Interest deductions from a loan entered to reduce capital

On October 25, 2005 Division A of the Argentine Tax Court (“Tribunal Fiscal de la Nación”) pronounced in re:“Swift Armour S.A. Argentina s/recurso de apelación – Impuesto a las Ganancias”, where the taxpayer and the Argentine Tax Authority discussed the deductibility for income tax purposes, of interest paid due to a loan entered into to execute a capital reduction.

Pursuant to the facts stated in the Court’s judgment, on June 7, 1999 the company approved a capital reduction of $ 55,000,000. Since it did not have fresh funds to pay the shareholders the credit derived from the capital reduction, it entered into a syndicated loan, the proceeds of which were directly applied to said payment.

The company deducted the interest paid and the Argentine Tax Authority challenged such deduction on the grounds that such interest was not related to obtaining taxable income and/or maintaining the source of said income.

On the other hand, the taxpayer supported the deductibility of the interest on the grounds that being an entity, it was ruled by the principle of global liabilities ("Principio de Universalidad del Pasivo"), which states that all liabilities finance all of the assets and all of the companies’ activities. It also argued that, even if the strict asset-liability relationship intended by the tax authority were to be applied, the deduction would still be applicable, because the capital reduction was part of the corporate purpose (objeto social) and therefore necessary to obtain taxable income and/or maintain the source of said income. Finally, it also argued that the only limit for interest deductibility is given by the thin-capitalization rules set forth in the income tax law, but that such limit had not been surpassed in the case under analysis.

The Argentine Tax Court unanimously decided in favor of the taxpayer, and rejected the assessment made by the Argentine Tax Authority. In this sense, the Tax Court accepted the taxpayer’s arguments, on the grounds that Income Tax Law does not foresee the apportionment method ("afectación patrimonial") for corporations, expressly foreseen for individuals and estates. Furthermore, the Tax Court considered that a capital reduction is directly related to the commercial activities of a company, and thus related to the conservation of the source that produces the taxable income.

In other words, the Argentine Tax Court confirmed the deduction of interest paid for a loan entered with the only purpose of executing a capital reduction.