On October 13, 2011, the Spanish High Court of Appeal (“Audiencia Nacional”) issued an interesting decision on arm’s length valuation of participative loans.

For Spanish legal purposes, a participative loan falls within a hybrid category –similar to shareholders' subordinated loans- with the following main features:

  • Remuneration (interest) must be variable and linked to the borrower’s business performance. Examples of valid indicators of performance are net profit, turnover or equity. Fixed remuneration is allowed, but is not mandatory.
  • It cannot be voluntarily prepaid unless the equity of the borrower company is increased in an equal amount.
  • It ranks junior to all other indebtedness.
  • The borrower company considers the participative loan as equity, for purposes of compulsory dissolution / share capital reduction rules (i.e. where the company's Equity falls below certain thresholds).

The facts where the following:

On 1997 a Spanish company granted a 3-year participative loan to its Portuguese subsidiary. The remuneration formula consisted of a variable interest to be fixed annually by the parties, but that could not exceed 50% of the borrower’s net annual profit. Additionally, it was agreed that interest would be paid only as of the moment in which the borrower’s accumulated losses where offset by its activities’ profits.

At the end of year 3, the Portuguese subsidiary repaid the loan without having paid any interest during the duration of the loan, due to its recurrent loss-situation.

The Spanish Tax Administration, in application of transfer pricing regulations, considered that the remuneration agreed was not arm’s length, and determined that the Spanish company should recognize interest income equivalent to a fixed 4% rate (determined by using comparables in financial markets).

The Spanish High Court of Appeal, following the arm’s length principle, agrees with the Spanish Tax Authorities on the need to apply a deemed interest to the loan, since this is a related-party transaction. However, it rejects the specific criteria followed by the Tax Authorities to assess the transaction (4% fixed rate).

In particular, the Court concludes that, being the instrument a participative loan, interest must be variable and linked to the borrower’s business performance (examples of indicators: net profit, turnover or equity), and cannot be determined under other parameters (i.e. financial markets, which led to a 4% fixed rate).

Accordingly, the Spanish High Court overruled the Spanish Tax Authorities’ assessment, and decided in favor of the Spanish company.

Source: Gomez Acebo y Pombo (


« Back to overview

News archive