Volume 5, Number 8, Page 1

Argentina's Tax Treatment of Leasing Agreements

by Martin Barreiro

For several years, tax treatment applicable to a lease of assets with a purchase option ("Leasing Agreement") was uncertain. It was not adequately clarified by the Argentine tax authority ("Tax Authority"). The logical consequence of the uncertainty was that the Argentine market did not enjoy the benefits deriving from one of the most advantageous mechanisms for obtaining technology at a low cost.

On various occasions, Argentine taxpayers filed official consultations with the Tax Authority to obtain rulings supporting favorable tax treatment of Leasing Agreements. Generally, taxpayers sought advantageous depreciation treatment and clear definition of when the Tax Authority could characterize a Leasing Agreement for tax purposes as a financed sale rather than a true lease.

On one such occasion, an Argentine bank asked for depreciation of assets over the term of the Leasing Agreement, rather than over their useful life. The bank wanted to treat the assets as an investment, depreciating them over a term which might be shorter than their useful life. Pursuant to the general useful life rules in Argentina, the annual depreciation rate for machinery and equipment is 10%; for dies, tools and vehicles, 20%; and for buildings, 2%. In special cases, the Tax Authority may authorize higher depreciation rates.

The response of the Tax Authority was contrary to the position of the bank. It required the assets to be depreciated on a straight line basis over their useful lives, rather than pursuant to the financial terms and conditions of the Leasing Agreement.

An alternative approach would be to recharacterize a Leasing Agreement as a financed sale. Section 12 of the Argentine Tax Procedure Law empowers the Tax Authority to treat a transaction for tax purposes by applying principles of substance over form. This possibility has been the subject matter of varying views of the Tax Authority which do not lend certainty to the matter.

Recent Legislation

On June 20, 1996, the National Executive Branch issued Decree 627/96, recently amended by Decree 873/97 of September 3, 1997 (the "Decrees"). They are intended to give certainty regarding the foregoing issues. They set parameters for characterization for tax purposes of a Leasing Agreement. Herein we describe the main provisions of the Decrees and their VAT and income tax effects. We do not cover provincial or municipal taxes, which are not addressed by the Decrees.

The Decrees apply only if the lessor is: (i) a financial entity organized in Argentina; (ii) a company organized in Argentina for the purpose, inter alia, of leasing real and/or personal property ("leasing company"); or (iii) a manufacturer or importer, organized in Argentina, of personal property used by a lessee as an amortizable asset.

Pursuant to the Decrees, and depending on the characteristics of the transaction, a Leasing Agreement may be treated for tax purposes as a loan agreement, a lease agreement with a purchase option, a financed sale, or a lease-back of realty. The bases for and tax consequences of these characterizations are described below.

Loan Agreement

A Leasing Agreement is treated as a loan agreement if:

a. The lessor is a financial entity or leasing company; and

b. The term of the Leasing Agreement is longer than:

(1) 50% of the useful life of the asset, if it is personal property;

(2) 10% of the useful life of the asset, if it is real estate used for housing; or

(3) 20% of the useful life of the asset, if it is real estate used for other purposes.

The option price must be set forth in the Leasing Agreement and must be a certain and determined price. It may not be the fair market value of the asset. If it is, the Leasing Agreement will be treated as a lease agreement with a purchase option, as described below.

If a Leasing Agreement is treated as a loan agreement, VAT is payable on each of the rental payments and the option price. The lessor and lessee may agree to make advance payment of VAT. In the case of real estate, VAT does not apply.

From an income tax point of view, the lessor does not depreciate the asset based on its useful life. Rather, "depreciation" is calculated by spreading the cost of acquisition over the rental payments and the option price. This "depreciation," or recapture of acquisition cost, is considered to be repayment of the principal of the loan.

The excess of any payment over the allocated depreciation is considered to be interest, taxable as income.

For the lessee, rental payments are deductible. After acquiring the asset by paying the option price, the lessee depreciates the asset on a straight line basis, pursuant to its useful life.

Lease Agreement with a Purchase Option

A Leasing Agreement is treated as a lease agreement with a purchase option if:

a. The lessor is a manufacturer or importer, regardless of the term of the Leasing Agreement, or is a financial entity or leasing company and the Leasing Agreement has a term shorter than as indicated in b. above; and

b. The option price is equal to or higher than the acquisition cost of the asset after applicable depreciation.

If a Leasing Agreement is treated as a lease agreement with a purchase option, in general VAT is payable on each of the rental payments and on payment of the option price. The lessor and lessee may agree to make advance payment of VAT. In the case of real estate, VAT does not apply.

From an income tax point of view, the lessor depreciates the asset on a straight line basis, pursuant to its useful life. It includes rental payments in income. Upon payment of the option price, the lessor has taxable income in an amount equal to the option price less the acquisition cost (as reduced by applicable depreciation) and related expenses.

For the lessee, rental payments are deductible. After payment of the option price, the lessee depreciates the asset on a straight line basis, pursuant to its useful life.

Financed Sale

A Leasing Agreement is treated as a financed sale if:

a. The lessor is a financial entity or leasing company; and

b. The option price is lower than the acquisition cost of the asset after applicable depreciation.

If a Leasing Agreement involving personal property is treated as a financed sale, VAT is payable on each rental payment and on payment of the option price. The lessor and lessee may agree to make advance payment of VAT.

In the case of real property, VAT applies on the value of the buildings constructed thereon by the lessor. VAT is payable at the time the lessee has the tenancy of the real estate, on the allocable portion of rental payments and the option price.

From an income tax point of view, consequences for the lessor and the lessee vary depending on whether the option is exercised. The lessor must notify the lessee that the Leasing Agreement will be treated for tax purposes as a financed sale. The lessor has taxable income in an amount equal to the rental payments plus the option price, less acquisition cost. The asset is depreciated by the lessee.

But if the lessee does not exercise the option, or replaces the asset, the Leasing Agreement is not treated for tax purposes as a financed sale. Rather it is treated as a lease of assets. The original income tax treatment has to be adjusted to reflect the tax treatment applicable to a lease of assets

Lease-Back of Realty

If the lessor for a Leasing Agreement is a financial entity or leasing company, and the Leasing Agreement effectuates a lease-back of realty, the Leasing Agreement is treated as a loan agreement, with income tax consequences as described above.

However, VAT applies on the portion of the rental payments and option price considered to be interest, that is to say, on the excess of any payment over the allocated depreciation.

Martin Barreiro is with the Baker & McKenzie office in Buenos Aires, Argentina. This article was reprinted with the authorization of Baker & McKenzie.

VAT Basics information provided by Marval, O'Farrell and Mairal

Rate: Standard rate of 18% to 21%

Items Subject to the VAT: Sales Rentals of movable assets within Argentina Leasing Rendering of services Imports of goods