Context and Legal Background
The Transition Tax is a levy introduced by the 2017 U.S. tax reform (Section 965 of the Internal Revenue Code). It deems U.S. shareholders to have repatriated the undistributed earnings and profits of foreign corporations accumulated between 2001‑2017 and imposes a one‑off tax on those profits. It applies to U.S. citizens or residents who own at least 10 % of the stock of a foreign corporation. The default rate is 17.5 %, with a reduced rate of 9.1 % for cash or cash‑equivalent holdings. Payment may be spread over eight annual instalments, and from 2018 onward a GILTI tax continues to tax the earnings of foreign subsidiaries.
A Spanish resident (also a U.S. citizen) asked Spain’s “Dirección General de Tributos (DGT)” in a binding consultation (V0948‑25) whether the Transition Tax paid in the United States could be considered either:
- a deductible expense
- a capital loss under Spain’s personal income tax (IRPF).
The question arises because double taxation may occur: the U.S. taxes its citizens’ worldwide income irrespective of residence, and Spain taxes the worldwide income of its residents. The Spain–U.S. Double Taxation Convention (DTC) (1990) assigns primary taxing rights to the state of residence. However, Article 25 of the treaty includes a “citizenship reservation” allowing the U.S. to tax its citizens as if the treaty did not exist.
DGT Reasoning
The DGT reasoning establishes that the taxpayer, as a resident of Spain under the DTC, is primarily subject to Spanish taxation on worldwide income.
The undistributed profits of Spanish companies are not considered U.S. source income, and without the citizenship reservation they would be taxable only in Spain. However, the treaty’s citizenship clause allows the U.S. to tax its citizens on undistributed foreign profits even when they relate to non-U.S. companies and activities, which means that Spain must disregard the U.S. Transition Tax when calculating the taxpayer’s Spanish liability; the treaty assigns to the U.S., not Spain, the obligation to provide relief from double taxation.
Under Spanish tax law, income from shares or participations, such as dividends or distributed profits, is classified as investment income (“rendimientos del capital mobiliario”) rather than as capital gains or losses, and taxes paid abroad on such income are not deductible as administration or deposit expenses; therefore, the Transition Tax cannot be treated as a deductible expense under the IRPF. Moreover, since this tax arises from undistributed profits and does not stem from an actual sale or a loss of shares, it does not generate a patrimonial loss and cannot be offset as a capital loss.
Finally, if those Spanish companies later distribute dividends, such dividends will be taxed according to Spain’s domestic rules, without any credit for the Transition Tax previously paid; if the U.S. also taxes those dividends, it must apply its own mechanisms, such as foreign tax credits, to prevent double taxation.
Implications For Taxpayers
The DGT concludes that the U.S. Transition Tax is a unilateral U.S. tax whose burden cannot be neutralized in the Spanish tax system. Spanish residents who are also U.S. citizens must:
- Report the deemed income (the undistributed profits) in their Spanish IRPF and pay tax on it.
- Ignore the Transition Tax paid to the U.S. when calculating IRPF; it is neither a deductible expense nor a capital loss.
- Rely on U.S. tax relief (such as foreign tax credits) to alleviate double taxation.
This interpretation emphasizes the significance of the citizenship reservation in the Spain–U.S. DTC and illustrates how dual‑taxation conflicts can leave individuals exposed to duplicate taxation. Taxpayers in similar situations should plan cash flow carefully because the U.S. allows instalment payments, but Spain requires the full inclusion of the income in the year it is deemed realized.
