A workshop, a signwritten van, two or three employees and a trading name. Behind it, a sociedad limitada (Spanish private limited company) and, running alongside, the same individual registered in his own name as a sole trader. The arrangement is common in small service businesses and it is seldom the product of a plan. It predates the company, and nobody ever fully separated the two. Judgment 987/2026 of the Spanish Supreme Court, dated 23 July 2026, appeal 957/2024, sets out what the tax authorities may do when that coexistence makes it impossible to tell which income and which costs belong to whom.
The facts: two taxpayers, one business
The company under inspection repaired domestic electrical appliances. Its director, who held 50 per cent of the share capital, also traded in his own name in a substantially identical activity, taxed under estimación objetiva (the flat rate regime for personal income tax) and under the simplified regime for Impuesto sobre el Valor Añadido, Spanish VAT.
The inspectors found that the two shared premises and registered address, used the same trading name, issued invoices with identical descriptions and drew on the same workforce without distinction, to the point that neither the employees nor the customers could say, in many cases, which of the two had performed the work.
The figures explain the interest of the tax authorities. In 2006 and 2007 the individual declared sales above 313,000 euros a year against purchases of only 32,332.97 and 13,568.63, while the company, with sales of a similar order, carried purchases of 212,132.33 and 177,677.13 euros. Income gravitated to where it had almost no effect while the individual remained within the flat rate regime, and costs to where they reduced taxable profit directly. The assessment came to 142,771.81 euros of Impuesto sobre Sociedades, Spanish corporate income tax, and 76,046.47 euros of VAT, with penalties on top, and ended in a declaration of joint and several liability against the shareholder under article 42.1.a) of the Ley General Tributaria, the Spanish General Tax Act, fixed at 312,784.40 euros.
Neither recharacterisation nor abuse of law
The order granting leave to appeal asked whether the authorities could recharacterise the transactions under article 13 of the Ley General Tributaria, or whether they were bound to follow the abuse of law procedure of article 15. The Court observes that the question rested on a false premise, since the inspectors had relied on neither provision, and reformulates it.
The reasoning matters. Article 13 allows a tax liability to be determined according to the legal nature of the act or transaction actually carried out, whatever form or label the parties gave it. Here the reality of the services was never disputed and their legal nature was never altered, and the Court accepts that part of the work may genuinely have been done by the company and part by the sole trader. On that basis it distinguishes its own judgments of 2 and 22 July 2020, appeals 1429/2018 and 1432/2018, where a single activity genuinely belonging to the company had been found.
Article 15 was equally inapt. It requires acts that are manifestly artificial or improper and that produce no relevant effects beyond the tax saving, and the authorities never argued that the coexistence of the two was artificial. The saving came from the arbitrary allocation of income and costs between two real taxpayers.
What relying on estimación indirecta actually means
The correct instrument was article 53 of the Ley General Tributaria, which permits estimación indirecta, the indirect assessment method, where the authorities cannot obtain the data needed to determine the tax base in full, among other reasons because accounting and record keeping obligations have been substantially breached. The method is subsidiary and exceptional, yet it requires no prior administrative act declaring it. It is simply applied, and whether it was warranted is argued afterwards, on appeal against the resulting assessments.
The first consequence is where the figures come from. Article 158.3 allows them to be drawn from the indicators and coefficients of the flat rate regime, from the taxpayer's own economic data for other years, from sector studies prepared using statistical techniques, or from samples of comparable businesses gathered by the inspectors themselves. Two rules deserve particular attention. Data relating to the period in which the audit is carried out may be applied to earlier years unless an adjustment is justified and quantified. And homogeneous transactions may be assessed by sampling, with the average of the sample extended to the whole period unless the taxpayer establishes specific reasons against it.
The second is scope. For direct taxes, sales, purchases and costs, or the net profit itself may be estimated, and the estimate may be confined to one of those figures where the other is sufficiently evidenced. For VAT, both the taxable amount and output tax and the deductible input tax may be estimated, but the latter only to the extent that the tax is found to have been charged and actually borne. Where the authorities lack information on that point, the burden falls on the taxpayer to identify who charged him the tax. And no input tax or cost relating to a year assessed by this method may be deducted in any other year.
The third concerns timing. For taxes with settlement periods shorter than a year, the estimated annual liability is spread evenly across the quarters unless the taxpayer justifies a different allocation. For a seasonal business, which in the Balearic Islands is the rule rather than the exception, an even spread can depart considerably from reality.
The fourth, and the one that matters most, is the shift in the ground on which the case is fought. Article 158.1 requires the assessment to be accompanied by a reasoned report on the grounds for applying the method, the state of the accounting records, the justification of the sources chosen and the calculations performed, and that report is the natural target of any challenge. But the debate ceases to be legal and becomes quantitative. The question is no longer who carried out each transaction but whether the official estimate is reasonable, and anyone contesting it must offer a better founded figure drawn from records that, by definition, allowed nothing to be quantified.
One further effect is easily overlooked. The very accounting irregularities that open the door to the method may also amount to fraudulent means under article 184.3.a) of the Ley General Tributaria, which would classify the offence as very serious. It is not automatic, since incorrect bookkeeping must account for more than 50 per cent of the penalty base and culpability must be reasoned case by case, but it is a scenario to anticipate rather than to discover on receiving the proposal.
Derivative liability and what the notice will not tell you
The second question decided carries more practical weight than doctrinal weight. Article 174.4.b) requires the liability notice to state the available appeal, the body before which it is filed and the time limit. Article 174.5 further allows the person held liable, when challenging that notice, to dispute both the grounds of liability and the assessments and penalties raised on the principal debtor. The Court separates the two: stating which appeal lies is one thing, explaining everything that may be argued within it is another, and the statute does not require it. In practice, the notice will not alert the recipient to the most valuable right available to him, and the clock runs regardless.
Practical implications
The ruling does not depend on the sole trader being within the flat rate regime. It is enough that the records do not allow income and costs to be attributed, so the doctrine extends equally to shifts between tax rates or between VAT regimes.
Separation must also be demonstrable, not merely real. Two tax numbers and two sets of books prove nothing on their own. What withstands an inspection is distinct invoicing under its own name, staff formally assigned to one taxpayer, and identified assets, with an arm's length hire agreement and genuine cross invoicing where they are shared. That exercise belongs at the outset: reconstructing after the event a separation that was never documented carries little evidential weight.
The exposure is greater still for anyone who has just converted a co-ownership into a company and keeps the sole trader registration running in parallel, since inspectors then find two titles over the same activity with no genuine separation between them. The same demand for documentary substance arises where shareholder contributions above the holder's stake produce a result the tax authorities recompose for want of any other explanation, and where a loan is waived between companies held by the same shareholder with no underlying economic substance: what is not precisely documented tends to be resolved against whoever bore the burden of documenting it.
Conclusion
What the judgment penalises is not the coexistence of a company and a sole trader in the same line of business, which remains entirely lawful, but the impossibility of reconstructing it. Where the accounts cannot show who did what, the authorities need prove neither artifice nor recharacterisation. It is enough for them to establish that they cannot determine the tax base directly.
At Lexon we review structures in which a company operates alongside the personal business activity of its shareholder, from our offices in Palma de Mallorca and Manacor. If premises, staff or a trading name are shared between the two, the separation is best documented before the inspectors are the ones assessing it.
Source: judgment of the Spanish Supreme Court, Contentious-Administrative Chamber, Second Section, 987/2026, of 23 July 2026, appeal 957/2024, ECLI:ES:TS:2026:3455; articles 13, 15, 42.1.a), 53, 158, 174 and 184.3.a) of Ley 58/2003, the General Tax Act; and judgment of the Spanish Supreme Court of 16 March 2023, appeal 3855/2021.
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This article is provided for general information purposes only and reflects the administrative interpretation in force at the date of publication. It does not constitute legal or tax advice, nor does it replace the individual analysis of each case.