3Tax implications of e-commerce in Spain

3.2. Direct taxation

The following chart shows the main potential issues of this nature.

The most relevant considerations and the progress made in analyzing those issues are summarized below:

3.2.1 The permanent establishment problem

The issue concerns whether the paradigmatic elements of e-commerce, such as a server, a website, etc., can be deemed a permanent establishment (“PE”) in the country where a company supplying a good or service on the Internet is located:

In the Commentary published in December 2017 on the OECD Model Tax Convention, the comments regarding article 5 (concerning the definition of PE) remain unchanged from those published in 2003, in which the elements defining the new forms of commerce were already foreshadowed. Based on the observations made in the Commentary, the following chart shows the scenarios in which, as a general rule, a PE can be deemed to exist and those in which it cannot:

The reasons justifying the characterization of a PE in each case are as follows:

• A computer or server can constitute a PE whereas the software used by that computer cannot. This distinction is important because the entity that operates the server hosting the website is normally different from the entity that engages in the online business (hosting agreements).

  In order to characterize a server as a PE, regard must be had to the following considerations:

  • A server will constitute a fixed place of business only if it is permanent and located in a certain place for a sufficient length of time. What is relevant here is whether it is actually moved from one place to another, rather than whether it can be moved. A server used for e-commerce can be a PE regardless of whether or not there is personnel operating that server, since no personnel is required to perform the operations assigned to the server.
  • In determining whether or not the server installed by a given enterprise in a country constitutes a PE, it is particularly important to analyze whether the enterprise engages in business activities specific to its corporate purpose through that server, or whether, on the contrary, it only engages in activities of a preparatory or auxiliary character (such as advertising, market research, data gathering, providing a communications link between suppliers and customers, or making backup copies).
• A website does not, in itself, constitute tangible property and, therefore, cannot be deemed a “place of business,” defined as facilities, equipment, or machinery capable of constituting a PE. ISPs do not generally constitute a PE of enterprises that engage in e-commerce through websites since ISPs are not generally dependent agents of those nonresident enterprises.

3.2.2 Legal characterization of income

The second relevant issue is the characterization of income and, in particular, the possibility that certain goods supplied online may, merely by virtue of the fact that they are protected by intellectual or industrial property laws (such as music, books and, particularly, software), be characterized as generators of royalties and, therefore, be taxable in the country of source.

The Commentaries on the OECD Model Tax Convention characterize as business profits (instead of royalties) almost all payments made for all intangible goods delivered electronically, on the ground that the subject-matter of those transactions are copies of images, sounds or text, rather than the right to exploit them commercially.

Initially, Spain included an observation on the relevant Commentary on the 2003 Model Tax Convention qualifying the treatment of the acquisition of rights to software by arguing that payment for those rights could constitute a royalty. Specifically, Spain considered that payments relating to software were royalties where less than the full rights to it were transferred, either if the payments were in consideration for the use of a copyright on software for commercial exploitation or if they related to software acquired for business or professional use when, in this latter case, the software was not absolutely standardized but somehow adapted to the purchaser.

However, the relevant Commentary on the OECD Model Tax Convention published in July 2008 took the novel line that payments made under arrangements between a software copyright holder and a distribution intermediary do not constitute a royalty if the rights acquired by the distributor are limited to those necessary for the commercial intermediary to distribute copies of the software. Thus, if it is considered that distributors are paying only for the acquisition of the software copies and not to exploit any right in the software copyrights (without the right to reproduce the software), payments in these types of arrangements would be characterized as business profits. The Commentary published in December 2017 maintains this position.

In light of this change in the Commentary on royalties in the OECD Model Tax Convention, Spain introduced a qualification in the observations published in July 2008 (which was kept in the Commentary on the OECD Model Tax Convention published in December 2017), indicating that payments in consideration for the right to use a copyright on software for commercial exploitation constitute a royalty, except payments for the right to distribute standardized software copies, not comprising the right to customize or to reproduce them.

Therefore, as acknowledged by the Directorate-General of Taxes ("DGT") in its binding ruling of November 10, 2008 and other subsequent rulings, Spain considers that payments made for the right to distribute standardized software copies are business profits, although it continues to treat as royalties any payments made for the right to distribute software where the software has been adapted. This issue is also addressed, in relation to a “cloud base software distribution agreement”, in ruling V2039-15 of July 1 2015, in which the DGT resolves, on the basis of agreements of this type, on the distinction between business profits and royalties. In any case, as was clarified in a binding ruling of November 23, 2010, the transfer, together with the distribution right, of other rights, such as a license to adapt the software being distributed, will mean that the payments are treated as royalties.

It should also be noted that article 13 of the Revised Nonresident Income Tax Law, approved by Legislative Royal Decree 5/2004, of March 5, 2004, treats as royalties amounts such as those paid for the use of, or the right to use, rights in software.

Also, in some tax treaties signed by Spain, income derived from the licensing of software is expressly characterized as a royalty. In this regard, one should note the Supreme Court judgment of March 25, 2010, which defined the licensing of software as a license of the rights to exploit a literary work, although the Court’s definition addressed a situation pre-dating the entry into force of the Spanish legislation specifically listing the items deemed to be royalties. However, in a judgment dated March 22, 2012, the National Appellate Court held that such a definition was no longer possible after the entry into force of the above-mentioned legislation. The Supreme Court confirmed this view in a judgment handed down on March 19, 2013, in which it held that characterization as a literary work is no longer correct after the change in the legislation, reflecting a criterion which has continued to gain strength in judgements delivered by this High Court (the most recent of which include judgement STS 2189/2016 of October 11, 2016).

Finally, it is relevant to mention the judgment issued by the National Appellate Court on June 18, 2021 in which it established that payments made for the transfer of the use of rights over computer programs in which the client is allowed to modify the software transferred (with access to the source code) cannot qualify as business profits, but constitute royalties. The Court reached this conclusion by stating that there are not only two types of software: standardized and custom-made. There is also a type of software which is called "customizable" and which, by its definition, can be considered as "non-standard" software.

3.2.3 Determination of taxable income and transfer pricing problems

The widespread use of intranets among different companies belonging to multinational groups, and the enormous mobility of transactions over computer networks, create highly complex problems when applying the traditional arm’s-length principle to pricing transactions within groups. This has been accentuated by the increase in transactions between group companies and the downloading of digital content or of free services.

Accordingly, the tax authorities of OECD countries (including Spain) are advocating the development of bilateral or multilateral systems for advance pricing agreements, applying the OECD transfer pricing guidelines to e-commerce. Noteworthy in this regard is the creation of an EU Joint Transfer Pricing Forum in which, among other matters, non-legislative measures are being proposed to enable a uniform application of the OECD guidelines across the EU.

Following the initial proposal in relation to Actions 8 to 10 of the BEPS Action Plan, which are ultimately aimed at ensuring that the results of transfer pricing are in line with the creation of value, the implementation of these measures was initially addressed in July 2017 by the OECD Guidelines on transfer pricing for multinational enterprises and tax administrations, which have recently (in January 2022) been updated.

The update reflected in this new version focuses on three main areas:

• Revised guidance in relation to the method for allocating results.
• Guidance for tax administrations regarding the application of the approach towards hard-to-value intangibles.
• Transfer pricing guidance on financial transactions.

In what concerns the second point, which reflects the work carried out by the OECD since the report published in June 2018 on this matter, it is now included in Appendix II of Chapter VI of the 2022 Guidelines. A particular aspect of this new publication regards the guidance reflected on the ex ante criterion, related to pricing, and the ex post criterion, which attends the reliability of evidence on financial results, related to transactions based on the arm’s length principle. Some examples are provided to illustrate the adjustments that can be made, in practice, in respect of intangible property of this type.

3.2.4 Application of the place-of-effective-management rule

Due to the special characteristics of e-commerce (which include easy detachability from location, relative anonymity, and the mobility of the parties involved), the traditional rules on taxation of worldwide income, based on the principles of residence, registered office or place of effective management, are more difficult to apply to taxpayers engaging in e-commerce.

Indeed, the parameters established in the tax treaties for apportioning the revenue powers among States in the event of a conflict (most of them based on the “place-of-effective-management” principle) are exceeded in the context of e-commerce, since the various managing bodies of the same enterprise can be located in different jurisdictions and be totally mobile during the same year. It can therefore be extremely difficult to determine where the enterprise’s place of effective management is situated, and this can lead to double taxation or to no taxation at all⁵.