Income Tax deductibility of losses derived from the assignment of credits

As per the facts and circumstances described in the sentence, Ormas –a company engaged in the construction of electro mechanic equipment- had granted loans to Central Térmica San Nicolás S.A. –a corporation in which Ormas was an indirect shareholder through Inversora San Nicolás S.A. - for an aggregate amount of US$ 10,000,000. In December 2004, Ormas started to disengage from these investments, selling its equity participation in Inversora San Nicolás S.A. and assigning the credits granted to Central Térmica San Nicolás S.A. The whole transaction was agreed in the aggregate amount of US$ 17,534,500 being the assignment of the credit agreed in US$ 4,000,000. Ormas deducted the difference between: i) the face value of the credits plus interest accrued until December 1993 (US$ 11,541,395) and ii) the assignment value (US$ 4,000,000) for income tax purposes.

The tax authority challenged the deduction arguing that it was a liberality in favor of the assignee of the credit, which was not deductible. Furthermore, it argued that Central Térmica San Nicolás S.A. was not going through any kind of insolvency situation.

The Federal Tax Court ruled in favor of the tax payer on the grounds that the loss was a “capital loss” without any limitation to be deducted. Furthermore, the Tax Court understood that the assignment price was arms-length because the discount rate was lower than the interest rate of the market and because the credit was a long term one and therefore repayment thereof was not certain.

This case is interesting because the Tax Court concluded that the loss arising from the assignment of the credit was a “capital loss” and therefore it had to be computed in the fiscal period in which the assignment took place; notwithstanding the fact that it was a financial transaction and as such, revolving around the passage of time.

Please be advised that this sentence has been appealed before the Federal Court of Appeals.