A novel judicial interpretation on tax-free reorganizations

On August 19 in re: “Grupo República SA v. AFIP-DGI”, Tribunal V of the Federal Court of Appeals (the “Court of Appeals”) made a novel interpretation seemingly in discord with the AFIP-DGI’s (“AFIP”) previous rulings. 

The judge of first instance voided the AFIP’s determination that the gains obtained by Banco República from the sale of a building (“Edificio República”) constituted taxable income. The court reasoned that the AFIP’s interpretation of the governing statute was in contradiction with its wording, which under its terms does not exclude the transfer of a sole asset and does not restrict non-recognition of gain to those transactions in which payment is made in stock.

Upon appeal the AFIP argued that:

(i)  the Income Tax Law (“ITL") establishes that every sale of property made by a legal entity is subject to income tax; and

Grupo República countered that the sale of goods between two companies which are a part of a single economic group does not generate profits to either company as they have common owners. To back this position, the party quoted the decision of the Argentine Tax Court (the "Tax Court") in the "Banco Sudameris Argentina S.A” case in 1999.

The Court of Appeals determined that the mere fact that two companies belong to a single economic group does not mean that a transaction between them is exempt from income tax.

Despite a series of rulings by the AFIP stating that a company’s business, which is normally comprised of multiple assets and liabilities, must be transferred in order to qualify as a tax-free reorganization under subsection c) of Article 77 of the ITL, the Court of Appeals concluded that the transfer of a single asset which is in itself a business is enough to fit the transaction under the scope of law.

The Court of Appeals emphasized that the ITL does not require that the seller receive stock of a party to the reorganization as consideration for the transfer, and therefore, it could be understood that any means of payment is acceptable. The Court of Appeals rejected the AFIP and the Tax Court’s interpretation that a tax-free reorganization does not exist when the seller receives cash in the exchange.

Notwithstanding the abovementioned arguments, the Court of Appeals rejected the tax-free reorganization holding that the continuation of activity requirement was not fulfilled because the decision to sell the building was made prior to the completion of the building’s construction, and thus the leasing activity could not have began. The Court of Appeals found that the acquiring company started its leasing activity once the building was purchased. Therefore, the Court of Appeals concluded that the continuation of business requirement was not met.

To summarize, this decision brings a new interpretation to the ITL and its regulatory decree, considering that:

(i)  the transfer of a single asset which is in itself a business could be treated as a tax-free reorganization; and

(ii) the payment in cash (not in stock) does not preclude its compliance with law.