Important Supreme Court Ruling on Tax-Free Corporate Reorganization

The Income Tax Law (the “ITL”) establishes a tax-free reorganization regime under which any gain resulting from mergers, spin-offs, and transfer of assets between entities belonging to the same economic group is not subject to Income Tax to the extent certain requirements are met.

These requirements arise from Section 77 of the ITL, and Sections 105 through 109 of its Regulatory Decree (“RD”). There are some specific requirements for mergers and spin-offs, not applicable for transfers between entities belonging to the same economic group.

In re: “Frigorífico Paladini c/ AFIP”, the company reported to the Argentine Tax Authority (“AFIP”) its corporate reorganization as merger, under the tax-free reorganization regime.

AFIP countered that requirements listed for mergers had not been met. Particularly, requirements set forth in article 105 of the RD, section I and II, which states that both companies should be operative and companies must develop same or related activities during the 12 months prior to the reorganization.

Upon appeal the taxpayer requested the reorganization to be considered as a transfer between entities belonging to the same economic group, to avoid the fulfillment of those requirements. AFIP refused this as well.

The Judge of First Instance and the Federal Court of Appeals of Rosario followed the AFIP’s ruling. The Federal Court held that requirements for the merger to be qualified as tax-free reorganization had not been met and did not allow the reorganization to be considered as an “economic group”. In fact, in such case the Federal Court believed that the requirement of continuance of activity, for at least 2 years as from the date of the reorganization had not been met.

On March 2, 2011, the Argentine Supreme Court of Justice, shared the arguments held by the Attorney General and withdrew the sentence of the Federal Court of Appeals.

This decision is important because it emphasizes that:

1. proceedings before the administration should be informal, in favor of the taxpayer; the circumstance that the taxpayer did not inform from the beginning was the reorganization as “economic group”, could not be a severe consequence.
2. The scope of the “economic reality principle”: economic reality should prevail over legal forms to evaluate if the corporate reorganization qualifies as tax-free reorganization.

As a consequence, the Supreme Court has overlooked the legal formalities and has analyzed the facts and the applicable law, withdrawing the AFIP’s ruling.