Paraguayan Supreme Court of Justice held a new criterion on unconstitutionality related to income tax payment applicable to local holdings´ of local corporations

Recently, the Constitutional Chamber of the Supreme Court of Justice (the "SCJ" for its Spanish acronym) issued Decisions No. 484 dated July 4, 2018 and No. 831 dated September 12, 2018.  By these rulings, the SCJ declared the unconstitutionality of part of the Paraguayan Tax Act N°125/91 (the “PTA”), in favor of the companies that filed an unconstitutionality motion. As a result, income obtained by holding companies domiciled in Paraguay, generated by their subsidiaries domiciled in Paraguay, are exempt from Income Tax on Commercial, Industrial and Services activities (“IRACIS” for its Spanish Acronym). The applicable IRACIS rate is 10% on the net income.

As a preliminary matter, it is important to clarify that under Paraguayan law, decision on unconstitutionality motions are only binding to the party that filed the motion, and only them may get the benefits related to the resolution.

The decision on unconstitutionality however, is extremely important, as it establishes the criterion of the SCJ, which may result in a change on the application of the law of the local tax authorities and may also anticipate an eventual change in the tax law.

Please find below a summary of the reasoning of the SCJ ruling.

According to the PTA, profits and dividends obtained by shareholders of companies subject to IRACIS or Income Tax on Agricultural Activities ("IRAGRO" for its Spanish acronym) in connection with their subsidiaries, are also subject to IRACIS.  On the other hand, the PTA states that profits and dividends generated by the subsidiaries are exempt from IRACIS, provided that such incomes do not exceed 30% of the gross income of the holding company.

Companies that filed the unconstitutionality motion   claimed that the rule that establishes the 30% limitation for tax exemption breaches the constitutional principle that prohibits double taxation.  Although this argument was dismissed by the SCJ, the SCJ ruled that the condition that the total income does not exceed 30% of the gross income of the holding was unconstitutional, since it violates the principles of equality and proportionality of taxes.

The SCJ interpreted, among other things, that the relevant section of the PTA, generates a discriminatory treatment among taxpayers that receive the same range of net income but different ranges of gross income within the year.