In our country there are no rules for «thin capitalization» to impose the maximum requirements for debt financing. But financing a project with liabilities or equity, has significant differences from the fiscal point of view.

Considering the following example (real case): let’s say that a company invested USD 10:000.000, money coming from abroad, bought land and made other investments to start business and by June 30th, those investments won’t have produced one single sale. However, there will be significant results that will cause a huge payment of Income Tax.

In fact, the purpose of the investment money was to capitalize an Uruguayan Corporation but incidentally took the form of a liability. The debt was initially recorded at a rate of $ 20,5 (Uruguayan pesos) per Dollar. By next June 30th the exchange rate will be $ 18,5 (or less) so we have two Uruguayan pesos «gained» per dollar. A total of $ 20:000.000 (Uruguayan pesos) income, approximately one million dollars, resulting on U$S 250.000 of Income Tax (the new land tax means nothing in comparison).

This is unbelievable from the perspective of a foreign investor. This can happen to local investors who may also «think» in US Dollars terms.

It is well known that financial performance could sometimes damage, and others help.

Indeed, if the exchange rate rises, then the exchange rate difference is negative (which compensates for the resulting lower operating results and IRAE payment).

Combo lethal earned more foreign exchange differences “AIPI” (Tax Adjustment for Inflation):

The problem is enhanced when considering the combined effects of, exchange differences and the tax adjustment due to inflation. So the liability will be postponed for the following year, on the basis of calculating the taxable profit generating more “AIPI” tax.

 What would be the way out?

Nominating  your  debt in Uruguayan pesos. Regardless of the currency turned from the outside was dollars or Euros, is part of the autonomy of the parties agree upon their return in a different currency. But we agree that is rare (so far), so it might attract attention. And, of course, solves the issue of exchange rate differences but not the “AIPPI”.

A more complete solution is to capitalize liabilities. But this is only possible since the creditor is itself a shareholder.

Our proposal: pay off taxes on the basis of the functional currency.

Understanding for «functional currency»:  a simplified currency that matters to the investor (dollars).

A company which invests in dollars, is financed in dollars and measures its results in dollars, will state its financial statements in U.S. dollars.

This is a groundbreaking event that can generate some kind of fear in the Administration. This option, like the use of “IPC” (Consumer Price Index) in the “AIPPI”, should be implemented on the basis of a three-year period.

Are we in time to implement a change in this regard?

Yes, of course. There is no need to wait until the exchange rate is $ 15.