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Directors’ Remuneration: Keys to complying with regulations and avoiding tax risks

Introduction

Directors’ compensation is a complex issue that cuts across multiple branches of law, including labor, tax, civil and commercial, and even criminal law. A thorough understanding of the regulatory framework and applicable legal requirements is crucial to ensure transparency, proper information management, and compliance with tax obligations. In this analysis, we will explore the most relevant aspects related to directors’ compensation, with an emphasis on current regulations and the most influential court decisions.

The labor perspective: Theory of the link and jurisprudential evolution

In the labor field, the bond theory is fundamental to define the legal nature of the relationship between the director and the company. This theory was consolidated by the jurisprudence of the Supreme Court, particularly in the 1988 judgment known as the Huarte Case. According to this theory, when an individual simultaneously performs labor and administrative functions, the labor relationship is absorbed by the organic link derived from his position as administrator. In other words, the commercial relationship prevails over the employment relationship in the case of executive or management functions.

The Court of Justice of the European Union (CJEU) has also issued pronouncements that introduce nuances to this theory, suggesting a less strict interpretation. However, in the Spanish legal context, the predominant position continues to be the preeminence of the commercial relationship in these cases.

The civil-mercantile perspective: Definition and formalization of remuneration

In the civil-commercial perspective, the Supreme Court Ruling of February 26, 2018 establishes that the remuneration of directors must be clearly defined in the articles of association. It is not enough to mention that the position is remunerated; it is necessary to specify the system through which such remuneration is determined, including the methodology for calculating its amount.

Article 217 of the Capital Companies Act, together with Articles 249.3 and 249.4 LSC, stipulates that the approval of the annual amount of remuneration must be approved by the General Meeting. However, the Supreme Court has shown some flexibility with regard to the need for full details of remuneration to be set out in the Articles of Association. This more adaptable interpretation has been endorsed by the Directorate General of Public Faith and Legal Certainty through various resolutions between 2018 and 2021, which seek to adapt the legal requirements to the business reality. In particular, several resolutions (RR. 4.6.20, 26.4.21, 25.5.21, 7.7.21, 16.11.21) establish guidelines according to which the director’s remuneration concepts must be stated in the bylaws, while their specific development may be reflected in the contract with the director.

On the moment to approve the remuneration

An important issue is the moment at which the resolution of the General Meeting on the director’s remuneration must be adopted. The Supreme Court Ruling of May 13, 2021 clarifies that it is not essential that such resolution be adopted prior to the beginning of the fiscal year in which the remuneration is to be paid; it is sufficient that the authorization be granted during the current fiscal year. This flexibility allows companies to adapt their remuneration decisions more dynamically and according to their needs.

The tax perspective: The millimeter theory and its evolution

In the tax field, the millimeter theory has been fundamental in interpreting the deductibility of directors’ remuneration. This theory was established in the Mahou ruling -STSof November 13, 2008, rec. 2578/2004-, which imposed considerable rigidity by requiring that all the details of the remuneration be precisely specified in the articles of association for the expense to be deductible. The purpose of this rigidity was to ensure that the remuneration was recognized as a “mandatory” and “necessary” expense, avoiding its consideration as a non-deductible liberality.

The Supreme Court emphasized that, in order for payments to directors to be deductible, they must be clearly provided for in the articles of association. In the case of variable remuneration, the bylaws must establish a specific percentage with no room for ambiguity. If the remuneration is fixed, the bylaws must define the exact amount or the criteria for determining the amount unequivocally.

Flexibility through the Carrefour Judgment

The Carrefour Case JudgmentSC Judgmentof June 27, 2023, rec. 6422/2021– marked a relevant change in terms of the rigidity of the millimeter theory. In this judgment, the Supreme Court recognized that, although commercial regulations must be respected, formal breaches do not always automatically imply that the remuneration is considered a non-deductible liberality. In other words, the Court adopted a more pragmatic approach, considering the economic reality of the company.

In the case of partnerships with a single partner, the lack of certain formalities should not prevent the deduction of remuneration expenses if they are justified as necessary for the business activity. This ruling introduced a less rigid criterion, more aligned with the practical needs of companies, prioritizing functionality and economic justification of expenses over excessive formalism.

This more flexible interpretation was reaffirmed in the Supreme Court Ruling of March 13, 2024, which holds that the commercial regulations in force at the time of the tax deduction must be applied consistently. Although the remuneration must be approved and provided for in the articles of association, exceptions are accepted where a pragmatic interpretation can be justified.

Obstacles to deductibility

The main obstacles to companies being able to deduct their directors’ remuneration relate to non-compliance with commercial regulations and lack of specificity in the articles of association. In addition, if the payments are considered liberalities-that is, expenses that are not necessary for the operation of the company- they cannot be deducted, in accordance with article 14.1.e) of the TRLIS. The millimeter theory insists that, in order to avoid this situation, the remuneration must be detailed in a precise manner, leaving no room for vague interpretations or general limits.

Remuneration in listed companies: Transparency and Control

In the case of listed companies, the regulations are even stricter in terms of transparency. Law 5/2021, of April 12, requires that directors’ remuneration be clearly specified in the remuneration report and that it be aligned with the company’s remuneration policy. This guarantees greater transparency and protects the interests of shareholders by ensuring that information on payments to directors is clear and accessible to all stakeholders.

Conclusions

Directors’ remuneration requires compliance with legal requirements from different perspectives: labor, civil-commercial and tax. To avoid tax and commercial problems, it is essential that the remuneration be approved and detailed in the company’s bylaws, thus ensuring transparency and proper business management.

The evolution of case law, which has moved from the millimeter theory of the Mahou case to a more pragmatic approach with the Carrefour ruling, shows a significant change in the interpretation of the Supreme Court. Initially, the approach was extremely formalistic, requiring literal compliance with the bylaws. Subsequently, it shifted to a criterion that assesses the necessity and functionality of the expenses, allowing the deduction even when some minor formalities are not complied with.

In the field of listed companies, transparency remains essential. Remuneration must be consistently reflected in reports and aligned with the company’s remuneration policies, ensuring that the articles of association are always up to date and that all decisions on remuneration are approved by the competent bodies. This not only avoids possible sanctions, but also contributes to a more transparent and efficient corporate management, ensuring respect for the law and protecting the interests of shareholders and other stakeholders.

Autor

Salvador Cabello Guillén 
Abogado - Attorney

Datos de contacto
 + 34 652 724 645
 salvador.cabello@lariostreslegal.com

Servicios
Corporative
Litigation and arbitration
Responsabilidad civil Civil liability
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