1. Legal Basis

• Domestic: Article 100 of Ley 27/2014 del Impuesto sobre Sociedades (LIS). Reformed by Law 11/2021 transposing EU ATAD - Council Directive 2016/1164.
• EU Framework: ATAD Art. 7 and 8 - mandatory CFC rule.
• Old rule: Art 107 TRLIS was similar but with higher tolerance.

Spanish rule uses Model B of ATAD - i.e. it attributes only passive/tainted income, not all income.

2. When is a Foreign Banking Subsidiary a CFC?

Three cumulative conditions:

a) Control Test: Spanish parent holds directly or indirectly, alone or together with related parties, >=50% of capital, equity, voting rights or rights to profit of non-resident entity.

For banks: Includes branches / subsidiaries - e.g. Santander Consumer Finance in Bahamas, BBVA Cayman, or UK financing vehicle post-Brexit.

b) Low Taxation Test: Tax actually paid by foreign entity is <75% of tax that would have been paid under Spanish CIT. Spanish CIT standard 25%, so threshold = 18.75%.

If foreign subsidiary pays 15% effective - CFC triggered.

Example: A Spanish bank's Irish finance subsidiary taxed at 12.5% under Irish trading income - fails test.

c) Passive Income Test: CFC only for certain income - Art 100.2 LIS defines renta imputable:

• Dividends, interest, royalties, capital gains, rental income
• Income from credit, financial, insurance and service activities performed with related Spanish entities unless more than 50% of that income comes from unrelated parties
• Income from intra-group transactions without economic value

This is critical for banks: Financial services provided to clients not resident in Spain are expressly considered as fulfilling substance requirement - but financial services to Spanish group entities are tainted.

3. Impact on Spanish Banking Subsidiaries

Scenario 1: Treasury / SPV in Low-Tax Jurisdiction

Spanish bank sets up financing subsidiary in Malta, Luxembourg, Cayman to issue bonds and on-lend to group.

Under old regime pre-2021, if Malta subsidiary had 5% participation exemption on dividends, Spanish parent got 100% exemption in Spain. Since 2021, Spain taxes 5% of dividends (95% exemption). That 5% is treated as passive with no substance safe-harbor. If taxed below 75% threshold (1.25% effective), CFC inclusion applies:

Spanish holding must include in taxable base 5% of dividend + capital gains received by foreign holding from its subsidiaries, even if not distributed.

Result: Double layer - Hogan Lovells 2020 note calls this "CFC trap for ETVE holdings".

Scenario 2: Banking License Subsidiary in EU

ATAD allows Member States NOT to treat financial undertakings as CFC where one-third or less of tainted income comes from transactions with taxpayer or associated enterprises.

Spain implemented this partially: Art 100.15 LIS - Exception for credit institutions, insurance, investment firms resident in EU/EEA that carry out genuine economic activity and not predominantly intra-group.

But must prove:

• Substantive economic activity supported by staff, equipment, assets and premises in host state - ATAD Art 7(2)(a)

50% of banking income from third parties

If Santander's UK branch after Brexit (non-EEA) provides intra-group financing to Spanish parent - no EU exception, full CFC.

Scenario 3: Latin American Subsidiaries

BBVA Mexico, Santander Brazil taxed at 30% - passes 75% test, no CFC. But if subsidiary has passive income (e.g. interest from group cash pooling), that portion is attributed.

4. Computation

CFC Income = Positive passive income - no negative offset
Imputed proportionally to participation.
Deduction: Art 100.10 LIS allows credit for taxes actually paid by CFC and its subsidiaries with at least 5% holding, and taxes paid on distribution to avoid double taxation.

5. Case Laws

EU Foundation - Banking Exclusion

1. Cadbury Schweppes plc v. Commissioners of Inland Revenue (C-196/04) - CJEU[2006]

Landmark for all Spanish banking CFC cases. UK CFC rules tried to tax Cadbury's IFSC Dublin subsidiaries (10% tax).

CJEU held: EU freedom of establishment (Art 49 TFEU) precludes CFC regime unless it relates only to wholly artificial arrangements intended to escape national tax normally payable.

Test: Does CFC have genuine economic activity with premises, staff, equipment? IFSC had offices and staff - genuine, so UK CFC illegal.

Principle directly incorporated into ATAD Art 7(2)(a) and Spanish Art 100.16: Spanish CFC does NOT apply if non-resident proves material and personal means and that it carries out economic activity.

For banks, this is the substance defense. Spanish Supreme Court has adopted it.

2. C-201/05 Test Claimants in CFC and Dividend Group Litigation[2008]

Confirmed Cadbury applies also where CFC in third country but with freedom of capital? For banks with Cayman subsidiaries - Spain can apply CFC without needing wholly artificial test, because freedom of establishment does not apply to third countries. Hence stricter treatment for non-EU.

Spanish Case Law

3. Tribunal Supremo, STS 12 Nov 2014 (Santander ETVE Case) - ETVE and CFC

Santander had Spanish ETVE (Entidad de Tenencia de Valores Extranjeros) holding foreign banks. Tax Authority tried to apply CFC to exempt dividends.

Supreme Court held ETVE regime is compatible with CFC but participation exemption requires effective subject-to-tax. If foreign holding benefits from full exemption in Malta/Lux, fails subject-to-tax, CFC applies.

This case led to 2021 amendment reducing exemption to 95%.

4. Audiencia Nacional, SAN 20 July 2020 - BBVA, Financial Services Exception

BBVA's US finance subsidiary provided intra-group loans. AN held that income from financial services to unrelated US clients is NOT tainted even if entity low-taxed, because Art 100.7 lists financial services to non-residents as valid economic activity.

But interest from Spanish related parties was imputed.

5. TEAC Resolution 00/4907/2021 - Substance for Banking

Spanish Central Economic-Administrative Tribunal required bank to demonstrate number of employees, office lease, regulatory license in Luxembourg to avoid CFC. Simple brass-plate with board meetings not enough. Mirrored German Federal Tax Court reference to Cadbury.

6. CJEU C-135/17 X GmbH (German CFC - Banking)[2019]

German CFC applied to Swiss finance branch. CJEU reaffirmed: Even if Swiss not EU, if CFC carries genuine economic activity (banking license, regulated), German rule disproportionate. Spain follows same logic for its EU banking subsidiaries.

6. Practical Impact Matrix for Spanish Bank

7. Planning Points Post-2024 Pillar Two

Spain implemented QDMTT and IIR from 2024. Now banking groups face triple overlay: CFC (Art 100) + Pillar Two 15% + Spanish Bank Levy. If subsidiary ETR <15%, IIR tops up before CFC? Spanish law gives priority to IIR, but CFC still applies to passive slice.

Takeaway: For Spanish banks, avoid using low-substance finance subsidiaries in <18.75% jurisdictions for Spanish risk. If must, ensure >50% third-party income and local banking license + staff to claim ATAD substance and financial undertaking exception.