What you always wanted to know about tax deductions when investing in start-ups

As mentioned in a previous entry, by my colleague, Diego Sánchez in his post “Why complement my portfolio with Venture Capital investment?”, investment in Venture Capital has the potential to increase the return of a diversified investment portfolio and decrease its risk. However, in addition to the attractive profitability that can be obtained, you enjoy different tax advantages, a reason that definitely carries weight when you are on the verge of making an investment decision. Among the tax incentives available under the current regulatory framework, I will specifically refer to the tax deduction entitled “investment into new or newly-created companies”.

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Regulatory background

The well-known “Law of Entrepreneurs” (Law 14/2013) (version only available in Spanish) gave rise to a state tax deduction that was applied to the individual investor’s personal income tax, with the purpose of encouraging further start-up investment and fostering alternative ways to secure traditional financing. In the same way, Spain’s autonomous regions also offer similar deductions to encourage local entrepreneurship.

The aforementioned tax incentive comes into force at two different points in time:

  • At the time of the actual investment in the newly or recently created company.
  • Under the condition that the divestment takes place within a time period of 3 to 12 years. The capital gain is exempt from tax only if the reinvestment occurs in proprietary shares or convertible equity shares of another company of new or recent creation.

This deduction will be applied to the purchase of certain proprietary and equity shares by legal entities made from 29/09/2013, with its latest update published on 04/07/2018, entering into effect from 05/07/2018 (Law 6/2018) (Spanish version).

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Requirements that start-ups must meet

  1. Legal structure of the company: Start-ups must either be: , Ltd. or what is called in Spain a “sociedad laboral” of public or limited nature (the beforementioned structure only exists in Spain and Mexico, where the majority of capital is owned by its employees) and neither of these company types are allowed to be trading as part of any regulated financial market.
  2. Type of economic activity: Start-ups are required to undertake economic activity that satisfies all personnel and developmental resources accordingly. The company cannot manage financial or real estate assets.
  3. Company-own funds: The start-ups proprietary capital may not exceed € 400,000 at the start of the tax period in which the individual purchases the proprietary or equity shares. This requirement excludes start-ups that have already reached a determinate level of own funds which can be considered sufficient.

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Conditions under which the investment should be carried out

  1. Seniority: Proprietary or equity shares should be acquired at the moment of the company’s incorporation or through a capital raise carried out within 3 years following said incorporation. This excludes any acquisitions made by another partner after the incorporation or capital raise.
  2. Duration of ownership: The proprietary or equity shares must remain in the investor’s ownership for a period of more than 3 years and less than 12 years.
  3. Maximum share ownership: The investor’s direct or indirect share ownership, in conjunction with his/her spouse or any other kin, may not exceed 40% of the share capital of the entity or the existing voting rights.
  4. New economic activity: The proprietary or equity shares must be of an entity that carries out a new economic activity and not one that has previously been carried out.

Finally, for the deduction to be applied, the investor requires a certificate detailing the acquisition of said proprietary shares or equity shares by the entity in question, indicating that the aforementioned requirements have been met.

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The tax deduction value

According to the current wording of Article 68.1 (Spanish only) of the “ley del impuesto de la renta sobre las personas físicas” or LIRPF in abbreviated form, a law particular to Spain and equivalent to personal income tax, the deduction is quantified as 30% of the amount paid during the period in question for the purchase of proprietary or equity shares. This takes into account that the investor can, simultaneously, bring his/her relevant entrepreneurial and business knowledge to bear, which may benefit the development of the entity in which he/she invests.

The maximum deduction permitted is € 60,000 per year, which is composed of the value of the proprietary or equity shares acquired. This is to say that in the case of an investment of € 60,000 or above, the maximum amount deducted will be € 18,000 (€ 60,000 x 30%).

The following table provides a summary of the differences between the previous and current regulation:

Diagram blog Lucía Marinelli

In conclusion, as we can see in the previous table, there is a strong tendency for governments to increasingly incentivise the investment in start-ups. Spain, much like other countries, has recognised the value of a strong entrepreneurial sector and the benefit that access to such projects provides by allowing entrepreneurs to convert these ideas into concrete business opportunities, thereby strengthening the national economy.

Investing in innovative start-up projects, besides boosting the economy, diversifying a portfolio and obtaining returns, can go hand in hand with beneficial tax deductions. This is why, at Faraday, we focus our efforts not only on identifying and offering the best investment opportunities and strengthening our investee companies, but we also work to offer our Partners the best advice when it comes to the application of potential tax benefits.

Firma Lucía Marinelli

Lucía Marinelli

Head of Finance and Administration