Tax Treatment of Compensation Received for Compulsory Expropriation

Tax treatment and timing of compensation received for compulsory expropriation

A transfer resulting from a compulsory expropriation gives rise to a capital gain or loss because it changes the taxpayer’s assets, as provided for in Article 33(1) of Law 35/2006 of 28 November on Personal Income Tax and the partial amendment of the Corporate Tax, Non-Resident Income Tax and Wealth Tax Acts (Official State Gazette of 29 November; hereinafter, the “PIT Act”).

The general timing rule for capital gains and losses is set out in Article 14(1)(c) of the PIT Act: they are allocated to the tax period in which the change in assets takes place.

When does the change in assets take place?

In compulsory expropriation cases, the change in assets is deemed to occur when the fair compensation has been determined and paid and the expropriated property is consequently occupied.

This rule does not apply, however, to urgent expropriation under Article 52 of the Compulsory Expropriation Act. In that procedure, the authority may immediately occupy the property after depositing or paying an advance to the expropriated party. That amount is calculated by capitalisation and is not the final fair compensation, which is determined later under the ordinary rules.

In principle, the gain or loss arises when the advance is deposited and the property is occupied, rather than when the final compensation is paid. Given the special nature of this procedure, however, the instalment or deferred-price rule in Article 14(2)(d) of Law 35/2006 may apply if more than one year elapses between delivery of the property and the date on which the compensation becomes payable. The amounts are then allocated as they become due, that is, to the tax period in which payment of the fair compensation becomes enforceable.

Accordingly, the compensation for the expropriation must be allocated to the tax period in which the property was occupied.

Where the amount of compensation is appealed

If the expropriated party challenges the amount through administrative proceedings and a final administrative decision grants the taxpayer additional compensation, the right to that additional amount arises at that point. For tax purposes, it is a further change in assets and therefore falls within the definition of a capital gain or loss in Article 33(1) of the PIT Act.

Under Article 14(1)(c) of the PIT Act, the gain is allocated to the tax period in which the change in assets takes place. It must therefore be included in the period in which the administrative decision recognising the right to payment becomes final.

Payment is made after the right is recognised

If payment is made in a later tax year and more than one year has elapsed between recognition of the right and payment, the instalment or deferred-price rule may apply. In that case, the gain is allocated to the tax period in which payment becomes due.

This capital gain is included in the savings tax base because it results from a transfer arising from the expropriation.

Late-payment interest

Late-payment interest is classified differently depending on whether it is remunerative or compensatory. Remunerative interest is consideration for lending capital that must be repaid or for allowing payment to be deferred. It is generally taxed as income from movable capital, unless it qualifies as business or professional income under Article 25(5) of Law 35/2006. Compensatory interest, by contrast, compensates the creditor for loss caused by a breach or delay. Given its compensatory nature, it is not income from movable capital; under Articles 25(5) and 33(1) of the same Act, it is taxed as a capital gain.

Accordingly, late-payment interest arising from delay in determining and paying the fair compensation (Articles 56 and 57 of the Compulsory Expropriation Act) is classified as a capital gain.

How the capital gain is included in the tax base

Under the former personal income tax legislation, the Directorate-General for Taxation considered that compensatory late-payment interest covering a period of more than one year belonged in the special part of taxable income. Although Law 35/2006 abolished that category, the continuity of that interpretive approach, together with the inclusion in savings income of interest classified as income from movable capital, supports treating late-payment interest that is a capital gain as savings income under Article 49 of the PIT Act.

As a general rule, capital gains and losses are allocated to the tax period in which the change in assets takes place (Article 14(1)(c) of the PIT Act). For late-payment interest, the change in assets occurs when the interest is recognised—that is, when it is quantified and payment is ordered. In this case, that occurred in 2019.