Are Spanish self employed / autonomos overtaxed?

As a British accountant operating in Spain I sometimes feel the need to defend the Spanish tax system against accusations of (a) unfairness and (b) expensiveness.

At times that is a bit like trying to defend a war criminal or the English back four's performance in that World Cup defeat to Germany - because it is indefensible. Mostly though it is the Social Security system that is the real villain not income tax. There are two main problems with social security in Spain:

autonomos (Spanish self-employed) have to pay a minimum of 250€ before they can legally operate and this does not go down even if they earn a big fat €0 during any given period. A big disincentive that I have talked about before on this blog (Spain won't recover without encouraging its autonomos). But there is at least some leeway - see this article lower rates of Spanish social security in our Autonomo guide.

Also employers have to pay a whopping 30% or so in NI contributions making it ludicrously expensive and risky to hire anybody.

At least you get something for social security - health and pension rights. But what about Spanish income tax? When self-employed clients or small businesses start rolling their eyes at all the tax they must pay on top of those nasty social security contributions, I have to remind them of a few points:

- the contributions themselves are set against the self-employed's taxable income (thus reducing the effective cost of social security by up to 43%)

- the UK's top rate is now higher than Spain's (50% vs 43%)

- Spain's allowances are more generous (see Spanish tax rates)

- there is more scope to create tax efficiencies in Spain. Say no more.

Part of the resentment about autonomo tax comes from a misunderstanding of retenciones and the quarterly income tax that the self-employed have to pay. Without going into all the details, besides social security, autonomos must pay income tax every quarter and (sometimes) suffer a sort of PAYE on their invoices, where the customer deducts up to 15% and pays it to the tax office. But both of these types of tax are kinds of advanced income tax and the autonomo gets credit for them when they do their tax returns. Retenciones are offset against the quarterly tax bill and that in turn is credited against any tax payable when the annual Renta tax return is due. Quite often this can mean a tax rebate to the self-employed taxpayer.

That's enough defending the taxman. I can't keep it up for long.

Getting a Spanish tax refund

There aren't many nice things about being a tax accountant. It's not a great ice-breaker at parties and you sometimes feel a bit like a dentist or a doctor delivering bad news when you have reckoned up someone's liability and have to tell them. But then there are those lovely occasions when your client gets some money back and you get the "shoot the messenger" syndrome in reverse ("hug the messenger"?) because they are so surprised and grateful.

This scenario is particularly rewarding when you have come up with the idea that got the tax refund in the first place and the recent Spanish tax reporting season threw up some good examples of this.

Refunds can only occur when someone has paid too much tax during the year and they have submitted an annual tax return after the year is over which proves as much: the Agencia Tributaria will credit their bank account with the difference. What I mean by "paying too much tax during the year" is that the Spanish government take automatic retentions of tax from people's income as it arises and, as this is done on a flat rate taking no account of people's personal circumstances, too much can be taken. Examples of such retention payments taken by the government are:

- % deductions of bank interest

- retentions from salary (like PAYE in England)

- deductions from dividends paid by companies

- retentions paid on self employed earnings

- rental income retentions

The most common reason why people find they have paid too much out in retentions is that they have low income overall compared to their personal allowances (tax free income allowance). This often happens when people start work or start a business part way through the year so they get a full year's personal allowances to use against a part year's income. Also a married couple can claim the higher Spanish married couples allowance when only one of them is earning.

Such refunds are one good reason why it can often pay to do a tax return particularly if you take advantage of all the allowances available to you. There are allowances such as for young children (under 3) and against rent paid that can lead to a tax refund in the right circumstances.

Anyone wanting more details of how the Spanish tax system works should check out the Advoco page Spanish Income Tax 2010.