Income Tax: restrictions to deduction of expenses

On December 17, 2008 the Federal Tax Court (“FTC”) ruled in the “Novos” case and confirmed the assessment made by the Federal Tax Authority (“AFIP”) to Novos S.A. (“Novos”) on Income Tax for the fiscal year 2000.

Pursuant to the facts of the case, a foreign shareholder of Novos made a capital contribution provided that Novos would pay any taxes levied on the participation of the shareholder. One of these taxes was Personal Assets Tax (“PAT”). Novos paid the corresponding PAT and deducted it for Income Tax purposes. The AFIP objected to the deduction, because the PAT paid was not necessary to obtain and maintain taxable income.

In general, as of December 31 of each calendar year, shares owned by individuals –domiciled in Argentina or abroad– and legal entities domiciled abroad are subject to PAT. The PAT must be paid by the local companies who are entitled to request a refund from its shareholders.

The FTC held that according to Income Tax Law those taxes which arise from assets that produce gains may be deducted from Income Tax. Therefore, the PAT paid could not be deducted because it did not arise from Novos’ assets. Moreover, the FTC held that waiving the right to claim a refund from the PAT paid was not the equivalent of uncollectible credit (“crédito incobrable”), which is a deductible expense. Only uncollectible credits coming from the taxpayers’ commercial activities are deductible.