Volume 5, Number 15, Page 1

Argentine Tax Bill Hits Investors

An Argentine tax reform bill pending in Congress promises major changes, including changes impacting foreign investors. The bill would eliminate existing exemptions and increase tax rates. It contemplates disparate treatment for subsidiaries vis-a-vis branches, changes the VAT law, and adds a new tax on interest paid and the financial cost of business debt (IFD).

Companies would also face a new assets tax (the tax on “minimum presumed income,” or MPI), which would be imposed at a rate of one percent. The rate would be lower for banks, insurance companies and some consignees. It would require foreign investors to consider the potential risks of creating a permanent establishment (PE) in Argentina. In addition, inter-company transactions would be subject to new transfer pricing rules. The scope of tax-free reorganizations would also be limited.

The bill also introduces more than 60 sections covering a wide array of topics in the international tax arena. These include definitions of residence and foreign-source income, modifications to the treatment of foreign PEs and subsidiaries, new rules on currency conversions, timing of recognition of income and expenses, the use of net operating losses, exemptions, income characterization and foreign tax credits, and the allocation of income and expenses.

The income tax, VAT, excise tax, personal assets tax (PAT) and social security tax (SST) laws would be amended by the bill. In addition, two new taxes, the MPI and the IFD, would be implemented. Congress has already begun reviewing the provisions. The bill would take effect on the date of its publication in the official gazette, with the following exceptions:

1) Changes to VAT would take effect one month after publication in the official gazette;
2) Changes to the excise tax and IFD would take effect on January 1, 1999;
3) Changes to the income tax would, in general, be effective as of the date of the bill’s publication in the official gazette, but the new exemption on interest on loans granted to individuals and the elimination of the temporary character of some exemptions would take effect on January 1, 1999;
4) Changes to the MPI would be effective as of the first fiscal period after date of publication in the official gazette; and
5) Changes to the PAT would take effect on December 31, 1998.

The proposed law would make changes in the following areas:

Income Tax - Argentine business entities are subject to a 33 percent income tax rate— the same rate applied to individuals in the highest bracket. Dividends or remittances by branches are not subject to withholding tax.

The tax rate for business entities would increase, and a new top bracket for individuals with taxable income exceeding $200,000 would be added. The maximum rate for individuals and corporations would be 35 percent. In addition, dividend payments meeting certain conditions would be subject to withholding.

Definition of Resident - Argentine residents are taxed on a worldwide basis. The amendments would include the following in the definition of resident:

1) Argentine individuals, unless there is a loss of residence;
2) resident aliens;
3) estates of Argentine individuals and resident aliens;
4) domestic entities, such as corporations, limited liability companies, associations, and foundations;
5) other domestic companies or businesses; and
6) trusts and closed-end funds.

Individuals who have lost their resident status would become foreign beneficiaries for purposes of determining Argentine-source income.

Definition of Nonresident - Nonresidents are subject to income tax on their Argentine-source income. The bill defines the term nonresident to include: (1) PEs; (2) members of foreign countries’ diplomatic and consular missions in Argentina, their foreign technical and administrative personnel, and their relatives; foreign representatives of international organizations of which Argentina is a member who conduct activities in Argentina, and their relatives; (3) foreign individuals working in Argentina for less than five years and their relatives; and (4) foreign students and researchers authorized by the Argentine immigration control authority to stay temporarily in Argentina. PEs would not be taxed on their foreign-source income.

Foreign-Source Income - Under the bill, foreign-source income includes income arising from: (1) assets located, placed, or economically used abroad; (2) the performance of any for-profit act or activity abroad; or (3) activities outside Argentina, unless specifically considered sourced in Argentina, such as the offshore sale of assets exported from Argentina.

Foreign Losses - Foreign-source net operating losses could be used to offset foreign-source income over a five-year carryforward period.

Foreign PEs - Under the proposed reform, income attributed to a foreign PE of an Argentine resident would be considered foreign-source income, unless provided otherwise. Each foreign PE must have its own accounting records, and transactions between the Argentine owner and the foreign PE must occur on arm’s-length terms.

The foreign PE income would be attributed to the owner on an accrual basis in the fiscal year in which the PE ends its fiscal period. The exemption proposed for interest earned on deposits of domestic business entities at financial institutions would not be applicable to foreign PEs.

Foreign Partnerships - Income from foreign partnerships would be attributed to domestic partners in the tax year in which the foreign partnership ends its fiscal period.

Foreign Corporations - Transactions between Argentine residents and foreign corporations that they directly or indirectly control must occur on arm’s-length terms.

Dividends received from foreign companies would be considered taxable, and income from stock redemptions would be treated as dividend income.

Foreign Tax Credits - Argentine residents would be allowed a credit against their Argentine income tax liability on foreign-source income for similar taxes paid abroad. These credits could be carried forward for five years.

Dividends - The bill introduces a 35 percent withholding tax on dividends distributed by corporations, limited liability companies, trusts, and closed-end funds to the extent the amount distributed exceeds the entity’s taxable income. This rate may be lowered by applicable tax treaties.

The portion of the dividend subject to tax is computed as follows:

(+) Dividend
(-) Taxable income of the distributing company
(+) Tax paid by the distributing company
(-) Dividends or profits excluded from taxable income

Distributed dividends would be allocated on a first-in-first-out basis to the corporation’s earnings and profits. E&P retained as of the last fiscal period before publication of the reform in the official gazette would be grandfathered and, therefore, not subject to tax.

This provision would take effect with respect to the E&P of the first fiscal period after publication of the bill in the official gazette. It should be noted that the proposed bill contains no branch profits tax.

Interest for Nonresidents - Currently, interest paid abroad is generally subject to withholding tax at a rate of 13.2 percent.

Under the bill, if the borrower or recipient of any type of deposits permitted under Argentine banking laws is a financial institution or the lender is a financial entity located in jurisdictions where the banking control body has adopted the international standards of banking supervision of the Basle Banking Committee (BBC), 43 percent of the interest paid is deemed to be the net taxable income. This implies a 15.05 percent withholding tax.

For deposits in financial institutions, interest is exempt if the jurisdiction where the depositor is located does not impose a tax on that interest.

Nevertheless, if the borrower is not a financial institution and the lender is not a financial entity located in a jurisdiction that has adopted the BBC standards, 100 percent of the interest paid abroad is deemed to be the net taxable income, and the withholding tax would reach 35 percent.

Withholding taxes may be reduced by applicable tax treaties.

The bill would repeal the current withholding exemption for interest paid on loans obtained abroad to finance the acquisition of capital goods other than automobiles.

Interest for Residents - Other than Argentine financial institutions (AFIs), business entities would be exempt from income tax on interest earned on deposits at financial institutions. Interest on loans made by individuals domiciled in Argentina to business entities other than AFIs would also be exempt.

The bill proposes a 35 percent withholding tax on interest payments made by Argentine business entities other than AFIs to other Argentine business entities — other than AFIs.

The bill also prohibits business entities other than AFIs from writing off interest incurred on an accrual basis.

Interest could be deducted only if paid before or on the date the annual tax return for that period is due.

Moreover, businesses would not be allowed interest deductions exceeding the difference between (1) the total amount of liabilities accruing interest at the end of the fiscal period over the net worth at that date, and (2) the total amount of deductible interest over 50 percent of the taxable income (before the interest deduction). Nevertheless, 40 percent of the interest from loans granted by Argentine financial entities or from negotiable obligations whose holders are not Argentine business entities or nonresidents would be deductible.

Trademarks and Patents - The new bill authorizes the enactment of further regulations to limit the amount deductible for trademarks and patents owned by nonresidents.

Transfer Pricing - The bill retains the arm’s-length principle but introduces the following methods to assess whether the arm’s-length standard is met: the comparable uncontrolled price method, the resale price method, the cost-plus method, the profit-split method, the residual profit split method, and the transactional net margin method.

Reorganizations - To be granted nonrecognition treatment, business reorganizations would be subject to an additional requirement. Tax-free status would be accorded only if the currently required two-year holding period or listing in a stock exchange after the date of the reorganization is extended to the two-year period before the reorganization date.

Exporters - Export reimbursements granted by the government would no longer be exempt.

Severance Payments - The bill repeals the option granted to taxpayers to deduct a special reserve for severance payments in connection with seniority.

Trusts and Mutual Funds - Trusts and closed-end funds would finally become income taxpayers by statute.

Foreign Annuities - Annuities managed by foreign entities or PEs would in general be granted the same treatment as those managed by domestic companies.

IFD - The IFD may apply to business entities on any interest paid that is deductible for income tax purposes, as follows:

Originated In	Rate
Credit Transaction with Argentine financial institution	15%
ONs whose holders were Argentine business entities or non-residents	15%
Loans granted by individuals resident in Argentina	35%

The tax would be paid by business entities acting as borrowers or issuers of negotiable obligations and would not be deductible for income tax purposes.

MPI - The proposed MPI tax replicates, to some degree, the assets tax repealed in June 1995.

The MPI rate would be 1 percent, and the tax would be imposed on the worldwide assets of Argentine business entities, including trusts, closed-end funds and foreign PEs.

Like its predecessor, the assets tax, the MPI contains a broader definition of PE than the one contained in the OECD model treaty. Income tax would be creditable against MPI tax, and if the income tax liability is greater than the MPI, the taxpayer would be allowed to credit against the income tax the excess during the two prior fiscal periods.

To avoid double taxation, equity interests in other Argentine business entities would be exempt, and financial institutions and insurance companies would consider only 20 percent of their assets taxable. Consignees of cattle, fruit and Argentine products would consider 40 percent of their assets taxable.

The bill would grant a credit for similar taxes paid abroad with respect to assets located outside of Argentina, and tax treaty provisions may reduce or eliminate the MPI tax.

VAT - VAT in Argentina is generally imposed on the sale of goods within Argentina, the importation of goods, and the rendering of services within Argentina. Services performed within Argentina but actually used or exploited abroad are deemed to be exports and are exempt from VAT. The general VAT rate is 21 percent.

Cross-Border Services - The bill adopts a new approach to cross-border services transactions. Under current law, compensation for services is taxed only if the services are performed within Argentina. The proposal takes a “country of destiny” approach, taxing services when the recipient is a VAT taxpayer in Argentina.

Under the reform, services performed outside Argentina but actually used or exploited within Argentina would be deemed to be performed in Argentina and then subject to VAT, but only to the extent that the recipient is a registered VAT taxpayer in Argentina. In general, this rule would affect such services as data processing, leases, telecommunications, advertising, technical assistance, reinsurance and financial services. It would not affect intangibles such as intellectual property rights, industrial designs, patents and trademarks.

In general, the tax would be due at the earlier of the end of the performance of the service or the partial or total payment for the service. For financial services, the tax on the interest portion would be due at the earlier of the due date for the interest component and the partial or total payment for the service. The recipient would be entitled to credit the VAT paid against its VAT debit in the following VAT return.

Services performed within Argentina but actually used or exploited outside would be deemed performed outside Argentina. Under this approach, inbound services would no longer be “exports,” and it is inferred that they are not going to be eligible for credit for VAT inputs, offsetting against other federal taxes, or refund by the fisc.

VAT Breakdown - The VAT imposed on each transaction would have to be outlined in invoices or equivalent documents.

This article was reproduced with the authorization of Tax Analysts. Dana Jaffe Ferre is a senior associate at Coopers & Lybrand LLP in New York. Daniel Rybnik is an international tax manager with Harteneck, Lopez y Cia on secondment at Coopers & Lybrand LLP in New York.