Compulsory purchase order: tax implications in case of reversion

Compulsory purchase order (or CPO, known as eminent domain in the USA), is the power to take private property for public use by a state or authorized corporation to exercise functions of public character following the payment or just compensation to the owner of the property.

It has been a widely-used tool in Western Europe throughout the 20^th century to develop the road and railway networks, among other uses.

This is a remarkably sensitive matter, since the right of private property is one of the foundation rights of our society and legal system; moreover, it is granted constitutional protection in most of countries.

 In Spain, it is regulated under Law 16^th December 1954, and besides its traditional elements, it includes a provision which protects the original purpose of each compulsory purchase order: in case that the property is not devoted to the public use that it was intended in the first moment, its property will return to its previous owners, i.e., a resolution of the compulsory purchase order occurs.

This resolution implies bringing the parties back to the position in which they were before the CPO: the owner retakes property and the public entity gets its just compensation back, as well as an interest.

It seems clear from the Public Law point of view, but what about the tax implications of these transactions?

A recent tax ruling (V2045-14) answers the previous question:

1    - Regarding property reintegration, the administrative body considers that it does not suppose a taxable event in the Personal Income Tax, with no further explanation. However, it points out that a new date of acquisition will be established: the date of the compulsory purchase order. This has several consequences in different taxes:

Urban property value added tax: the law is restrictive to allow owners to establish a new acquisition date, as the taxable base consists of the increment of the property value in the last 20 years, counting from the date of acquisition. This means that being able to set the acquisition date two or three years ago has a direct impact on the total amount of tax to be paid.

Personal Income Tax: until 31 December 2014, the Personal Income Tax Law allowed a reduction on the acquisition price of real estate property to compensate the effect of inflation. Setting a new acquisition date would imply the inability to take advantage of this mechanism. However, after 1st January 2015, this inflation reduction no longer exists.

2    - As far as interests are concerned, the administrative body discriminates between two different kinds of interests: remunerative and compensative interests (those which act as remedies of a contract, e.g.)

Each category has a different treatment in terms of Personal Income Tax. In our case, the interests received by the landowner are considered compensative interests, as they do not represent any kind of remuneration, but a way to compensate the financial loss suffered by him. According to this, this income should be treated as capital gain.

The tax ruling examines how this income should be treated, once considered capital gain. Since the interests object of study compensate a period longer that a year, they should integrate the taxable saving base. In case that these interests compensate a period shorter that one year, they would integrate the general taxable base, which has a higher rate.