Sovereign debt swap: tax aspects

Argentina has recently settled the sovereign debt swap (“canje de deuda”), a debt which it stopped honoring after the economic crisis of 2002. According to official data, 76.15% of bondholders have agreed to enter into the swap.

The debt was restructured through the issuance of three types of government bonds (Par, Discount and Quasi-Par) and it only comprised the outstanding principal. Accrued interest due before December 31, 2001 will be swapped for new bonds called “GDP-Linked Securities”.

The principal amount of any PAR, Discount and Quasi-pars is equal to the outstanding principal amount as of December 31, 2001 plus any accrued but unpaid interest up to but excluding December 31, 2001 multiplied by the following exchange ratios:

Par and Discount bonds will be denominated in four different currencies: Pesos, US Dollars, Euros and Yens. There will only be a single class of Quasi-Par bonds, which will be denominated in Pesos.

The maximum aggregate principal amount of Par bonds will be of US$ 15,000 million. The Par bonds are due on December 31, 2038.

The interest rate to be paid by US Dollars denominated Par bonds will step up from 1.33% to 5.25% through its term, the ones denominated in Pesos will go from 0.63% to 2.48%, Euro denominated Pars will increase from 1.20% to 4.74%, and the interest rate of the Yen denominated Pars from 0.24% to 0.94%. All interest rates are fixed.

The maximum aggregate principal amount of Discount bonds will be up to US$ 11,932 million face value. Discount bonds will be due on December 31, 2033.

The interest rate of Discount bonds will be fixed. US Dollar denominated Discount bonds will bear an annual interest rate of 8.28%, Peso denominated Discount bonds of 5.83%, Euro denominated Discount bonds of 7.82% and Yen denominated Discount bonds of 4.33%. Part of the interest accrued prior to December 31, 2013 will be paid in cash and part will be capitalized.

The maximum aggregate principal amount of Quasi-Par bonds will be up to US$ 8,329 million face value and will bear a fixed annual interest rate of 3.31%. Quasi-Par bonds will be due on December 31, 2045. Interest accrued on or before December 31, 2013 will be capitalized. After December 31, 2013 Argentina will make interest payments in cash.

All Peso denominated new securities will be adjusted to reflect inflation based on the consumer price adjustment rate (Coeficiente de Estabilización de Referencia -CER), created by Decree No 214/2002.

Each Par, Discount and Quasi-Par bond will have attached GDP-Linked Security which, as mentioned above, was swapped for unpaid accrued interest of the defaulted securities, as of December 31, 2001.

GPD-Linked Securities will release payments if the performance of Argentina’s GDP exceeds the values established in the offer. GPD-Linked Securities shall expire no later than December 15, 2035 and their first payment, if any, shall be on December 15, 2006. These securities do not accrue interest.

The main tax consequences of the swap are the following:

1.      Income Tax (IT)

The Income Tax Law establishes as general criterion that bonds’ profits and losses arising from sales or other acts of disposal dispose of property, interest, adjustment, exchange and listing differences, obtained by legal entities, companies and individuals that carry out stock exchange activities and by permanent establishments located in Argentina are subject to IT.

The following issues are related to the income taxpayers mentioned above.

Nevertheless, profits obtained by non-Argentine beneficiaries and by certain individuals resident in Argentina are exempt from this tax.

1.1   Profits and losses resulting from the swap

The swap of government bonds in default for new government bonds may trigger profits or losses subject to IT. This result is determined by the difference between: a) the tax value of the new government bonds and b) the tax value of defaulted bonds, at the beginning of the fiscal year in which the new government bonds are delivered.

Taxpayers may find it difficult to value both bonds as Argentina does not ensure that new government bonds will be listed in stock markets or that they will have market value. Likewise, several defaulted bonds lost their listing after 2001 and the IT Law does not establish a valuation criterion for these cases. If defaulted bonds were never listed in stock markets, they have to be valued in accordance with their purchase price, plus interest, adjustments and exchange differences accrued until the beginning of the fiscal year in which the new government bonds are delivered.

1.2   Profits and losses resulting from the holding of the bonds

The variation of an asset’s value during the term of a fiscal year may result in a gain or loss subject to IT. As would have occurred with defaulted bonds, new government bond holders’ profits and losses are subject to IT. In order to estimate these profits and losses the following valuation criteria must be followed:

a)if government bonds are listed in stock markets or stock exchanges: the last listing value at the fiscal year’s closing date;

bif government bonds are not listed in stock markets or stock exchanges: the purchase price, plus interest, adjustments and exchange differences accrued up to the fiscal year’s closing date.

1.3   Bonds’ interest

New government bonds will accrue interest as from December 31, 2003 and theirpayments will be made every six months. IT Law provides as general criterion that interest on government bonds will be subject to tax the year they are made available to the holders.

As we explained above, interest accrued prior to December 31, 2013 of Discount and Quasi-Par bonds will be capitalized. Accordingly, the amount of principal of Discount and Quasi-Par bonds will be increased by the amount of the capitalized interest. The greater nominal value is subject to IT in the fiscal year that the capitalization takes place.

Accrued interest due before December 31, 2001, will be swapped for “GDP-Linked Securities”. If Argentina pays this securities, these payments must be considered as a gain subject to IT in the fiscal year of the payment.

2.      Tax on Presumed Minimum Income (TPMI)

New government bonds are subject to TPMI as it is the case of defaulted bonds.

In order to estimate TPMI it is necessary to analyze whether government bonds are listed in stock markets or stock exchanges.

3.      Personal Assets Tax (PAT)

New government bonds are exempted from this tax. This exemption also applied to government bonds declared to be in default.

4.      .Holders of government bonds in default who did not enter to the swap

Defaulted bonds not swapped in the offer lost their listing and there is no stock market for them. IT Law and TPMI Law do not contain specific regulations on valuation to show the capital losses that their holders might suffer.

Law No 26,017 (Official Gazette February 11, 2005) forbids the Government to reopen the swap process or to carry out any sort of deal involving these bonds. This law also requires that the Executive Branch withdraw the listing of defaulted bonds from all stock exchanges and stock markets.

In addition, the Ministry of Economy informed that government bonds in default which were not part of the swap “may remain unpaid for ever” (www.mecon.gov.ar – “Final results of the sovereign debt swap”, Buenos Aires, 03/18/05).

At the end of year 2002, while Argentina had not provided the conditions for the exchange of debt in default, the Tax Authority (AFIP) rejected the possibility of considering defaulted bonds that lack market price as bad debts, and thus deductible as an expense for IT purposes (Ruling No 84/2002, 11/14/2002).

It is our opinion that, under the new legal and economic circumstances explained above, it does not make any sense not to allow a defaulted bond holder to consider the capital loss for tax purposes.