Tax liability is one of those things that new business starters may find difficult to understand.
From the very beginning, there may be tax payments to make.
The most frequent payments you might need to deal with are IVA, income tax and retentions. Here is how they work.
IVA
Simply put, the government uses your business to collect IVA.
You add IVA, normally 21%, to your services or sales and pass that money to Hacienda each quarter.
At the same time, your business may have paid IVA on its own expenses. That input IVA reduces what you have to pay, leaving only the net amount to send to Hacienda each quarter.
In practice, you pay as much as you collect, one way or another. There is nothing left for you, but also no tax loss if the system is applied correctly.
Why you may pay IVA even without profit
This can happen because some business expenses are exempt from IVA, such as Social Security payments and salaries.
For example, imagine the following simplified quarter:
- Sales: EUR1,000 plus EUR210 IVA.
- Suppliers: EUR800 plus EUR168 deductible IVA.
- Social Security: EUR250, with no IVA.
- Business result: EUR50 loss.
- IVA balance: EUR42 to pay.
What if the IVA balance is negative?
Any negative IVA balance from one quarter is carried forward to the next quarter.
At the end of the year, if there is still a negative balance, you can apply for a refund.
Hacienda, by law, must refund the negative amount within six months or pay interest until the refund is made.
Income tax
On this subject, we need to differentiate between corporation tax and personal income tax applying to individuals, such as self-employed persons.
In this article, we are focusing on personal income tax for autonomos.
The basic idea is simple: income minus business expenses equals profit.
Quarterly income tax payments
Every quarter, most autonomos under direct assessment pay 20% tax on the quarter's profit.
This amount is not the final tax to be paid. It could be less or more.
It is an advance payment against the tax that will actually be calculated after the end of the year.
The tax year ends on 31 December. During May and June of the following year, the actual income tax due is calculated in the Renta tax return.
Personal allowances are not included quarterly
No personal allowances are taken into account in the quarterly payment calculation.
This means that, for quarterly payments, a working single parent with three children pays under the same basic calculation as everyone else.
Personal allowances, such as children, medical circumstances or qualifying deductions, are considered when the annual Renta tax return is prepared.
If applicable, those allowances may reduce the final result or produce a refund.
It also means that if your overall annual profit is high because you had a very good year, and your final tax rate is higher than the 20% paid quarterly, you will pay the difference when filing the Renta.
A few words on the modulo system
Under the modulo system, your profit and therefore the amount of tax are assessed based on statistical information for your type of business, rather than the actual figures from your business.
Not every kind of business can be assessed this way.
The benefit is that if you make more than the modulo system estimates for your business, you pay no more tax under that system.
The downside is that if your real profit is lower than the modulo estimate, you will have paid more tax than you would have under the direct assessment system.
On top of that, you usually have to stay on the modulo system for a minimum period.
Retentions: amounts withheld to pay someone else's tax
Retention comes from the Spanish word retenciones, meaning withheld tax.
Essentially, it is part of a payment owed to somebody else that is withheld in order to pay that person's income tax.
There are several common situations where the law requires retentions to be applied.
- Employers withhold part of an employee's salary in order to pay the employee's income tax.
- Companies withhold part of the payment due to self-employed individuals in order to pay the autonomo's income tax.
- Tenants may withhold part of the rent due to the owner in order to pay the owner's income tax.
Except in the first case, where the employer produces the payslip, it is usually the person issuing the invoice who includes the applicable retention percentage in the invoice.
How do retentions on rents work?
In this case, the rent retention is money withheld by the tenant in order to pay tax owed by the owner.
It is important to note that this amount belongs to the owner, not to the tenant.
Imagine that owner and tenant agree on a rent of EUR500. IVA at 21% must be added, so the tenant expects a monthly bill of EUR605.
The tax authorities require the tenant to retain 19% of the rental amount, which is EUR95, and pay that directly to Hacienda.
So out of the EUR605 owed to the owner, the tenant actually pays EUR510 directly to the owner, while the EUR95 retention must be paid to Hacienda using the relevant tax form.
Example rent invoice
- Rent: EUR500.
- IVA: +EUR105.
- Retention: -EUR95.
- Total paid to owner: EUR510.
The tenant must remember that when paying the rent, they have not paid the full amount yet. The retained EUR95 still has to be paid to Hacienda.