B Law & Tax
20 October 2023

Tax advisor: Taxation of dividends and its impact on investment

Dividends represent the way companies reward their shareholders, but they are subject to different taxation compared to stock gains. Even though both are taxed at the same rates within the savings income categories, dividends are classified as movable capital income, while stock gains and losses are considered gains and losses on equity assets. This has specific implications in terms of the taxes you must pay in each situation, as will be explained later.

Furthermore, depending on how you receive dividend payments, you will have to meet specific tax obligations. Currently, you have the option to receive dividends in cash, in the form of additional shares, or as subscription rights.

Investing in dividends is an effective strategy for generating recurring income. However, just as the modes of receiving dividends have evolved, there have also been changes in dividend-related tax regulations over time. It is crucial to understand how this aspect works to avoid surprises when filing your tax return.

 

How Dividends Are Taxed

Since the 2015 reform, the taxation of dividends in Spain no longer offers significant tax advantages, such as the exemption from taxes on the first 1,500 euros. The taxation of dividends depends on whether they are received in cash or in shares. When filing the income tax return, it is necessary to distinguish between gains from the sale of stocks and the returns obtained through dividends.

 

Taxation of Cash Dividends

Cash dividends generally fall under capital income in the savings income category. This means that the gains from your stock dividends will be included along with other assets such as deposits, current accounts, or treasury bonds and will be taxed based on the applicable tax brackets.

How much will you pay in taxes on your dividends? The rate will range between 19% and 26%, depending on your other investments. Before applying the savings rates, capital income returns will be added to capital gains and losses (stocks, investment funds, ETFs, among others).

Does the taxation of dividends in an unlisted limited company follow the same pattern? Yes, in the case of cash dividends, the taxation is similar, regardless of whether the company is publicly traded or not.

The difference lies in the fact that shareholders of a limited company can take advantage of a deduction for internal double taxation of dividends, with the purpose of avoiding double taxation: first in the Corporate Income Tax of the company and then in the Personal Income Tax (IRPF) of the shareholders. The deduction will be 100% if certain requirements defined in Article 30 of the Corporate Income Tax Law are met; otherwise, it will be 50%.

 

Taxation of dividends in stocks

What if, instead of receiving cash, the company compensates you with shares? What is the tax treatment for dividend payments in stocks? The use of dividends in kind, through what is known as a “script dividend,” has become more common. With this, the company allows shareholders to receive dividends in the form of shares through subscription rights.

To better understand, they provide you with the option to receive shares, sell the rights on the market, or, in some cases, convert them into cash through the company’s buyback. Your tax burden will vary depending on the choice you make. Here’s how to declare subscription rights for shares on your tax return.

Regarding the taxation of dividends paid in stocks, if it is a capital increase, these dividends in the form of shares will be taxed as a dividend in terms of Personal Income Tax (IRPF), with a corresponding withholding tax of 19% by the tax authorities.

If you receive subscription rights as new shares (without selling the rights to the company or in the market), the tax payment is deferred until you sell the underlying shares. In other words, you will not have a tax obligation until you dispose of the shares acquired as part of the stock dividend.

When you sell those shares, the taxation will be similar to that of any other asset in the stock market. Specifically, it will be considered a capital gain or loss, and the purchase price of the shares will be the result of dividing the total acquisition cost by the number of new shares, and their age will match that of the shares that generated the subscription rights.

 

Taxation of dividends from funds and other financial products

Dividends come from various investment sources, such as stocks, investment funds, ETFs, SOCIMI, and SICAV. The taxation of dividends in investment funds depends on whether they are distributing or accumulating. Distributing dividends are taxed as regular dividends, while investors do not pay direct taxes on accumulating dividends. In the case of ETFs, the withholding tax at the source varies depending on whether they are UCITS or not.

SOCIMI (Real Estate Investment Trusts) are taxed at 0% if shareholders with more than 5% ownership pay a 10% tax on dividends; otherwise, a 19% tax rate applies. SICAVs are taxed as movable capital income for both the company and the shareholders.

 

Withholding on Dividends

The receipt of dividends may or may not involve withholding of Personal Income Tax (IRPF), depending on the method of reception and the payer.

When recording dividends, the company must consider this withholding and comply with the corresponding deadlines.

In general, dividends are subject to a 19% withholding tax to prepay IRPF. However, there are exceptions and specific rules that depend on the recipient of the dividends, whether it’s a limited company or not.

  • If the shareholder is an individual, a 19% IRPF withholding tax will apply, except in the case of shares being delivered as dividends, where no withholding is made.
  • If the shareholder is a company with less than 5% ownership, a 5% withholding tax applies.
  • If the shareholder is a company with ownership of more than 5%, no withholding tax is applied as long as they have had that percentage, or higher, in the previous 12 months.

 

Double taxation on dividends

The taxation of dividends from foreign stocks is similar to that of domestic stocks, and the same applies to investment funds. Each country has its own tax regulations that affect companies based within its territory.

Double taxation of dividends occurs when they are taxed twice for the same concept, once in the country of origin and once in the country of residence. To prevent this, there are double taxation treaties that set limits on withholdings. Spain generally sets a limit of 15% in these treaties.

In summary, foreign dividends are subject to withholdings that can vary depending on the country of origin. Double taxation treaties help prevent you from paying excessive taxes and allow you to recover part of the withholdings on your tax return.

 

How to reclaim withholding tax

If there is a double taxation agreement in place, the procedures are straightforward. You can reclaim that 15% per the agreement by reporting it on your tax return. You should indicate that it pertains to foreign companies with a double taxation treaty when reporting the dividends, using box 0588, and providing the amount that was withheld in the country of origin.

If the withholding tax exceeds that 15%, as in countries like Germany, you will need to manage the refund directly with the tax authorities of those countries. In the case of the United States, you will need to complete the W-8BEN form.

When there is no double taxation agreement, you can still reclaim the money, but the process is more complex. The Spanish Tax Authority allows for the direct recovery of the lesser of the foreign withholding tax, with a limit based on what is paid in Spain for this concept, or the result of applying the average effective tax rate on dividends minus expenses, multiplied by the taxable base and divided by the income for the period.

In summary, dividends are not deductible on the tax return and are not considered income exempt from taxation.

 

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