In a recent ruling, the Spanish Supreme Court ("TS") has established doctrine on a long-debated issue that frequently arises in tax planning for estates that include rental real estate: compliance with Article 27.2 of the Personal Income Tax Law ("LIRPF") in relation to applying the 95% reduction in the Inheritance and Gift Tax ("ISD") when the transferred asset is a company dedicated to renting properties, and one of the partners or heirs is employed full-time under a labor contract.

The Case

This case arose after the death of a woman who was the sole owner of a Joint Ownership Entity (Comunidad de Bienes, "CB") dedicated to leasing commercial premises. Upon her death in 2008, her children inherited the CB in equal parts and continued the rental activity, filing their ISD self-assessments with a 95% reduction in the taxable base, in accordance with Article 20.2.c) of the ISD Law and Article 2.1.d) of Law 21/2001 of Catalonia.

However, the Tax Agency of Catalonia denied the reduction, arguing that the activity could not be considered an economic activity since the only employee was one of the heirs, who was also a co-owner. According to the tax authorities, there was no genuine labor relationship, which is a mandatory condition for rental activity to be considered an economic activity under Article 27.2 of the LIRPF.

Interpretation by the Supreme Court

The Administrative Chamber of the Supreme Court, in its ruling 969/2025 (Case 4148/2023), ruled that:

1. A co-owner’s contract is not automatically invalid as a labor contract. Being a co-owner does not preclude the possibility of a real employment relationship, as long as the legal requirements of labor law are met: alienation, dependency, and remuneration.

2. The Tax Authority failed to prove there was no genuine employment. The worker had been registered under the general Social Security scheme years before the decedent's passing, and her employment status remained unchanged after becoming a co-owner.

3. The Catalan High Court ruling violated the right to effective judicial protection, as it was based on a new argument not raised during the proceedings: that no economic activity existed even before the decedent's death.

4. The rental activity did continue after the decedent's death, meeting the necessary conditions for the ISD reduction. Therefore, the tax benefit should not have been denied.

Practical Implications

This ruling represents progress in the traditionally restrictive and formal interpretation by tax authorities in the case of family businesses involved in property rentals, especially concerning the application of Article 27.2 LIRPF.

The Supreme Court clarifies that the possibility of applying the reduction cannot be ruled out automatically, especially when the relationship meets the essential requirements of labor law, regardless of co-ownership in the CB.

Furthermore, the ruling supports a purpose-driven interpretation of tax rules, that aim to foster the continuity of family businesses rather than hinder them with overly strict formalities.

In this regard, the following passage from the ruling is key:

"The purpose of Article 27.2 LIRPF is to set minimum requirements for rental activity to be considered a business activity. In this case, this translates into how the requirement of a full-time employment contract affects the need for a minimum business infrastructure.

However, there is no doubt that this provision must be interpreted in light of the interpretative principles supported by the EU Court of Justice. In particular, the Commission Recommendation 94/1069/EC of December 7, 1994 calls for favorable tax treatment of business succession to ensure business continuity.

This Recommendation requires a purpose-based interpretation of Article 27.2 LIRPF that goes beyond a strictly formal understanding, especially since the legal text does not explicitly refer to labor law for its definition.

Labor law cannot be automatically applied as a supplement to tax law, because the principles and rules of labor and tax law are not interchangeable.”

Conclusion

Supreme Court Ruling No. 969/2025 makes it clear that the 95% ISD reduction cannot be denied merely because the worker is also a co-owner, provided there is a real and effective employment relationship.

A decision that contributes to legal certainty, common sense, and greater clarity on a long-disputed issue.