities to control and the possibility of structuring business through corporate patterns). In other words, that reduction does not imply any tax benefit that shall be suppressed, but a measure aimed at safeguarding the fairness of such tax and greater neutrality among the different income levels.

In addition, this type of reduction is one of the few ‘tax expenses’ that the European Commission seem to assess positively as regards the Personal Income Tax in each member state, in that it reduces tax burdens on the work factor [11].

As taxpayers with lower income have less saving possibilities (and, therefore, less possibilities of obtaining capital gains) it is reasonable that the advantage derived from such reduction is higher in their case.

In any case, it seems to be clear that if the reduction decreases and an even amount is fixed (as the Report suggests) this will harm people obtaining labour income and, especially, people with lower income derived from labour.

The Commission of Experts is aware of this problem and, therefore, it suggests combining such measure with other kinds of reform:

– On the one hand, the aforesaid change in tax credit provided by current article 80 bis of the Income Tax Act with a view to ensuring exemption of ‘more modest’ labour income.

– On the other hand, the so-called tax gauging [“calibraje fiscal”]: ‘no doubt – as the Report points out – the final tax gauging should take all tax rates as well as all parameters related into consideration. Nevertheless, according to a more realistic approach, the final adjustment of the burden could be reasonably well achieved by using just four variables jointly: first, the tax rates; second, the tax brackets; third, the reduction of the tax base and fourth, tax credit to prevent taxpayers with low labour income from paying the tax. A careful adjustment of those four variables could neutralise any unwanted distribution of the burden that might occur as a result of such a far-reaching, deep and complex reform like the one set out here’.

Obviously, the current reduction according to labour income is not the only technical solution possible to compensate for the disadvantages of labour income as opposed to other types of income (especially in the case of lower and middle incomers with less saving capacity). A tax credit together with appropriate tax gauging can possibly have positive effects.

However, and I disagree with the majority perspective on this: ‘gauging’ is an ambiguous formula for me that will pose considerable technical complexity. That is why I would like to emphasise the need to structure the reform, so that labour income is still duly protected (including both lower and middle incomers who account for the vast majority of taxpayers).

Furthermore, it must be born in mind – while ‘gauging’ the reform – that the Report suggests a clearly more favourable approach to savings income. So, in view of such measures, I deem it necessary to insist, even more than what the Report already does, upon the need to ‘balance’ the approach to labour income (particularly lower and middle ones).

Prof. Pedro Manuel Herrera Molina

18 February 2014


[1]Itis a discrepancythatisreflectedupon technical and legal detailsthroughoutthereport, eventhough I willnotpayanyspecialattention to them, sincethey are notreallyrelevant in practice.

[2]See a sharp criticism of taxation on income imputed to housing in the work by Jesús Ramos Prieto, ‘La imputación de rentas inmobiliarias en la imposición sobre la renta de las personas físicas’, CEF, Madrid, 2008, pp 158 et seq. The author is based upon some considerations on tax fairness and supports his view through that of other prestigious professors, such as Fernando Sainz de Bujanda or Cristóbal Montoro Romero (F. Sainz de Bujanda, considers that we are before a ‘fictitious income’, ‘La Contribución Urbana. Meditación en la víspera de un nuevo sistema de financiación local’, Consejo General de Cámaras de la Propiedad Urbana de la Comunidad Valenciana, Valencia, 1987, p 297). Cristóbal Montoro Romero and Francisco Utrera Mora criticised the taxation of imputed real estate income in the former regulation and considered that they distorted the nature of the IRPF (VAT) (‘La reforma del Impuesto sobre la Renta de las Personas Física’, in La Reforma del Sistema Tributario Español, Monográfico de la Revista del Instituto de Estudios Económicos, no. 1/1990, p 27).

[3] Jesús Ramos Prieto expresses himself in similar terms, op. cit., p 178. Furthermore, searching Country Surveys database from the International Bureau for Fiscal Documentation, last updated for 2013-2014,I was able to find this type of ‘income’ from the habitual residence only in Italy’s, Belgium’s, the Netherlands’, Luxembourg’s and Switzerland’s VAT, as far as the OCDE is concerned.

[4] The Commission of Experts report suggests a solution to ITP-AJD’s  assessment problems. This solution would be to limit the verification means stipulated in art 57.1 LGT, but, with all due respect to majority opinion, I do not think that solution is structured enough from a technical point of view. Besides, as for the reference to the closure of the diary book in the Report, I do not find it appropriate (art 251 of Ley Hipotecaria(Mortgage Act)) within a context regarding the ‘registry closure’ analysis (arts. 254 and 255 with regard to art. 17 of Ley Hipotecaria(Mortgage Act)).

[5]Actually, the inaccuracy of rateable values and the rough calculation of the ‘imputed income’ do not allow to calculate a ‘net income’ according to the ability to pay principle.

[6]Unless people drawing income under €20,000 are exempted from tax on imputed income regardless of the rateable value of the habitual residence.

[7] International MonetaryFund, ‘Spain: Financial Sector Reform. ThirdProgressReport’, IMF Country Report, 205, 2013, p 4; EuropeanCommission, Directorate General forTaxation and CustomsUnion, ‘Taxreforms in EU MemberStates 2013’, EuropeanEconomy, 5, 2013, p 66. The ‘Mirrlees Review’ goes further and suggests – as an ideal – to fix a periodical tax on utilities derived from the housing unit, thus suppressing the VAT and the Real Estate Transfer Tax on these real estate goods (James Mirrlees, Diseño de un sistema tributario óptimo, Spanishtranslationby JulioViñuela Díaz, Editorial Universitaria Ramón Areces, Madrid, 2013, p 428).

[8] Therefore, even though the tax on imputed income to the personal housing unit might seem to be consistent with an all-comprehensive concept of income, it is not with the general concept of income stipulated by law(implicit in the definition of capital gains in art. 33) nor with the non-taxation on the enjoyment of other goods by their owner.

[9] So, in the Informe para la Reforma del Impuesto sobre la Renta de las Personas Físicas, IEF, Madrid, 1998, it is stated that ‘any imputation of supposed income from non-rented or subleased real estate breaks with the criterion of realised income that shall affect this tax in its new structuring. That structuring is about subjecting only actually obtained market income – either in cash or in kind – to taxation’(p 126). The Informe para la Reforma del Impuesto sobre la Renta de las Personas Físicas, IEF, Madrid, 2002 points out the following idea: ‘The former Commission considered that the imputation of supposed income from non-rented or subleased real estate infringed the criterion of realised income that should affect the Personal Income Tax in its new structuring. According to that criterion, only actually obtained market income – either in cash or in kind – should be subject to taxation. And that is the reason why it suggested not to classify as income other than those obtained on the market – either in cash or in kind -, but not those merely imputed by the use of consumer durables. In partial response to such recommendation, Act 40/1998 excluded both the habitual residence and the non-built land from the imputation of real estate income, but maintained the imputation system for the rest of non-rented or subleased real estate goods. Now the Commission of Experts considers that the imputation of real estate income that is still provided by Act 40/1998 does not appropriately meet the principle of realised income that affects the current Personal Income Tax and, therefore, it suggests to suppress such system permanently’ (pp 151-152, author’s italics).

[10] The preamble of Act 35/2006 of 28 November points out a variety of objectives on justice grounds: ‘the tax burden on labour income is reduced in order to improve equity, thus substantially increasing the reduction fixed for them, especially for lower-income groups. It is all about dealing with this type of income in a special way for the following reasons: compensate for the general expenses incurred by a worker with a certain amount at a fixed price, recognise the contribution of this income source to the tax base as a whole; the fact that it is easy to control and that it is a non-capital income’.

[11]EuropeanCommission, Directorate General forTaxation and CustomsUnion, ‘Taxreforms in EU MemberStates…’, quot., p 59.




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