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Should I sign an Earnest Money Agreement?

Fiscal News

Inmaculada Domecq

 

When buying a property, it is common practice to sign an Earnest Money Agreement (EMA). But this is not the only way, or necessarily the most appropriate one, to secure the transaction in some cases.

Under an EMA the parties can desist of their respective obligations by bearing a penalty. The seller can withdraw its obligation to sell, and the buyer its obligation to buy, by the former being obliged to reimburse double the money received, and the latter by losing the moneys already paid upon signing   the EMA. These EMA are aimed at enabling the parties (both) to withdraw from the contract, so an EMA, although commonly used, is not the best option to secure the purchase of a property.

The signing of a Confirmatory Deposit Agreement (CDA) is a more adequate agreement to sign if the aim is to secure the deal. Under this contract, the buyer makes a payment to the seller in advance and on account of the purchase price agreed. In the event the purchase agreement is not executed in due course, the affected party will be entitled to either i) demand the execution of the purchase or ii) rescind the agreement reached and demand an indemnity.

There is a third alternative to reserve the purchase of a property by signing a Call Option Agreement (COA). Under this agreement, the buyer acquires the right to execute the purchase of a property in accordance with the terms and conditions agreed, paying in consideration for this right, a premium. This agreement is mandatory for the seller (who will be bound to sell) and optional for the buyer, who will lose the premium paid if he/she decides not to purchase the property.

The taxation involved may be different depending on the alternative chosen by the parties. In the case of an EMA, providing the sale is subject to VAT, the buyer will pay the money agreed plus VAT, since these amounts are deemed an advance payment. However, if the sale of the property falls under the scope of the Transfer Tax, the payment of these moneys is not subject to Transfer Tax at that stage, since Transfer Tax will be payable upon the execution of the public title deed.

Whereas a Call Option Agreement option is signed, and the grantor/seller is a VAT taxpayer, the buyer will have to pay the premium agreed plus VAT. In this case, the amounts paid are in exchange for the acquisition of a right to buy. It is important to expressly agree that the premium paid will be deducted from the purchase price upon execution of the public deed in order to avoid the payment of the VAT over the premium paid twice. If nothing is stated regarding this deduction, VAT will apply on the purchase price agreed, regardless of the fact that VAT was paid on the premium. Furthermore, if the Call Option Agreement is executed in a public title deed, Stamp Duty tax will be payable by the buyer since a right to buy a real estate property is a registerable document in the Property Register.

In cases where the sale is subject to Transfer Tax, the Call Option Agreement will also be subject to Transfer Tax. The taxable base will be the premium agreed among the parties, unless this amount is below 5% of the purchase price agreed. The subsequent execution of the purchase agreement is treated as an independent transaction for the purpose of the Transfer Tax. Thus, even in cases where the parties agree to discount the premium paid from the purchase price payable, the Transfer Tax upon execution of the sale will be determined based on the full purchase price agreed.

It is therefore important to carefully consider which of the existing alternatives better suits  your interests before entering into any kind of Sale and Purchase Agreements.

 

Inmaculada Domecq is a qualified Spanish Lawyer and a Director of Tax at UHY Fay & Co.

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