Deduction of interest of loans taken out to acquire shares

On March 30, 2007, the Federal Tax Court ruled in the case “Entertainment Depot S.A.”, where the tax authority had challenged the deductions of the interest originated in several loans that the taxpayer had taken out to acquire the shares of Musimundo S.A.

According to the facts described in the ruling, Entertainment Depot took out the loans, bought the shares of Musimundo S.A. and afterwards both companies merged in a tax free reorganization process. For purposes of determining its income tax liability, Entertainment Depot deducted the interest as an expense on the grounds that it had acquired the stock because it intended to carry out Musimundo’s activity and that for such purposes it had amended its by-laws.

The Federal Tax Authority rejected the deduction arguing that the interest was not related with the generation of taxable income.

The Federal Tax Court confirmed the position of the Federal Tax Authority on the grounds that the interest was not related to the generation of taxable income. Furthermore, it highlighted that the structure chosen by the taxpayer to finance the acquisition of the target company did not allow the interest deduction.