This edition of Argentine Business Law Watch1 responds to our readers’ clamor for a summary of the various tax reforms recently signed into law by Argentine President Néstor Kirchner. In June 2003, Argentine Business Law Watch reported on four tax reform bills sent by the executive branch to Congress. Laws 25,784 and 25,795 represent the first of these reforms to be enacted.
Laws 25,784 and 25,795 (collectively, the "Amendments") aim to enhance public revenue by closing certain perceived loopholes. Law No. 25,784 introduces substantive changes to the Argentine Income Tax Law, expanding presumptions favorable to tax, enhancing the tax authority’s power to disallow credits and deductions, and creating new rules to control international transactions. Law No. 25,795, enacted last month, modifies various procedural matters to counteract tax evasion. The Amendments, centered on transfer pricing, thin capitalization rules, withholding tax on interest payments and expense accounting for transactions with foreign related parties, are directed primarily at corporate taxpayers.
Until the Amendments, Argentine exporters reported their tax on income from international trade based on the higher of the export price or the market price for the goods at destination. Non-Argentine exporters were not subject to Argentine withholding tax unless the import price for the goods exceeded the prevailing wholesale price at origin. If the import price did exceed the wholesale price at origin, the difference was taxed as Argentine source income for the foreign exporter. Insurance and freight were always added to the transaction price when comparing the prevailing wholesale price.
The Amendments repeal the prevailing wholesale price method, adopting a clearer rule in which foreign exporters are never subject to Argentine income tax on gains from exports to Argentina. Instead, tax adjustments will be made to the Argentine counterpart’s income tax burden and commodities or other products with a determinable international fair market value will be assigned that value to determine the tax. When Argentine taxpayers enter into international trade transactions with foreign related parties or entities located in tax havens,2 these adjustments will be made according to transfer pricing rules. Alternatively, the tax authorities will apply a yet-to-be-regulated method to international trade transactions between unrelated parties, which exceed a not-yet-defined annual aggregate amount.
The Amendments subject related-party exports to stricter transfer pricing rules to determine the arm’s length price of the transaction. Argentine commodity exporters will be required to apply the "comparable uncontrolled price method" when selling products abroad through a foreign broker that does not take physical custody of the goods. In this case, the comparable uncontrolled price means the fair market value of the commodity on the date of shipment if this value exceeds the recorded price of the sale. This method may prove adverse to Argentine commodity exporters accustomed to fixing a sales price at the date of sale. The Amendments effectively preclude exporters from hedging against price fluctuation between sale and shipment Moreover, the rules could mean a change in the current accrual method of accounting, which books the transaction as of the sales date.
The comparable uncontrolled price method does not apply if the foreign party is the final purchaser of the exported goods. Moreover, the Amendments provide a safe harbor under which the method will not apply, even if the counterparty is a foreign broker. Under this exception, the foreign broker must meet all of the following:
- It conducts business in its country of domicile, with "sufficient material and human resources" to engage in brokerage activities, and assets, risks and functions compatible with the transacted volumes.
- Its principal business activity is neither passive investments nor the brokered sale of goods originated in Argentina, shipped to Argentina or involving parties related to the Argentine exporter.
- Not more than 30% of its total annual gross revenues derives from intermediary activities with companies of a single economic group.
The Amendments apply transfer pricing rules, in lieu of anti-deferral rules, to allocate to Argentine exporters presumed income of their foreign intermediaries. A similar result might have been achieved by treating the foreign intermediary’s income as passive under anti-deferral rules, although that approach would only have reached Argentine exporters selling goods through intermediate subsidiaries. Transfer pricing rules, on the other hand, apply a broader test to the relationship allocating presumed intermediary income to the Argentine exporter based not only on control, but also considering debt leverage and other functional equivalents that exceed the test of ownership. The drafters of the Amendments have sought to close a loophole and cast a broad net to capture income allocated offshore.
Thin Capitalization Rules
Until the Amendments, thin capitalization rules conditioned 60% of Argentine companies’ (other than banks and other regulated financial institutions) interest expense deduction on bank loans or publicly-offered bonds , if two limits were exceeded. The first threshold referred to a 2.5:1 debt-to-equity ratio,3 while the second turned on a pre-deduction interest expense equal to 50% of the taxpayer’s net taxable income.4 When both were exceeded, the excess amounts on each were quantified as percentages, with the nondeductible portion of the interest expense determined by reference to the greater of the two percentages. Any disallowed interest expense could be carried forward to the following five taxable years and a deduction taken during that time, as long as the thin capitalization rules were not triggered in the relevant year.
The Amendments narrow the scope of thin capitalization rules but imbue them with more severe consequences. While financial institutions continue to be excluded, the rules apply to interest expense on cross-border loans qualifying for the lower 15.05% withholding rate, which cause the borrower’s debt-to-equity to exceed a 2:1 ratio (see also the following section, "Withholding Tax on Interest"). In that event, the full interest accrued on the principal exceeding the ratio will be disallowed as a deduction (rather than deferred) and recharacterized as a dividend distribution. Though unclear, the Amendments appear to apply only to loans by a foreign bank deemed for tax purposes a "related party" based on the bank’s share of the local entity’s indebtedness.
The repeal of the former thin capitalization rules raises questions as to how to compute previous years’ disallowed interest expense. It is also unclear if the characterization of disallowed interest as a dividend means only disallowance of the deduction or implies taxation of the amount as a dividend.5
Withholding Tax on Interest
The Amendments also modify the withholding tax rate applicable to interest. Previously, nonresidents were subject to withholding tax on interest payments at a 35% rate, unless the borrower was an Argentine financial institution, in which case the withholding rate decreased to 15.05%. The reduced withholding tax rate also applied to interest payments on loans by (i) foreign financial institutions domiciled in jurisdictions observing international banking supervision standards of the Basel Banking Committee or (ii) foreign providers of capital assets. Interest on loans from foreign financial institutions providing only offshore banking services was subject to the 35% withholding rate.
The Amendments change the conditions for a reduced withholding rate applicable to financing by foreign financial institutions, and domicile in a jurisdiction abiding by the Basel rules is no longer determinative. To qualify for the 15.05% withholding rate on interest payments, the lender must meet the following requirements:
- Be subject to oversight by a Central Bank or similar entity.
- Not be domiciled in a tax haven 6 or be domiciled in a jurisdiction that adheres to by an information exchange treaty with Argentina.
- Not be exempt from information disclosure to local tax authorities due to bank secrecy or other privacy laws.7
In addition, principal, fees and other payments (other than interest) paid on the loans will be treated as interest. This departs from former rules, which did not treat ancillary fees (e.g., commitment or advisory fees) as interest for tax purposes. These fees were thus exempt from Argentine withholding tax when generated by activity outside Argentina.
Deduction of Foreign Related-Party Expenses
The Amendments also modify expense accounting for payments to foreign related parties. Former rules allowed the deduction of expenses incurred with foreign related parties when accrued and paid, thus preventing a borrower from accelerating the deduction through prepayment. The new rules apply the same accrual method but broaden the meaning of "related party" to any person with "substantial influence" over the management or activity of the Argentine taxpayer.
Joint and Several Liability
The Amendments modify the tax liability of companies acting in a joint venture. As amended, participants of these associations (which do not qualify as a separate legal person under Argentine law) are jointly and severally liable for the venture’s tax obligations. As most taxes are already passed through to the participants, this liability essentially relates to VAT. The Amendments do not specify if joint and several liability applies to a company with a passive interest in the venture’s business, and this legislative gap is likely to generate criticism. Taxpayers involved in a joint venture will now be treated as investors in any other structure that does not afford limited liability.
Unreported Increases in Net Worth
Argentine tax law penalizes in general unreported increases in net worth by treating it as net taxable income for income tax purposes and as the basis (transaction price) for VAT In addition, the law adds a 10% of presumed nondeductible expenses (e.g., personal expenses) to the unreported increase in determining the taxes payable. The Amendments extend the same presumptions to these other contexts:
- The difference between reported production figures and those assessed by the government through use of satellite images. The imputed net worth increase will assume the fair market value of the goods in the taxpayer’s principal place of sales. The increase will be considered for income tax, VAT, assets and personal assets taxes purposes.
- Bank deposits in excess of sales or declared taxable income.
- Compensation to unregistered employees, as well as unreported wages paid to registered employees.
The Amendments shift the burden of proof from the tax agency to the taxpayers and consider all funds received from tax havens as undocumented increases in net worth. As a consequence, those amounts (plus 10% as presumed nondeductible expenses) will be deemed the basis for the assessment of unpaid income tax and VAT. Taxpayers are allowed to prove –with adequate supporting evidence– that funds were generated by activities genuinely performed by the taxpayer or third persons. Nonetheless, the rules declare the tax agency adjustments as conclusive and binding, absent the taxpayer’s proof of the contrary.
Liability and Limitation to Claim Deductions or Credits
The Amendments require taxpayers entering into transactions with their suppliers of goods and services to verify supporting documents. Failure to do so diligently will subject the taxpayer to liability for taxes avoided through false or incomplete documents. If a taxpayer does not verify invoices issued by its providers, deductions, VAT credits and other tax benefits accrued from the transaction will be disallowed. Taxpayers failing to comply with rules governing payment means (e.g., checks or other documents for amounts in excess of AR$1,000) imposed by the tax authority will be treated identically.
Until the Amendments, failure to file special transfer pricing returns, underpayment of taxes and tax fraud related to international transactions were not subject to specific fines. The Amendments change this to establish specific fines for this conduct. The most significant aspects are:
- Failure to file required information related to import-export transactions with unrelated parties is subject to a fine of AR$1,500. For Argentine business associations and trusts or "permanent establishments" (e.g. branches) belonging to foreign persons, the fine is increased to AR$9,000 per violation.
- Failure to file information (to be specified by future regulations) with respect to other international transactions, including those with related parties, is subject to a fine of AR$10,000. For foreign-owned taxpayers, the fine is increased to AR$20,000.
- Failure to comply with the tax authority’s demand to provide information related to an international trade transaction or to maintain books and records reflecting the transaction price is subject to fines ranging from AR$150 to AR$45,000. These fines may be cumulative to the previously described ones.
- Violations of transfer pricing rules resulting in an adjustment will subject the taxpayer to a fine of one to four times the underpaid income or withholding tax, with the specific amount determined by reference to the taxpayer’s history of compliance with reporting requirements.
In addition to fines, the Amendments empower the tax authority to demand evidence of the international trade transactions in the course of an audit. The failure to comply with the demand is subject to an additional penalty ranging from AR$500 to AR$45,000. For larger taxpayers (those with annual gross revenue equal to or greater than AR$10 million) failing to respond to three demands, the fine may be increased by an amount anywhere from AR$90,000 to AR$450,000.
The punitive aspect of the Amendments emphasize a policy to discourage taxpayer efforts to hide from the tax authorities foreign transactions or the full tax value of those transactions. Another apparent policy choice is to punish more severely a foreign-owned taxpayer. This disparate treatment begs to be challenged in the courts as unconstitutionally discriminatory. It also is subject to challenge on the basis that it violates any applicable double tax or bilateral investment treaty.
In addition to these new sanctions, the Amendments authorize a specific fine for taxpayers reporting sham net operating losses. For this conduct, the taxpayer will be subject to a fine equal to two to ten times the unpaid tax. The "unpaid tax" will be assessed by applying the maximum income tax rate to the sham net operating loss.
Refunds and Prescription of Claims
The Amendments alter the refund of indirect taxes, allowing the taxpayer to seek a refund for these amounts only if not passed on to the consumer (i.e., increase of the final price). The Amendments also set a five-year statute of limitations for two particular claims. Thus, the government is limited in its claims to recover improper tax credits and the taxpayers are similarly prescribed for their claims to a refund. In both cases the five years begins on January 1 of the following calendar year in which the credits were taken or the refunds accrued. As prescription of these claims had not been specifically regulated under former rules, the measures enhance certainty.
Disclosure of Information
The Amendments also address the official exchange of information pursuant to applicable treaties between Argentine and other countries’ tax authorities. As revised, the government will share requested information, as long as the foreign agency agrees to treat the information confidentially and deliver it only to employees or representatives of the tax authority or judicial branch.
1 "Argentine Business Law Watch" is a periodic news service provided free of charge to clients and friends of Negri, Teijeiro & Incera. To read past editions of "Argentine Business Law Watch", visit our website atwww.negri.com.ar.
2 Transactions with entities located in tax havens are considered per se as not arm’s length.
3 The debt-to-equity ratio only considers debt generating interest subject to thin capitalization rules.
4 The test only considers interest expense subject to thin capitalization rules.
5 Dividends distributed out of certain exempt income are subject to a 35% withholding tax.
6 For tax purposes, Argentina specifies the following countries or territories as tax havens: Albania, American Samoa, Andorra, Angola, Anguila, Antigua & Barbuda, Aruba, Ascension, Azores Islands, Bahamas, Bahrain, Barbados, Belize, Bermudas, British Virgin Islands, Brunei Darussalam, Campione D'Italia, Cayman Islands, Channel Islands (Guernesey, Jersey, Alderney, Great Stark Island, Herm, Little Sark, Brechou and Jethou Lihou), Christmas Island, Cook Islands, Cyprus, Djibouti, Dominica, Free Zone of Ostrava, French Polynesia, Gibraltar, Granada, Green Cape, Greenland, Guam, Guyana, Honk Kong, Isle of Man, Isle of Norfolk, Isle of San Pedro and Miguelon, Jordan, Keeling Island, Kiribati, Kuwait, Labuan, Liechtenstein, Liberia, Luxembourg (with respect to holding companies governed by the law of July 31, 1929), Macao, Madeira, Maldives, Malta, Marshall Islands, Mauritius, Monaco, Montserrat, Nauru, Netherlands Antilles, Niue, Oman, Pacific Islands, Panama, Patau, Pitcairn, Puerto Rico, Qatar, Qeshm Island, Saint Kitts & Nevis Islands, Saint Vicent & Granadines, Salomon Islands, San Marino, Santa Lucia, Santa Elena, Seychelles, Sri Lanka, Svbalbard, Swaziland, Tokelau, Tonga, Trieste, Trinidad & Tobago, Tristan Da Cunha, Tunisia, Turks & Caicos, Tuvalu, United Arab Emirates, Uruguay (only with respect to offshore "finance" companies), U.S. Virgin Islands, Vanuatu, Western Samoa, and Yemen.
7 This requirement may exclude Luxembourg financial institutions from the benefit of reduced withholding tax.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.