Greater Transparency and Rigor in Directors’ Compensation

The obligations related to the approval of directors’ compensation in capital companies in Spain have undergone significant changes in recent years to establish more transparent and rigorous mechanisms.

The Path to the Current Framework

Before the Supreme Court ruling of February 26, 2018, the compensation of executive directors did not require explicit approval by the general meeting. Instead, it was regulated through individual contracts between the board of directors and each director.

Following the 2018 ruling, regulations stipulated that directors’ compensation, whether executive or not, must adhere to a more transparent process to provide shareholders with clarity and to prevent potential challenges. Since then, companies have been required to meet the following key requirements:

1. Inclusion in bylaws: The company’s bylaws must specify whether the director’s position is remunerated or unpaid, as well as detail the compensation concepts (e.g., fixed or variable allocations, allowances, profit-sharing, etc.) for both their role as directors and for any specific functions performed within the company.
2. Approval by the general meeting: The general meeting must approve the maximum annual amount for the compensation of all directors, granting shareholders greater control over remuneration.
3. Distribution by the board of directors: The board allocates the approved compensation, but for executive directors (in cases where there is a board of directors), a contract must be formalized specifying their functions and corresponding remuneration.

This ruling compelled companies to review their bylaws and implement more transparent and rigorous mechanisms. Failure to comply with these obligations could result in directors’ compensation agreements being challenged for non-compliance with commercial regulations. Additionally, compensation could, in some cases, be deemed non-deductible for Corporate Income Tax (CIT) purposes, especially in situations where an individual simultaneously acted as a director (under a commercial relationship) and as a senior executive (under an employment relationship). In such cases, the Spanish Tax Agency (AEAT) could classify the compensation as gratuitous.

Change in Criteria Regarding Tax Deductibility

However, as a result of recent Supreme Court rulings (January 18, 2024, February 20, 2024, and June 13, 2024, among others), directors’ compensation is now deductible for tax purposes even if the company fails to comply with corporate regulations, due to the following reasons:

• The compensation is onerous and linked to the provision of services, making it ineligible to be classified as gratuitous. This applies whether the payment is for directors’ duties or for specific functions performed.
• The absence of provisions in the bylaws does not automatically render these compensations as donations. If it can be demonstrated that they correspond to services rendered, they are deductible.
• The Court emphasizes that commercial law provisions do not affect tax deductibility. Non-compliance should not lead to the loss of the right to deduct properly recorded expenses.

The Spanish Central Economic-Administrative Court (TEAC), and consequently the AEAT, has aligned with the Supreme Court’s jurisprudence, affirming that directors’ compensation, when duly substantiated and recorded, should be considered a tax-deductible expense.

Compliance Is Still Crucial

Despite the relaxation of tax-related consequences, ensuring proper substantiation of directors’ compensation is vital to avoid potential fiscal challenges. Moreover, while tax regulations no longer require strict compliance with commercial law, the latter remains critical to prevent internal disputes and the escalation of issues into other areas.

Potential Shareholder Challenges for Non-Compliance

Failure to meet the legal requirements outlined above may no longer disqualify directors’ compensation as deductible expenses, but it continues to provide grounds for shareholders to challenge payments. Common causes for challenges include:

• Deviations from the bylaws or shareholder agreements: Any modification exceeding the limits approved in the bylaws or general meeting must receive appropriate shareholder approval.
• Harm to corporate interests through disproportionate compensation: Compensation may be deemed harmful to the company’s interests, and thus challengeable, if it is disproportionate to the company’s profitability or the directors’ performance.
• Lack of transparency or insufficient information: Properly detailing compensation concepts and justifications is essential. Shareholders must be adequately informed of any intended modifications.
• Abuse of majority power: Compensation may be challenged when approved without adequate oversight or when it disproportionately benefits some directors or a majority of shareholders to the detriment of the minority, potentially jeopardizing the company’s financial stability and overall well-being.

Conclusion

Directors’ compensation requires proper formalization. While failure to comply with commercial regulations is no longer a cause for loss of tax deductibility, it remains a risk for shareholder challenges.

At Across Legal, we provide specialized advice to help you align your company with the new regulatory framework. Don’t hesitate to contact us for a personalized analysis of your situation.