New Argentine Tax Rules On Leasing

By Guillermo Teijeiro and Leandro Passarella

For Argentine legal purposes, a leasing is an agreement pursuant to which one party (lessor) grants to another (lessee) the right to hold, use and enjoy property for a specified term in consideration for a periodic payment of a price, with an embedded option to the lessee to purchase such property at the termination of the agreed upon lease period for a predetermined or determinable strike price. Argentina did not have specific rules dealing with leasing until January 1995, when the Leasing Contract Act (the "LCA") was enacted as Title II of Law No. 24441.¹

In June 2000, the Argentine Congress passed Law No. 25248 (the "New Leasing Contract Act" or "NLCA"), which completely amended the LCA. The NLCA abrogated Title II of Law No. 24441 and set forth an expanded legal framework aimed at promoting this financial scheme, which has not quite developed in Argentina yet. NLCA contains clearer rules and targets a broader scope of leasing alternatives. It should follow, then, that Argentina will have now available a better instrument (i) to modernize infrastructure at conditions beneficial to both lessor and lessee, (ii) to promote consumption in the domestic market, and (iii) to finance business activities in general. Based on these amended rules, the Executive Branch issued the Decree No. 1038/2000 (the "Decree"), which replaces the old tax rules contained in Decrees No. 627/96 and 873/97, and provides the new tax framework applicable to leasing transactions under NLCA.

Section B of this Chapter summarizes the new legal framework applicable to leasing agreements. Chapter II and Chapter III discuss the new income tax and value-added tax regulations provided by the Decree, respectively. Chapter IV summarizes the potential benefits that Argentine taxpayers may derive from the leasing in terms of savings of tax on interest. Chapter V presents the issue of cross-border leasing transactions, which is not covered by the Decree. Finally, Chapter VI contains our final remarks on the expected impact of NLCA and the Decree.

The NLCA modified and expanded the existing legal rules applicable to leasing agreements. The most relevant aspects of the current regime are summarized below:

1. Property that can be leased: Under the NLCA, not only tangible property but also certain intangibles—namely, trademarks, patents, industrial designs and software—can be leased. Under prior law, only tangible property could be object of a leasing agreement.
2. Leaseback of personal property: While under both prior and new law it is possible to enter into a leaseback of real property, the NLCA expressly permits the leaseback of personal property, which was implicitly forbidden under prior law.
3. Installment calculation: The LCA required that the lease installments had to be calculated based on the depreciation of the assets. The NLCA expressly provides that the amount of the installments can be freely agreed upon by the parties with no reference to the property's depreciation or amortization. In addition, the NLCA contemplates the possibility that fees for certain services that the lessor may provide to the lessee under the leasing (i.e., the design of the leased property, its installation, its beginning of operations and its delivery) be considered for purposes of the installment calculation.
4. Option exercise: Under both prior and current law, the lessee is allowed to exercise the purchase option in advance to the termination of the agreement. The LCA permitted the exercise of the option once half of the sum of all lease installments agreed upon by the parties was paid up. The NLCA now provides that the purchase option can only be exercised once three-quarters of such sum has been already paid.
5. Registration requirements: The NLCA establishes a clearer registration procedure that eliminates doubts that arose under prior law.
6. Change of location of leased property: Under the NLCA, the leased property must be placed in the location mutually agreed by lessor and lessee. In the event that the lessee intends to relocate the leased property, it must obtain express authorization from the lessor.
7. Expenses related to the leased property: The NLCA expressly provides that all maintenance-related expenses of the leased property must be borne by the lessee, unless the parties agree otherwise.
8. Bankruptcy issues: The LCA only contained rules that dealt with those cases where the lessor or the lessee were declared bankrupt. The NLCA also provides with rules for those cases in which the lessor or the lessee seek protection in a composition proceeding.
9. Tort liability: Under the NLCA, it is clear that the lessor is not liable for any damages that may result from the use or misuse of the leased property.
10. Securitization: The NLCA allows the lessor to transfer any receivables originating in leasing transactions to an Argentine financial trust (fideicomiso financiero) for purposes of securitizing those assets, with no obligation for the lessor to notify the lessee of the assignment.

The Decree establishes rules on the timing for calculation of the lessor's and lessee's income tax liabilities, and the amount of taxable income or deductible expense that they are required to include or entitled to claim, respectively. There are three different categories of leasing transactions defined by the Decree. Those categories are the financial leasing, the operating leasing, and the leasing assimilated to a sale on credit. As it is explained below, the income tax treatment applicable to leaseback transactions combines the income tax treatment granted to financial leases, operating leases and leases assimilated to sales on credit.

A leasing transaction is characterized as a financial leasing when the following four requirements are simultaneously met:

• The lessor is either an Argentine financial institution, an Argentine financial trust or an entity that is primarily engaged in the leasing business and secondarily provides financial services exclusively.²
• The property leased is either tangible personal property or real property.
• The term of the agreement is longer than one-half, one-fifth or one-tenth of the leased property's useful life, depending on whether such property is tangible personal property, real property not to be utilized as a place of abode, or real property to be so utilized, respectively.³
• The strike price, although freely agreeable by the parties, is precise and certain at the time that the agreement is executed.

In order to assess its income tax liability, the lessor is required to apportion and allocate on a pro-rata basis the adjusted basis of the leased property among the strike price and each of the lease payments to be made during the term of the agreement. The adjusted basis so apportioned and allocated is recovered from each of the lease installments paid by the lessee and the strike price. Thus, the lessor accelerates the depreciation of the leased property. The excess of each of those payments over the apportioned and allocated adjusted basis is the lessor's gross income. The lessor is required to include such gross income in the taxable year in which each of the lease payments accrues and the purchase option is exercised.

In the event that the lessee exercises the purchase option before termination of the leasing agreement, the lessor is deemed to have recovered all the adjusted basis allocated and apportioned to the lease payments that are not paid because of the early termination of the agreement. Thus, the lessor should never realize a loss from this transaction. On the other hand, should the lessee not exercise the purchase option, the lessor's adjusted basis on the property will be the portion of such basis that was allocated to the strike price.

From the lessee's standpoint, all lease payments made are fully deductible.⁴ Consequently, the lessee also benefits from the accelerated depreciation of the leased property. In addition, in the event that the lessee exercises the purchase option, the lessee's adjusted basis in the property acquired is the strike price. The lessee should then be allowed to deduct the depreciation of such property's adjusted basis over the term of its useful life.

A leasing transaction is an operating leasing if (i) it does not fulfill one or more of the requirements for financial leases, and (ii) its strike price is higher than the lessor's expected adjusted basis in the leased property at the time that the purchase option must be exercised pursuant to the leasing agreement.

During the term of the agreement, the lessor has to (i) include the lease payments as taxable income in the taxable year in which they accrue, and (ii) claim the depreciation or amortization deductions that may be available pursuant to the Argentine Income Tax Law ("AITL"), depending on the type of property being leased. Upon the exercise of the purchase option, the lessor must recognize as taxable gain the excess of the strike price over the adjusted basis in the property at the time that it is transferred. In the event that the lessee exercises the option in advance, the lessor must add the depreciation or amortization allowances that would have been deducted until the termination of the agreement to the strike price. Thus, the lessor should never realize a loss from this transaction, as it is the case of the financial leasing. Should the lessee not exercise the purchase option, the lessor receives the property with the adjusted basis calculated according to AITL rules.

From the lessee's standpoint, the income tax treatment is identical as if the leasing transaction were characterized as a financial leasing.

A leasing transaction is assimilated to a sale on credit if it is neither a financial nor an operating leasing. This characterization must be effectively notified to the lessee. A reference to the characterization of the transaction as a sale on credit must also be incorporated in the text of the leasing agreement.

In this case, the lessor is not subject to income tax at the time that the leasing agreement is entered into because it is deemed to transfer the leased property to the lessee at its book value. However, the lessor is deemed to derive taxable income over the term of the agreement equal to the excess of the sum of the payments that the lessee makes over the lessor's adjusted basis in the leased property. The amounts recognized by the lessor as taxable income constitute deductible expenses for the lessee. It is not clear, however, whether such amount should be accrued on a pro-rata basis or according to the economic accrual method (i.e., using the effective yield). In addition, since the leased property is deemed transferred, the lessee will be the one entitled to either depreciate it or amortize it (depending on the nature of the asset), pursuant to the rules provided in AITL.

In the event that the lessee does not exercise the purchase option or substitutes a new asset for the leased property, the lessor is required to report as taxable income the excess of (i) the sum of lease payments accrued during the agreement, over (ii) the sum of (a) the taxable income actually reported from the transaction and (b) the depreciation or amortization deductions that it would have been entitled to claim. Likewise, the lessee is required to recapture any depreciation or amortization deductions that it may have claimed. In turn, the lessee is entitled to deduct the nondeductible portion of the lease payments, pursuant to the formula to assess the lessee's deductible expense explained in the previous paragraph.

In order to analyze the income tax treatment of leaseback transactions, it is necessary to distinguish the two separate transactions that take place, the initial sale and the subsequent lease. Regarding the sale, the lessee is not required to recognize any gains that it may realize from this transaction at the time of its execution. Rather, such gains will be recognized when the lessee exercise the option to repurchase the assets transferred to the lessor. Consequently, any net operating loss offset would be also deferred until the termination of the agreement.

With respect to the subsequent lease, the lessor is required to treat the transaction as a financial leasing, regardless of whether the four requirements referred to in Section II.B. above are met. Consequently, the lessor's income tax treatment in a financial leasing is also applicable to a lessor in a leaseback. On the other hand, the income tax treatment of a lessee in a leaseback is similar to the one applicable to a lessee in a leasing assimilated to a sale on credit. This is because the lessee is entitled, over the term of the agreement, to deduct the excess of the sum of the lease installments and the strike price to be paid to the lessor, over the purchase price paid by the lessor to the lessee (which is the lessor's book value of the property). In this case, however, it is clear that the deductible amount is determined on a pro-rata basis rather than applying the economic accrual method. Notwithstanding the fact that the lessee's treatment in a leaseback is not directly assimilated to the one applicable to a leasing assimilated to a sale on credit, the lessee is entitled to deduct the depreciation or amortization allowances for the leased property, which are calculated on the purchase price paid by the lessor upon the sale pursuant to AITL rules (i.e., on a straight-line basis).

Upon the exercise of the purchase option, the lessee's basis in the acquired asset is equal to the sum of the strike price paid and the sum of the nondeductible portion of the lease payments made, reduced by the depreciation or amortization deductions claimed. As previously mentioned, the lessee may opt at this time to apply any gains that it may have realized upon the sale of the leased property to the lessor against such basis, thus reducing it accordingly.

Should the lessee not exercise the purchase option, the lessor is required to include in taxable income a portion of the lease payments already received in the current and previous taxable years. That portion is equal to the excess of the capital recovered pursuant to the rules applicable to a financial leasing, over the amortization or depreciation deductions that the lessor would have had available had the leasing been characterized as an operating leasing. Likewise, the portion of the lease payments that is taxable for the lessor is deductible for the lessee.

In sum, a leaseback is characterized as a financial leasing for the lessor while it is assimilated to a sale on credit for the lessee during the term of the agreement, as long as the leased property is repurchased by the lessee upon termination. However, the transaction is recharacterized as an operating leasing for both lessor and lessee if the purchase option is not exercised. This recharacterization does not require both parties to amend their income tax returns for previous taxable years to report any necessary adjustments. Rather, such adjustments must be considered in the year in which the leaseback terminates.

The VAT treatment applicable under the LCA was provided in the then-applicable tax regulations rather than in the VAT Law or in the LCA. Those regulations did not promote the leasing as a financial instrument for the general public to acquire durable consumer goods because the VAT was levied at the time of the execution of the agreement on the full price of the transaction (i.e., lease payments plus purchase option). The NLCA provides specific rules on the timing of accrual of the VAT on leasing arrangements.

Under the NLCA regime, the VAT on the installments agreed-upon by the parties is deemed as accrued in the period in which they are paid by the lessee or they become due, whichever occurs first. Likewise, the VAT on the strike price is deemed to accrue the sooner of the period when the purchase option is exercised or the period when the strike price is paid. In addition, the NLCA allows the Executive Branch to issue regulations providing a regime for financing the payment of VAT liabilities arising from leasing transactions. The rationale behind these rules is to make the VAT no longer a barrier for either the lessor or the lessee to enter into this type of arrangements and, thus, to promote this financial instrument.

The Decree provides for rules on the timing of accrual of the VAT and the base to be utilized by the lessor to assess its liability. The analysis of the Decree's VAT rules applicable to leasing transactions herein is made based on a distinction between pure leasing transactions and leaseback transactions.

The VAT treatment of this type of leasing transactions depends on the type of property being leased. If such property is tangible personal property, the VAT is levied at the sooner of the accrual of the lease payments and the strike price or their payment. This treatment is applicable regardless of the characterization of the transaction for income tax purposes (i.e., whether it is a financial leasing, an operating leasing or a leasing assimilated to a sale on credit).

When the leased property is a newly-constructed building, value-added taxation depends on whether the transaction is assimilated to a sale on credit or not. Should the transaction be characterized as a financial leasing or an operating leasing, the transaction is treated as a pure lease not subject to VAT. The same exemption applies upon the exercise of the purchase option if the building is leased for a period longer than 3 years. In such case, the lessor is required to recapture any input credits previously taken.

If the leasing transaction is assimilated to a sale on credit of such newly-constructed building, it is subject to VAT for the construction services rendered. The VAT base is identical to the amount that the lessor must recognize as taxable income and the lessee is allowed to deduct as a business expense for purposes of assessing their income tax liabilities. In addition, the VAT on these transactions accrues the sooner of the deadline for payment of each of the lease payments and the exercise of the purchase option or their actual payment. In the event that the lessee does not exercise the purchase option or substitutes another newly-constructed building for the one leased, the lessor is allowed to take an input credit for an amount equal to the product of the VAT rate times the sum of lease payments during the term of the agreement.⁵ On the other hand, the lessee is only required to recapture the input credits that it may have taken.

The transfer of the property to be leased by the lessee to the lessor is not subject to VAT at any time. In the case of a leaseback of newly-constructed buildings, however, the lessee is not required to recapture input credits if such transfer occurs within the 10 years of purchased such newly-constructed building, unless it does not exercise the purchase option.

Since lessors in leaseback transactions are required to treat them as financial leases, the VAT to be levied on those transactions is assessed on the amounts that the lessor is required to include as taxable income for purposes of assessing its Argentine income tax liabilities. The timing of accrual of the VAT is the sooner of the deadline for payment of each of the lease installments and the exercise of the purchase option or their actual payment. The lessee has an input credit available for an equivalent amount.

If the lessee does not exercise the purchase option, several VAT consequences arise. First, the lessee is required to pay the VAT that would have otherwise been levied upon the transfer of the leased property to the lessor, while the lessor has available an input credit for such amount. Simultaneously, the lessor is required to pay the VAT on the portion of the lease payments that were not treated as base for purposes of the transaction if the leased property is tangible personal property, while an input credit is available for the lessee for this amount.

The Decree also provides with rules that allow the lessor and lessee to agree on the frontloading of the VAT on the transaction, which is paid with the first lease payment or payments. Additionally, the Decree also establishes a regime available to lessors to finance the payment of the VAT levied on the importation of property to be leased or on its purchase in the Argentine market. Several conditions must be fulfilled for these exceptional regimes to apply.

Argentine corporate taxpayers are required to pay a 10% tax on the interest payments made under loans granted by Argentine financial institutions.⁶ However, the Decree incorporated new regulations under the tax on interest law providing that lease payments will always be characterized as repayment of principal for purposes of such tax. Therefore, the tax on interest is not applicable. This is relevant in the case of (i) leasing transactions (a) characterized as financial leases or (b) assimilated to sales on credit, and (ii) leaseback transactions, where the lessor is essentially taxed on the interest component of the lease payments. Consequently, it could be claimed that the lessee pays interest in those occasions. Therefore, leasing becomes a tax-efficient alternative to avoid the tax on interest for Argentine corporate taxpayers with financing needs to acquire capital assets.

The Decree does not contain rules applicable to cross-border leasing transactions. Consequently, those provided in the regulations under the income tax and value-added tax laws would continue to apply. However, as it is discussed in Section V.D below, foreign persons might enter into leasing transactions with Argentine counterparts that would be covered by the Decree if the lessor in the transaction is an Argentine financial trust.

The Regulations under AITL provide with a different tax treatment for financial leases and operating leases. As a general rule, all cross-border leasing transactions are characterized as operating leases, except when they meet the following requirements simultaneously:

1. The Argentine lessee is not allowed to either terminate the contract unilaterally or cease payment of the agreed-upon lease installments.
2. Any insurance purchased recognizes a compensation to the lessee proportionate to the lease payments that it has made until the occurrence of the insured hazard.
3. One of the following events occurs upon the termination of the lease term:

1. Legal ownership on the asset is transferred to the lessee for no consideration; or
2. The lease agreement includes a strike price lower than 0.25% of the original purchase price; or
3. In the event of an early purchase, the lessee is required to pay only the residual price of the leased asset.

The different characterization of a cross-border leasing transaction has an impact on the withholding tax treatment applicable to the lease payments. Thus, if a cross-border leasing is treated as a financial lease, the Argentine withholding tax is levied only on the interest component of each lease installment paid to the foreign lessor. The applicable rate is 15.05% if the lessor is the supplier of the leased property or a foreign financial institution located in a country whose central bank (or other regulatory body) follows the international banking standards set by the Basle Committee.⁷ Under this characterization, no withholding tax is levied on the capital component of each installment. If, instead, the transaction is treated as an operating lease, a 14% withholding tax is levied on the full amount of the lease installments. In addition, a 17.5% withholding tax will be levied upon the exercise of the purchase option under an operating lease.

VAT is not a cost for either foreign lessors or Argentine lessees under cross-border leasing transactions. Foreign lessors are not required to file any VAT returns with the Argentine tax authorities because Argentine lessees are required to self-assess the VAT on the lease payments that they remit abroad at a rate of 21%.⁸ Subsequently, Argentine lessees are granted an input credit for the self-assessed VAT to offset the lessees' VAT liabilities. Consideration should be given, however, to the fact that the VAT is also levied upon the importation of tangible personal property into Argentina. Consequently, cross-border leasing transactions must be properly structured to minimize any adverse financial effects that the VAT may originate.

Notwithstanding the absence of rules applicable to cross-border leasing transactions in the Decree, foreign lessors may fall within the scope of the Decree if alternative structures involving Argentine financial trusts are utilized. Such possibility may result attractive to foreign investors with current or prospective operations in Argentina in light of the preferential tax treatment granted to both financial leases and Argentine financial trusts by the Argentine tax laws.

The NLCA and the Decree provide with a new legal and tax framework applicable to leasing transactions. In many instances, the new regime follows the trend set by the abrogated rules. In other, a new tax environment is created. In general, the Decree rules are designed to promote the utilization of leasing arrangements by Argentine taxpayers as a financial instrument. However, there is still uncertainty on how the provinces will levy their taxes (mainly the gross receipts tax and the stamp tax) on these transactions. Although the impact of these provincial taxes is generally low and they are usually not levied on cross-border transactions, they have proved being distorting in the past. Therefore, rapid action by the provincial authorities is required to smooth the way for the leasing to develop as an efficient instrument and to eliminate any obstacles that may prevent the creation of a domestic market of lessors and lessees within their jurisdictions.

1For a detailed analysis of the prior situation, LCA rules and tax regulations issued thereunder, see Guillermo O. Teijeiro, Leasing Transactions: New Legal and Tax Framework in Argentina, in 25 Tax Planning International Review 8 (May 1998).

2There is no express requirement that these entities be Argentine. Consequently, under a possible interpretation of the applicable rules, foreign lessors could claim the application of the income tax treatment for financial leases to the extent that all other requirements are met. However, there are certain aspects of this treatment that would, in turn, make it inapplicable to foreign lessors. Notwithstanding this uncertainty, the possibility that Argentine financial trusts be lessors would make any interpretation discrepancy abstract, as it is discussed in Section V.D below.

3The Decree provides with estimated useful lives for a list of certain general assets, such as buildings, equipment and machinery, among others.

4Certain limitations in the deductibility may apply in the event that the property being leased is an automobile.

5In these cases, the lessor may derive an actual benefit, since it will have available an input VAT larger than the sum of VAT liabilities accrued during the term of the agreement because of the different VAT bases utilized to calculate the lessor's VAT liability and its input credit available if the lessee does not exercise the purchase option or substitutes the leased property. However, this mismatch of amounts owed to and by the Argentine tax authorities may also be interpreted as an involuntary mistake that should be solved shortly.

6Law No. 25402, published in the Argentine Federal Register on January 12, 2001, sets forth a schedule to gradually eliminate this tax since January 1, 2001. Pursuant to this law, the tax on interest will be abrogated effective July 1, 2002.

7In all other cases, the applicable withholding tax rate is 35%.

8Neither the VAT Law nor the regulations thereunder contain rules determining the base that Argentine VAT taxpayers have to utilize to self-assess the VAT when making payments under leasing transactions characterized as financial leases for Argentine withholding tax purposes. Notwithstanding the absence of precise rules, it could be interpreted that the VAT should be levied on the interest component only. Under this interpretation, the VAT rate could be reduced to 10.5% in the event that the lessor is a foreign financial institution located in a country whose central bank or other regulatory body follows the international banking standards set by the Basle Committee.