Tax planning and anti-avoidance measures: abuse of law and sham transactions

At a time when the Spanish Tax Administration’s audit activity is relentless—and supported by increasingly sophisticated control tools—it’s important to remember that not all tax savings constitute fraud. There is also the entirely legitimate concept of “freedom of choice” or “tax planning”, i.e., the right to make lawful decisions that minimize the tax impact of a given transaction, provided these decisions do not contravene tax legislation.

Simple examples of valid tax planning include applying tax incentives established by law to encourage specific activities or investments, such as the corporate income tax reduction for capitalization reserves, duly supported R&D tax deductions, or the application of the tax consolidation regime

In other cases, tax planning may involve selecting the most suitable legal structure to achieve a desired outcome in the least burdensome manner. Generally speaking, this is a perfectly lawful option. However, carrying out artificial transactions with the primary aim of avoiding taxes that would otherwise be due is not considered legitimate.

In such cases, the law provides anti-avoidance tools, such as the abuse of law provision (Article 15 of the General Tax Law – LGT) and the concept of sham transactions (Article 16 LGT)

Both mechanisms allow the Tax Administration to challenge behavior that, while formally lawful, unduly seeks to reduce the taxpayer’s tax liability.

When does tax abuse of law (conflict in the application of the rule) occur

Abuse of law in the application of tax rules occurs when legal transactions or acts are used, which—though valid under civil law—have the primary purpose of avoiding the application of a tax rule, thus obtaining an undue tax advantage. For the Tax Administration to declare such abuse, a favorable opinion from the Consultative Commission referred to in Article 159 LGT is required

The Spanish Tax Agency’s (AEAT) website includes a section specifically dedicated to abuse of law, found under “Legislation and Interpretative Criteria.”

Legal requirements

Three conditions must be met for a finding of abuse of law in the application of a tax rule:

• Use of artificial or improper legal acts or transactions to achieve the desired result.

• Absence of significant economic or legal effects other than the tax benefit.

• Obtaining a tax benefit that contradicts the object or purpose of the applicable tax rule

Consequences of a finding of abuse of law

The main consequence is that the Tax Administration may recalculate the tax owed as if the artificial transaction had not occurred. Additionally, under Article 206 bis LGT, these behaviors may be subject to penalties if culpability is proven, but penalties are not automatic in such cases.

Example: abuse of law

A common example is the creation of independent entities solely to claim a VAT deduction on the construction or renovation of a building intended for an exempt activity (e.g., healthcare services).

Suppose an entity engaged in VAT-exempt healthcare services forms a separate legal entity to carry out renovation works and deduct VAT on those works. It then leases the property to the main entity to carry out the exempt activit

This structure has been considered a case of abuse of law, as it involves an artificial setup designed to obtain a tax advantage (the VAT deduction, which would otherwise be non-deductible). The result is a tax reassessment and a demand for repayment of the improperly deducted VAT.

What is meant by a sham legal transaction?

Sham transactions occur when a legal act or arrangement is not genuine and is designed to disguise the true nature of a transaction, usually to obtain an improper tax benefit. Article 16 LGT states that, in cases of sham, the taxable event will be determined according to the actual transaction carried out by the parties.

Types of sham

• Absolute sham: The purported legal transaction has no real substance; in practice, it never occurred.

• Relative sham: A transaction is disguised as something else, hiding the actual agreement between the parties

Consequences of sham transactions

When the Tax Administration determines that a sham occurred, it will adjust the tax situation in accordance with the actual facts.

In most cases, sham arrangements do lead to penalties, as they involve deception or concealment, implying willful misconduct or at least negligence. This qualifies as a tax offense under the LGT, and the law explicitly allows for the imposition of sanctions.

Therefore, if an audit concludes that a sham has taken place, the likelihood of a penalty is very high, unlike in abuse of law cases, where sanctions are not automatically applied.

Example: sham legal transaction

A typical example is a fictitious sale in which the purchase price is never paid, used to disguise what is in fact a donation.

Another example is the use of a shell company to receive personal income: a professional sets up a company without real economic activity to invoice personal services, with the aim of paying tax under the Corporate Income Tax regime instead of the Personal Income Tax regime, which has progressive rates and would result in a higher tax burden. The Tax Administration, rightly or wrongly, may consider this to be a relative sham, as the company is merely a façade used to conceal the true nature of the income. It will then reassess the taxpayer’s position and impose the corresponding penalties.

Conclusions

Any poorly structured tax planning strategy—even if not expressly intended to defraud or primarily aimed at obtaining tax benefits—may still be treated by the Tax Administration as a case of tax avoidance, and become subject to anti-avoidance measures with serious financial consequences. Therefore, a sound legal approach and proper advice are essential to ensure strict compliance and to legitimately benefit from the tax incentives provided by law.

That said, the taxpayer is not always bound to accept the Tax Administration’s position. In the event of a declaration of abuse of law or sham, taxpayers must be ready to defend their legitimate interests and challenge any resulting administrative actions.