Court of Appeals Reaffirms Inapplicability of Double Tax Treaty

1. Facts

Molinos Rio de la Plata S.A. (“Molinos Argentina”) filed an appeal before the Tax Court (“TFN”) against two resolutions enacted by the Federal Tax Authority (the “AFIP”) by which it made a tax assessment regarding income tax for fiscal periods 2004 to 2009.

The main argument of Molinos Argentina is based on the fact that the AFIP overruled article 11 of the Double Tax Treaty between Argentina and Chile of 1976 (“CDI”) (see Marval News # 132), by incorporating dividends distributed by Molinos de Chile y Río de la Plata Holding S.A. ("Molinos Chile") into the taxable base of the income tax. Molinos Chile is a company incorporated in Chile under the regime of "platform of investment companies" established by Chilean law # 19.840.

Section 11 of the CDI in force at that time, stated that dividends will only be taxable by the Contracting State where the company that distributes them is located.

In 2002, Chile passed the Chilean Law mentioned hereinabove by which foreign investors could establish a Company in Chile in order to manage investments abroad without having to afford taxes in Chile connected with (i) dividends and (ii) services to related companies.

These concepts are not considered taxable under Chile’s legislation.

Molinos Argentina incorporated Molinos Chile under this regime in 2003. According to the facts of the case, Molinos Argentina exerts 99, 99% control over of Molinos Chile.

From 2004 to 2009, the Holding Company paid dividends to Molinos Argentina as they usually did. As most of those dividends came from the dividends’ distribution made by Molinos Uruguay and Molinos Peru to Molinos Chile, they were not taxed in Chile, as they were considered to be income from a foreign source. They were not taxed in Argentina either by means of section 11 of the CDI.

Therefore, the AFIP argued that Molinos Chile represented a "conduct company” whose only purpose is to allow Molinos Argentina to acquire the dividends from Molinos Uruguay and Molinos Peru without paying income tax in either Argentina or Chile.

According to the section 2 of the law on Tax Procedure ("LPT"), the AFIP claimed the existence of “tax abuse”. Therefore, the application of the CDI was dismissed in the particular case.

The TFN confirmed the tax claim based on the fact that (i) Molinos Argentina committed a “treaty abuse”; (ii) the substance over form principle envisaged in section 2 of the LPT is not contrary to the CDI since it specifically deals with abusive and unfair use of legal structures; (iii) a “conduct company” cannot be deemed as an "effective beneficiary".

2. The Court of Appeals Ruling

The Court of Appeals confirmed the ruling issued by the TFN by considering that Molinos Argentina had committed a "treaty abuse" when using the CDI together with the Chilean law in order to exclude the dividends of Molinos Chile from the taxable base of Argentine income tax.

Consequently, it upheld the arguments from the TFN emphasizing the following items:

• Most of the dividends received by Molinos Chile were remitted directly to its controlling company, Molinos Argentina. Molinos Chile never received dividends from Molinos Chile S.A., considering that those were the only ones that could have been taxable by the income tax of Chile as they were of "Chilean source".

• Section 11 of the CDI cannot be applied in this case since Molinos Argentina incorporated a holding company in the terms of a beneficial regime with the sole purpose of receiving through Molinos Chile dividends coming from Uruguay and Peru taking advantage of the benefits provided by the CDI.

• Through this circuit, the Company made a "treaty abuse", since had those dividends come directly through Uruguay and Peru, they would have been taxable income in Argentina. Since there is no obstacle for the implementation of the substance over form principle provided in local law, the CDI was correctly dismissed.

• It cannot be concluded that Molinos Argentina’s behavior was correct under the argument that Argentina had the chance to complain before the Chilean authorities about the regime and did not do so. This is because Argentina always maintains the powers to pursue tax investigations.

• These practices are against the purpose of the Treaty, so it can be dismissed in the present case. On the other hand, Argentina has not waived its powers to determine and collect taxes.

3. Comments

It is an important case related with the interpretation of treaties and the application of the “substance over form” principle set forth in Argentine law.

The ruling of the Court of Appeals –by contrast to the one issued by the Tax Court- understood that the case under analysis has a particular set of facts which were conclusive for the final decision. Thus, the general criteria for further cases should be not the sole existence of a holding company –since such circumstance does not in itself impede the application of the treaty- but the analysis of the particular situation under which such holding performs its corporate purposes.

In this sense, it should be highlighted that the Court of Appeals emphasized several times that the dividends were distributed to Molinos Argentina with such proximity in time from the date in which they were received by Molinos Chile. This created grounds to consider that such income was –in fact- meant to be directly sent to Molinos Argentina and not the possibility that such dividends could be reinvested in other companies of the group or distributed to Molinos Argentina but in a reasonable period of time after being in head of Molinos Chile. Such circumstance would perhaps have impeded the rejection of the application of the Double Tax Treaty as was done in this case.

Notwithstanding, extending the conclusions exposed therein to all the cases which involve holding companies could imply the non-recognition by Argentina of mandatory international treaties under the argument of “treaty abuse” just for the sole existence of a holding company without taking into consideration a proper analysis of its substance and corporate structure.

In such a situation, Argentina would be dismissing international rulings issued in similar matters under which it was upheld that the sole existence of a holding company as a receiver of dividends is not a conclusive ground to exclude the application of a Double Tax Treaty.

In the international leading case “Prevost Car Inc” –and other similar cases- the Tribunal understood that a Dutch holding Company that received dividends of a Canadian Company which were then paid to its shareholders –a British and a Swedish company- did not qualified as a “conduct company” since the holding company was neither in the obligation to distribute such dividends nor there was evidence showing that they were meant to be paid to the shareholders from the beginning.

It was also considered that prior to payment, the holding Company had to grant anticipated dividends and approve them before the effective transfer of funds so there was not an automatic flow of funds towards the British and Swedish companies.

It is likely that Molinos Argentina will file an extraordinary appeal before the Supreme Court of Justice so that tribunal will have the final decision on the matter.