Understanding Article 7(p) of the LIRPF: Tax Exemption for Income Earned Abroad

Article 7(p) of the Ley del Impuesto sobre la Renta de las Personas Físicas (LIRPF) is a crucial provision within Spanish tax law that offers significant tax relief to individuals earning income from work performed abroad. This article, often referred to as the "expatriate exemption," provides a partial or full tax exemption for income earned outside of Spain, subject to certain conditions. Below, we delve into the specifics of this article, the requirements for eligibility, and its practical implications.

Key Provisions of Article 7(p)

Under Article 7(p) of the LIRPF, income derived from work performed abroad may be exempt from Spanish income tax up to a maximum limit of 60,100 euros per year. This provision is particularly relevant for Spanish residents who are temporarily assigned to work in other countries by their employers.

Eligibility Requirements

For the exemption under Article 7(p) to apply, the following conditions must be met:

1. Work Performed Abroad: The work must be effectively carried out in a foreign country. This means that the physical presence of the employee in the foreign country is necessary, and the work must be performed outside of Spanish territory.
2. Foreign Employer or Entity: The work must be done for a company or entity that is not a resident in Spain. This includes foreign branches or permanent establishments of Spanish companies that are located abroad. If the employer is linked to the entity receiving the services, the exemption still applies as long as the service benefits the non-resident entity, aligning with Article 16.5 of the Ley del Impuesto sobre Sociedades (Corporate Tax Law).
3. Taxation in the Foreign Country: The country where the work is performed must levy a tax that is identical or similar to the Spanish Personal Income Tax (IRPF), and it should not be classified as a tax haven. Compliance with this requirement is generally presumed if Spain has a double taxation treaty with the country, which includes an information exchange clause.

Calculation of the Exempt Amount

The exempt amount under Article 7(p) is determined by calculating the income directly related to the work performed abroad, as well as a proportional allocation of the employee's annual salary based on the number of days spent working outside Spain.

For example, if an employee earns 75,000 euros annually and spends 91 days working in Brazil, the exempt portion of the salary would be calculated as follows:

• Daily Salary: 75,000 euros / 365 days = 205.48 euros per day
• Exempt Salary: 205.48 euros x 91 days = 18,698.63 euros
• Specific Foreign Income: If the employee received an additional 10,250 euros for services performed specifically in Brazil, this amount is also exempt.

Thus, the total exempt income would be 18,698.63 euros + 10,250 euros = 28,948.63 euros, which is well within the 60,100 euros annual limit.

Incompatibility with the Excess Regime

It is important to note that the exemption under Article 7(p) is incompatible with the "excess regime" detailed in Article 9.A.3.b) of the Reglamento del IRPF. The excess regime relates to the exclusion from taxation of certain allowances received by employees or public officials assigned abroad. Employees must choose between these two options depending on which is more advantageous for their specific situation.

However, the exemption is compatible with the general regime for travel allowances and per die that are not subject to tax, provided these do not exceed the legal limits.

Practical Implications for Employers and Employees

For employees, Article 7(p) represents a valuable tax benefit that can significantly reduce their tax liability when working abroad. It is particularly beneficial for expatriates and those who are temporarily assigned to international projects.

For employers, understanding the implications of this article is essential to properly manage the tax obligations of their employees and to optimize the overall tax burden. Employers should ensure that their payroll systems are correctly set up to apply this exemption where applicable and provide adequate documentation to support the exemption claims in case of an audit.

A DGT Ruling on the Impact of Employer-Provided Vehicles on Article 7(p) Exemption Calculations

A recent ruling by the Spanish General Directorate of Taxes (DGT) - V1822-23, dated June 23, provides clarification on the impact that an employer-provided vehicle, considered as a benefit in kind, may have on the calculation of the tax-exempt income under Article 7(p) of the LIRPF. The query addressed by the DGT concerned an employee who frequently works abroad and receives a company car as part of their annual compensation. Specifically, the question was whether this non-cash benefit should be included in the salary when calculating the exempt income using the proportionality criterion.

When calculating the income corresponding to work performed abroad, it is essential to consider the days the employee was actually abroad, as well as any specific compensation related to services rendered outside Spain. Additionally, the calculation of daily earnings from work performed abroad, excluding specific remuneration, is done by applying a proportional distribution based on the total number of days in the year. This means that, apart from specific remuneration, the calculation starts with the annual salary, which is divided by 365 days to determine the daily salary. This daily salary is then multiplied by the number of days the employee worked abroad.

The DGT's ruling clarifies that for the purpose of applying the proportionality criterion (to quantify the portion of non-specific remuneration earned during the year of relocation that qualifies for exemption), the employee may include both cash compensation and the benefit in kind, such as the employer-provided vehicle.

Example:

Suppose an employee was sent by their company to a subsidiary in Germany from March 1 to April 30 to provide advice on launching a new product. After this period, the employee returned to Spain and continued working for the company.

• Annual Salary (Cash Compensation): €62,500
• Company Car (Benefit in Kind): The car's acquisition cost is €35,000 (including taxes and other expenses). The value of using the company car is considered to be 20% of the acquisition cost annually, which amounts to €7,000.
• Specific Compensation for Work Abroad: €8,300

Calculation of Tax-Exempt Income:

1. Total Compensation for the Year:
   • Cash Compensation (€62,500) + Benefit in Kind (€7,000) = €69,500.
2. Daily Salary:
   • €69,500 / 365 days = €190.41 per day.
3. Days Spent Abroad:
   • 61 days.
4. Exempt Salary for Days Abroad:
   • €190.41 x 61 days = €11,615.01.
5. Specific Compensation Exempt from Taxation:
   • €8,300.

Total Exempt Income:

• €11,615.01 (proportional salary) + €8,300 (specific compensation) = €19,915.

Documentation Required for Article 7(p) Application

To apply the Article 7(p) exemption, it is essential to meticulously document the foreign assignment. The following should be retained:

• Airline tickets
• Hotel invoices
• Invoices issued to the foreign client for the work performed by the relocated employees

If the entity receiving the services is linked to the employee's employer, the requirement that the work be performed for a non-resident entity is considered fulfilled when it can be demonstrated that an intra-group service was provided to the non-resident entity because the service produced, or could produce, a benefit or utility for the recipient company.

How to Apply the Article 7(p) Exemption

The exemption can be applied in two ways:

1. Directly on the Payroll: The company calculates the exemption, resulting in a higher net salary for the employee.
2. On the Income Tax Return: The employee applies the exemption when filing their tax return.

Special Case of the General Manager

What happens if the work is carried out within companies of the same group, and the person relocating is the General Manager? The Spanish Tax Agency (AEAT) generally assumes that the duties performed by a General Manager are merely supervisory and do not generate a benefit for the subsidiary. However, a Supreme Court ruling on March 28, 2019, established a corrective criterion, indicating that even these functions allow the General Manager to benefit from the IRPF exemption.

Compatibility and Incompatibility of Article 7(p)

It is worth noting that Article 7(p) of the LIRPF is compatible with travel, subsistence, accommodation, and relocation expenses. However, it is incompatible for taxpayers assigned abroad with the excess regime excluded from taxation under Article 8.A.3.b of the IRPF Regulation, regardless of the amount.

Conclusion

Article 7(p) of the LIRPF provides a substantial tax exemption for Spanish residents who work abroad, covering income up to 60,100 euros annually. Recent clarifications by the DGT highlight the inclusion of benefits in kind, such as employer-provided vehicles, in the calculation of exempt income. This exemption is not only an important tool for reducing tax liability for employees but also offers significant financial planning opportunities for employers. Proper documentation and understanding of the eligibility criteria and potential incompatibilities are essential for maximizing the benefits of this provision.