Argentina's economy has expanded at an average rate of 6.5% each year since 2003. As a result, M&A and financing activities are increasing and foreign investors are seeking to continue doing business in Argentina despite intrinsic risks and lack of structural reforms that are much needed and long overdue.
In this growth scenario, investors have navigated different routes for the purpose of funding their operations in Argentina and overcoming different legal hurdles that sometimes make such funding activities a challenge. Two of the most commonly used channels have been debt and common equity. Preferred equity is rarely used. There are some important corporate, tax and foreign exchange control issues which need to be taken into consideration when investing debt or equity in Argentina.
Local companies are generally not restricted from a legal perspective from incurring debt. The incurrence of indebtedness requires limited corporate action and board approval is generally sufficient. In addition, it is common to find that a blessing is sought from the shareholders, either as an extra assurance to the creditor or as a way to rule out any personal liability of the directors with respect to the shareholders.
The main challenges when structuring a debt transaction in Argentina will relate to how to structure the debt facility such that it is feasible from an exchange-control regulations perspective, and is also tax efficient.
The Argentinean Central Bank (BCRA) rules provide that Argentine borrowers from foreign lenders must comply with the Argentine exchange control regulations. Under these regulations, Argentine borrowers must comply with the following requirements: (i) a one-year mandatory reserve requirement equivalent to 30% of the principal amount of the loan received, which must be deposited in an interest-free, US-dollar denominated, bank account in Argentina, which cannot be pledged as collateral (the mandatory reserve); (ii) a minimum term of one year to repay the principal of the loan; and (iii) the conversion of the foreign currency into Argentine pesos in the Argentine exchange market.
The mandatory reserve requirement is, however, excepted if:
- the loan has a duration of not less that two years, taking principal and interest payments into account; and
- the funds are used to invest in non-financial assets (for example fixed assets, intangible assets per mine cost, acquisition of exploitation rights, or intellectual property rights).
Loans granted by multilateral and/or bilateral lending agencies are also exempted from the mandatory reserve requirement.
Debt: tax issues
Under Argentine income tax law, Argentine residents (including branches and other permanent establishments of non-residents) are taxed on their worldwide income. To determine taxable income, Argentine taxpayers are allowed to deduct their ordinary and necessary business expenses, including – with some restrictions – royalties, technical assistance fees and interest.
Thus, interest is a deductible expense for Argentine income tax purposes, as long as the financing generating the expense is used to derive taxable income. Likewise, expenses incurred in obtaining, renewing and repaying loans are deductible. Loans entered into with a foreign-related party must comply with arm's length terms and conditions (see Transfer pricing below).
When deriving taxed and exempt income, taxpayers must apportion the interest expense on a pro-rata basis to deduct the portion of interest corresponding to taxed income only.
Usual strategies to push down debt on acquisitions include a leveraged buyout of the target company (LBO). Under this structure, a local company purchases the shares in the local target with third-party financing (usually, loans or tax-preferred corporate bonds placed through a public offering).
The Tax Authority scrutinised the interest deduction in an LBO scenario, as well as in another where there was no merger after the purchase of the shares. In both cases, the interest deduction was disallowed because the Tax Authority construed the income tax law to allow only the deduction of expenses that are closely related to the generation of taxable income. In the Tax Authority's view, the liability entry of the loan in the acquiring company's financial statement is balanced with the entry of the shares as an asset. Consequently, there is no such close relationship to allow the interest deduction because shares derive dividend income, which is not taxable.
However, it can be argued that such interest payments should be deductible because:
- dividends are already taxed at the distributing company's level, following the integration system adopted by Argentina; under this system, dividends that originate from earning of local companies that have been taxed are not considered to form part of the income net profits attributable to the shareholders;
- dividends are subject to equalisation tax when distributed to shareholders. The Income Tax Law provides that local companies must withhold 35% of the amount of dividends and earnings that are paid in excess of the net taxable income accumulated in the year before the distribution or payment of those dividends or earnings; and
- capital gains arising from the subsequent sale of Argentinean shares by Argentine companies are subject to income tax.
General Instruction 747
With this Instruction, the Tax Authority attempted to challenge the deductibility of interest and exchange gains/losses arising from loans in foreign currency between companies located in Argentina and foreign companies for reasons such as the lack of a formal agreement between the parties, the failure to specify the terms for the repayment of principal and/or interest and the failure to include an interest rate in the loan agreement.
In addition, it is important to meet the aforementioned formal requirements in the event of an LBO so as to avoid the possibility that the Tax Authorities may challenge the exchange gains/losses and interest derived from these loans.
Thin-capitalisation rules only apply to interest on loans granted by foreign-related financial institutions to local companies. Interest is not deductible when the debt/equity ratio of the local company exceeds a 2:1 ratio. Interest that is not deductible as a result of the application of this rule should be re-characterised as a dividend and treated accordingly.
Thin capitalisation rules do not apply to interest payments subject to an effective 35% withholding tax – this is the case for tax rate reductions under a double taxation treaty – or to Argentine financial institutions and other similar entities.
However, most double taxation treaties include a non-discrimination clause under which thin capitalisation rules do not apply to interest payments made to the treaty's other party.
As per the provisions set forth below, interest payable by a local company to a foreign-related company must conform to normal market practices on an arm's length basis.
Transfer pricing rules apply to cross-border related party transactions to determine their compliance with the arm's length standard. For Argentine tax purposes, relationship is determined by ownership; leverage, functional or other similar influence; or residence in a tax haven. Cross-border licences of trademarks and patents are also subject to transfer pricing rules.
The most appropriate of five methods (which are similar to the ones established by the OECD Transfer Pricing Guidelines) must be used to prove that related-party prices are at arm's length.
Payments from tax havens
Payments received by an Argentine taxpayer from a tax haven are presumed to be undeclared income, which – increased by 10% – is subject to income tax and value added tax.
To avoid taxation, the taxpayer must produce supporting evidence that those payments have been effectively originated from activities carried out in such tax haven, or transactions already informed to the Argentine tax authorities in previous tax returns.
Because of this, funding a local entity with debt or equity from a tax haven jurisdiction, even if the controlling parent is not ultimately organised in a tax haven jurisdiction, is not recommended.
Withholding tax on debt and methods to reduce or eliminate
A withholding tax is imposed on payments of interest to non-residents. The withholding rates for the payment of interest to beneficiaries abroad are:
- 15.05% withholding tax (17.72% if grossed up) when it is paid to foreign financial institutions supervised by a Central Bank or equivalent agency, and residing in countries not deemed tax havens or with exchange of information mechanisms with Argentina with no resort to bank secrecy or other types of privacy laws; and
- 35% withholding tax (53.85% if grossed up) for all other cases.
These withholding tax rates could be reduced if a double taxation treaty were to apply. The 12% withholding tax applies to interest payments made to beneficial owners of such income that reside in Belgium, Denmark, the Netherlands, Spain or the United Kingdom, among others; interest paid to a German bank is subject to a 10% withholding tax.
Elsewhere, interest payments will be subject to value added tax (VAT) if the local company is a VAT taxpayer.
The applicable rate will be: (i) 10.5% if interest is paid to a bank located in a non-tax haven jurisdiction; or (ii) 21% in all other cases. The local company will be able to use the VAT paid on the interest as a credit against its VAT liabilities in the immediately succeeding month after such payment.
The disbursement and repayment of the loan proceeds and its interest will also be subject to tax on financial transactions. This tax is imposed on deposits and withdrawals of funds to and from bank accounts. The general tax rate is 6%. 34% of the tax on financial transactions can be credited against the taxpayer's income tax or assets tax liabilities.
In addition, loan agreements will be subject to stamp duty, which applies on any written contract executed or with effects in the Argentine provinces and the City of Buenos Aires. The rate of stamp duty varies depending on the type of contract executed and the jurisdiction where the local company is located. In Buenos Aires the general rate is 0.8%.
Public offering of securities
Argentine corporations can issue corporate bonds (Notes) to finance their activities. The issuance of notes and their placement among investors are regulated by Law No 23,576, as amended, and its
Notes may be placed among retail or institutional investors through a private or a public offering. notes will be subject to the preferential tax treatment described in Section C below if the
following two conditions are fulfilled:
- a public offering and regulatory authorisation; and
- a specified use of proceeds.
Proceeds of the placement of notes are used by the issuer for: (i) working capital in Argentina; (ii) investments in capital assets located in Argentina; (iii) debt refinancing or restructuring; or (iv) capital contributions to a controlled or affiliated corporation that will use the proceeds for any of the aforementioned purposes.
The issuer must report the appropriate use of proceeds to the Comisión Nacional de Valores within 10 business days after their effective application.
If such application is to occur in stages, the 10-business-day term starts after the proceeds of each stage are effectively used.
In this case, the issuer has to file a special report issued by an independent public accountant, confirming that the funds have been effectively used as planned.
Note issuers can avoid the mandatory reserve if the notes are placed through a public offering authorised by the Argentine Exchange Commission
Tax issues for investors
Interest on notes paid to non-resident investors is exempt from Argentine withholding tax, provided that the above-mentioned legal requirements are met.
If the notes issuer claims the exemption and fails to comply with the legal pre-requisites, interest paid to non-resident investors would be subject to the tax withholding described in paragraph (f) above.
No Argentine tax is levied on non-residents that realise gains from the sale of the notes or currency gains, regardless of whether the legal requirements are met or not.
All services relating to the issuance, placement, transfer or amortisation of Notes placed through a public offering, as well as their interest payments and guarantees, are exempt from VAT. On the other hand, the same services related to the issuance of Notes offered through a private placement are subject to VAT.
In the latter case, while most of the services will be subject to VAT at the general 21% rate, interest payments may be subject to the reduced 10.5% rate if they are made to Argentine financial institutions or foreign financial institutions resident in countries that apply the international standards of banking supervision of the Basel Banking Committee.
Personal asset tax
The personal assets tax is imposed on resident individuals' assets located in Argentina and abroad, and non-resident individuals' assets located in Argentina. For purposes of this tax, notes are deemed taxable assets, whether they are subscribed through a private placement or a public offering.
However, no procedure for the collection of this tax has been established in the law to the extent the notes are directly held by foreign individuals.
The tax law also includes an irrebutable legal presumption that securities issued by Argentine private issuers directly held by foreign entities domiciled in a jurisdiction does not require the registration of shares or private securities, and either (i) pursuant to their bylaws or the applicable law, are only authorised to engage in investment activities outside their jurisdiction of incorporation, or (ii) are not authorised to perform certain transactions authorised in their by-laws or by the applicable law in their jurisdiction of incorporation, are considered held by individuals domiciled in Argentina, being therefore subject to this tax at a 2.5% rate payable to the issuer.
However, Decree No 812/1996 establishes that the legal presumption discussed above shall not apply to shares and private debt securities, such as notes, whose public offering has been authorised by the Argentine Exchange Commission and are traded on Argentina or foreign stock exchanges.
As a result of the foreign exchange control restrictions to providing debt to fund local operations, the most commonly used mechanism to fund local investments has been equity, mainly ordinary.
Funding a local company through equity is generally a very simple matter to the extent the local company's shareholders accompany the process.
The local company must pass directors' and shareholders' resolutions accepting the contribution, increasing the stated capital and issuing shares in consideration for the funds received. Once the resolutions are passed, they are registered with the local office of corporations along with an accounting certificate that certifies that the funds have been effectively provided in compliance with local rules and regulations.
If the local company has minority shareholders that will not vote favourably to the equity issuance, then the main hurdle will be the valuation of the company that receives the funding.
Usually a third-party fairness opinion will be required to support the valuation at which the equity is being issued such that minority shareholders' interests are protected.
Preferred stock that have features of both equity and a debt instruments are subject to certain key limitations under Argentine corporate law, which have resulted in it being rarely used.
Preferred dividends will be permitted to have a preference on dividends and a preference in assets in the event of liquidation.
However the main limitations will relate to the difficulty in forcing the redemption of preferred equity and forcing periodic distributions of dividends. Under Argentine law, a holder of preferred shares cannot cause the local company to redeem preferred equity that has a stated maturity, unless it has sufficient retained earnings to do so.
Also, corporations may only distribute dividends out of retained earnings. If there are no retained earnings, the preferred dividends may not be distributed.
Capital contributions are not subject to the mandatory reserve requirement as long as the capital contribution is registered before the local public registry of commerce, which is a simple administrative procedure, and the foreign investor holds more than 10% of the capital of the local entity.
Usually the filing with the public registry of commerce is submitted to the banking authorities and with that the mandatory reserve is avoided. (A temporary deposit may be initially required by the banking authorities and subsequently released once the documentation is submitted.)
Capital contributions are not taxed in Argentina. As a general rule, dividends distributed by Argentine companies are not taxable in the hands of their shareholders, whether Argentine residents or nonresident.
However, if dividends are distributed out of earnings that were not subject to Argentine income tax (pursuant to the general Argentine income tax regime), a 35% withholding tax applies. Gains from the sale of shares of an Argentine corporation by a non-resident stockholder are not subject to income tax.
On the contrary, similar gains from the transfer by non-residents of equity interest from other Argentine companies may be subject to income tax.
If the capital contribution results in an economic concentration transaction whereby any person attains control or substantial influence, directly or indirectly, of the local entity, the transaction may need to be cleared with the local antitrust authorities.
The antitrust authorities must be notified of economic concentration transactions involving Argentine companies which generate net annual sales in Argentina exceeding Ar$200 million ($48.9 million).
However, certain economic concentration transactions are exempted from the notification requirement, such as subscriptions of shares of companies in which the acquirer already owns more than 50% of the capital stock, or acquisitions of bonds, debentures and non-voting shares or notes of a company and subscriptions of shares of a single Argentine company by a single foreign company which owns no assets in Argentina or capital stock in other Argentine companies.
||About the author
Gustavo Garrido is co-founder of Estudio Garrido Abogados, and its present managing partner. Previously he was partner and member of the executive committee of a traditional Buenos Aires law firm. He worked as a foreign associate at the New York office of Sullivan & Cromwell, and worked for several months at Studio Chiomenti in Rome in 1993.
Garrido specialises in commercial law and particularly in M&A, having obtained an LLM from Duke University School of Law.
He is an invited professor of entrepreneurship at Universidad de San Andrés and member of the Evaluating Committee of the Naves Program at IAE Business School and of Endeavor.
Garrido is also a successful entrepreneur, and participates as a venture capital investor in companies such as Otro Mundo (brewery), Biosima (biotech), Centaurus (geothermal), Salix (forestry), Invertir On Line (online trading) and Jardines de Roosevelt (real estate).
He has been a member of the board of the local companies of several private equity funds such as Advent International Corporation, Eton Park and HM Capital. Today he is a board member of the Toronto Stock Exchange company Estrella Energy Services, of the Buenos Aires Stock Exchange company Celulosa Argentina and of other closely-held companies or Argentine subsidiaries of foreign multinationals in the internet, real estate, forestry, pharmaceutical and biodiesel sectors.
Garrido is the president of the Geothermal Committee at the Argentine Renewable Energy Chamber, and in such capacity he is drafting the Argentine geothermal law.
He has been recognised by the specialist media as an M&A expert, and as such has been cited and interviewed in many press articles.
Garrido is also a well-known art collector, with particular focus on Argentine figurative art. Because of his know-how in this field he was retained by the government of Buenos Aires to draft the bill for the Art District.
Avenida del Libertador 498 - 23rd floor -
City of Buenos Aires (C1001ABR)
t: +54 11 4850 4000
f: +54 11 4850-4001
||About the author
Raúl Granillo Ocampo is a partner of Estudio Garrido-Abogados. His practice is primarily focused on M&A, project finance, private equity and commercial law.
He holds an LLM from the University of Virginia (2001). From 2001 to 2003 he worked as a foreign attorney in Arnold & Porter’s Washington, DC office.
Ocampo has had an extensive career representing national and international clients in multi-jurisdictional transactions where risk allocation and protection rights require legal, economic and political expertise. He also advises clients on their day-to-day regional operations in Latin America. He acted as lead counsel to the sellers in the $200 million sale to Contax of 100% of the Allus group of companies that provides contact centre and BPO services and that has operations in Spain, Argentina, Colombia and Peru.
He acted as lead counsel to Crystalis Grupo Seidor in the acquisition of 51% of the equity stake of the Crystal Solutions’ group of companies with IT operations in Argentina, Chile, Bolivia and the Caribbean, and as lead counsel of Patagonia Bioenergia in the structuring, financing, construction and subsequent refinancing of its 500 ton per year biodiesel plant.
Ocampo represented Mandeville Argentina in its acquisition of 70 small and medium-size Cable TV companies, for an aggregate purchase price of approximately $350 million, transforming it at the time into the third-largest cable TV company in Argentina.
Ocampo is also a writer of articles on his areas of practice for the specialist press.
Raúl Granillo Ocampo
Estudio Garrido Abogados
Avenida del Libertador 498 - 23rd floor -
City of Buenos Aires (C1001ABR)
t: +54 11 4850 4000
f: +54 11 4850-4001