Foreign investors need to keep several issues in mind when structuring the acquisition of businesses in Colombia. These include financing issues, particularly the tax effects of using foreign loans or local financing; the tax effects of the purchase of assets or shares, the two traditional methods of making overseas acquisitions; and the tax free operations that can be used to minimize the Colombian tax consequences in the acquisition of businesses, or in the restructuring of the organization of a group of companies.

Financing the acquisition

In many cases it is desirable that the loans funding an acquisition be allocated to the business that is being acquired, so that the business supports the financial expenses of the funding. Exchange law controls, local interest rates, tax law restrictions and thin capitalisation rules are some of the factors that ought to be analysed when deciding to allocate a loan to the business that is being acquired, and when determining if the loan should be acquired with local or foreign institutions.

Foreign loans are subject to specific requirements and limitations set forth by the Central Bank (Banco de la República). The most important limitations are:

• Foreign loans must be channelled through the regulated exchange market, meaning this that the foreign currency that is required must be disbursed through Colombian financial institutions.

• As a general rule, Colombian residents are allowed only to obtain offshore loans from international financial entities.

It is possible to keep the funds in foreign-currency accounts abroad to protect them against exchange risks. The relevant accounts (so-called "compensation accounts) must be registered with the Central Bank, and a monthly report on the operations carried out through such accounts must be filed at the Central Bank. Conversion of funds to local currency, when needed, must be made through Colombian financial institutions.

Not every foreign financial institution is accepted by the Central Bank to act as a lender in a foreign loan agreement. For this, the Bank of the Republic must qualify the financial institution is a "first rate" financial institution.

Limitations on companies in the oil & gas sector

Colombian companies with foreign investment, as well as branches of foreign companies that perform oil & gas exploration and exploitation activities are allowed to conduct business in foreign currency. This regime is also available for branches of foreign companies devoted to certain mining activities, and to branches of foreign companies that provide oil & gas exploration and exploitation services.

As a trade-off for this special regime, companies and branches of this special regime cannot acquire foreign currency from the regulated exchange market intermediaries. The Central Bank has ruled that because of this prohibition, branches of the special regime are not entitled to acquire locally the foreign currency they would require for repaying foreign loans, and that consequently they may not acquire foreign loans.

The Colombian tax system is a hybrid system where domiciliary and source jurisdictions coexist. As a general rule, Colombian taxpayers are taxed both on their Colombian and on their foreign source income. The Colombian tax law grants Colombian taxpayers the possibility of crediting foreign income taxes against Colombian income taxes.

By contrast, foreign taxpayers (including branches of foreign corporations) are taxed only on their Colombian source income, which as a general rule refers to income originated in activities developed within Colombian territory.

In principle, interest on foreign loans is Colombian source income. However, Article 25 of the Tax Code provides exceptions to this rule so broad that, in practice, interest paid on most foreign loans is not considered Colombian source income, and consequently not subject to withholding taxes.

For example, according to Article 25, interest paid on foreign loans granted to companies whose activities are considered by the National Council of Economic and Social Policies (CONPES) of interest for the social and economic development of Colombia is not considered Colombian source income. Article 1 of Resolution 54 of 1992 of the CONPES, as reiterated by Regulatory Decree 2105 of 1996, states that all industrial, commercial, and services activities are considered of interest for the social and economic development of Colombia. In practice this means that as a general rule interest on foreign loans is not taxed in Colombia.

The borrower would be entitled to fully deduct the interest paid on a foreign loan, as well as the exchange difference, if the lender is not its foreign home office, an agency or branch of its foreign home office, or a foreign affiliate of any of those (Article 124-1 of the Tax Code). If the lender is related to the borrower in any of these ways, the borrower would not be entitled to deduct any interest or other financial expense (including exchange difference) related to the loan.

Generally speaking, there are no legal limitations to the possibility of funding an acquisition through loans obtained from Colombian entities. From a tax standpoint, the borrower would be entitled to deduct the financial expenses related to the loan.

Colombia does not have thin capitalisation rules. However, for project finance purposes, it is important to bear in mind that Colombia has capital impairment rules. According to these rules, a company must be liquidated when its accumulated losses reduce its net worth below 50% of its subscribed capital (Article 457 of the Commerce Code), and no action to remedy this situation has been taken in six months. Investors in projects that generate profits only after a certain number of years have needed to make additional capital investments during the first years to solve the capital impairment.

Recently, the Superintendency of Corporations, which is in charge of surveilling the financial situation of companies, has agreed not to apply the dissolution clause where it is demonstrated that the capital impairment is temporary, and that there is a degree of certainty that project is profitable.

The users of the financial system pay the tax. This tax is assessed at a 0.4% rate on transactions through which the users of credit institutions dispose of the funds deposited in checking or saving accounts, except for the transferring of funds between accounts held by the same user in the same credit institution.

Stamp tax accrues on public or private documents executed inside Colombia that document, create, modify, extend, assign or terminate obligations whose values are more than 6,000 UTVs (Units of tax value. Each unit currently is equal to COP 20,974 (basis for 2007) or $9.60). It also accrues on documents executed outside Colombia but that create, modify, extend, assign or terminate obligations whose values exceed 6,000 UTVs (basis for 2007). The agreement must be performed in Colombia, or generate obligations in Colombia. The tax rate is 1.5% and is assessed on the value of the obligations contained in the document. (Tax Code, Article 519). According to Law 1111, 2006, the rate will go down to 1% in 2008, then to 0.5% in 2009 and finally to 0% in 2010.

Documents related to foreign indebtedness are not subject to stamp tax (Article 529 of the Tax Code). By contrast, as a general rule documents related to local loans are subject to this tax.

Acquiring a business through the purchase of shares

The decision to acquire a business through a purchase of shares depends on many factors, not all of them tax related. Some of the tax factors that may influence this decision are:

• that the business that is being acquired has net operating losses that the purchaser wishes to preserve;

• that the business that is being acquired has been granted a special tax exemption from which the purchaser wants to benefit; and

• to avoid paying stamp tax on the purchase agreement.

Some of the factors that may influence a seller willing to sell its business through a transfer of shares are:

• to avoid other taxes that may be triggered when transferring inventories (industry and commerce tax) or real estate (registration tax).

• to reduce capital gains whenever the tax basis of the assets that are being transferred differ substantially from their fair market value.

Shares of Colombian companies represent assets located inside Colombia. Therefore, according to Article 24 of the Tax Code, income received on the sale of those shares is Colombian source income, subject to income tax.

As a general rule, Colombia imposes income tax or capital gains tax at a 34% rate on the difference between the tax cost of the shares and the selling price.

Transfer price

The parties to a transaction may freely agree on the transfer price. Nevertheless, according to Article 90 of the Tax Code, the Tax Office is entitled to reject the agreed transfer price and fix a different one for tax purposes, whenever the agreed price differs notoriously from the fair market value of the assets being transferred. Article 90 also establishes that there is a notorious difference whenever the difference between the fair market value of the asset and its sale price is more than 25%.

The Tax Office, given the difficulty of obtaining technical appraisals for establishing the fair market value of shares in companies that are not listed on the stock exchange (such as limited liability companies), has accepted as such the so-called "intrinsic value" of the shares. This value results from dividing the net equity of the company in which the shares is held among the number of shares.

As an example, minimum acceptable transfer price of stock may be determined in the following way:

Net equityCol:	$1,000,000
Outstanding shares:	÷ 5,000
Intrinsic value:	$200
Minus 25%:	(50)
Minimum acceptable transfer price:	$150
Number of shares:	* 1,000
Minimum acceptable transfer price of the total number of shares:	$150,000

In some cases it is possible to decrease the intrinsic value of the shares by issuing new shares at nominal value. Increasing the number of outstanding shares without substantially increasing the net equity of the company results in reducing the intrinsic value of the shares.

Transactions between foreign related parties or between resident and non-resident related parties are subject to transfer pricing regulations. In this case, the Article 90 rule will not apply.

Tax cost of the shares

The tax cost (basis) is the acquisition price of the shares. As a general rule, and until 2006, taxpayers obligated to keep accounting books for Colombian purposes had to adjust their non-monetary assets (including shares), liabilities and their equity for inflation. The Colombian Tax Code (articles 69, 70 and 868) also authorises taxpayers that are not obligated to make inflation adjustments (such as foreign investors without domicile in Colombia) to adjust the cost of their assets at certain rates established yearly by the government. As the cost increases due to these adjustments, the taxable income decreases.

As an example, the tax cost of the shares would be determined as follows:

Acquisition price of the shares:	$100,000
Plus:
Inflation adjustments:	$40,000
Tax cost:	$140,000

Taxable income and income tax payable

Minimum acceptable transfer price:	$150,000
Tax cost:	(140,000)
Taxable income:	$10,000
Minus:
Non distributed profits:	(1,000)
Taxable Income:	$9,000
Capital gains tax payable: (34%)	$3,060 (A)
Plus:
Tax on non-distributed profits (0%)	$0 (B)
Total tax payable: (A) + (B)	$3,060

To lower the income tax impact, it is sometimes possible to increase the tax cost of the shares in a company by capitalising the equity revaluation account. The capitalization of the revaluation account is a tax-free event.

The acquired company will continue to bear the tax liabilities preexisting to the moment of the purchase. It will also preserve its net operating losses, if any. The tax basis of the assets of the company will remain unmodified, so the possibility that the purchaser would have of partially recuperating its investment through the depreciation or amortisation of these assets would be limited.

Value Added Tax

No value added tax (VAT) applies to the transfer of shares.

Stamp tax

The assignment or endorsement of shares, as well as the documents that are prepared exclusively to document the transfer of shares are not subject to stamp tax (Article 530 of the Tax Code).

The documents containing the transfer agreement of quotas in limited liability partnerships will not be subject to stamp tax but to registration tax.

Registration tax

Documents that have to be registered at the Chamber of Commerce or at the Public Registry of Instruments are subject to the so-called registration tax, whose rate ranges between 0.3% and 0.7%. While the transfer of shares in corporations (sociedades anónimas) need not be registered in the Chamber of Commerce, and consequently is not subject to registration tax, the transfer of quotas in limited liability partnerships has to be done through public deeds that have to registered at the Chamber of Commerce. The tax basis would be the quotas' selling price. (Law 223 of 1995, article 226 onwards). There may be alternatives for reducing the effects of this tax.

Acquisition of a business through the purchase of assets

A purchase of assets is useful for avoiding tax, commerce and labour contingencies, and for obtaining a step-up in the tax basis of the assets that are being purchased.

Capital gains are treated as ordinary income. Thus, the income received from a transfer of assets would be added to the company's gross income, and allowable tax deductions related to the transferred assets would be added to the company's tax deductions. Corporations are subject to income tax on their net taxable income. The income tax rate is 34%. Net income is defined as gross income minus certain allowable tax deductions.

The tax effects in an asset transaction vary depending on the nature of the assets that are going to be transferred. As a general rule, the company would have to pay income tax on the taxable income originated in the transfer of assets. The taxable income would be the difference between the sales price of the assets and their tax cost (basis) (Tax Code, article 26).

The parties may freely agree on the sales price of assets. However, Article 90 of the Tax Code authorises the Tax Office to reject the agreed price and establish a different one for tax purposes, whenever the agreed price differs by more than 25% from the fair market value of the assets sold. There are some other special rules in the case of transfer of real estate.

Tax treatment of goodwill

For tax purposes, Colombian tax laws divide intangible property (goodwill included) in two categories: intangible property that has been acquired by the taxpayer from a third party and intangible property that has been created by the taxpayer.

The cost of acquired intangible property is its acquisition price, as adjusted for inflation. The Colombian tax laws authorise taxpayers to amortise the cost of the intangibles they acquire for income tax purposes. As a general rule, the minimum amortisation period for intangibles is five years, but it can be shorter when the characteristics of the intangible call for a shorter amortisation period.

Marketing, advertising, quality control and other expenses that contribute to create goodwill are usually not capitalised, but deducted in the period in which they are incurred. Nevertheless, it is unquestionable that the goodwill of a company may constitute one of its most important assets. But even if a company decided to appraise and capitalise its goodwill, such capitalisation would only have effects in its financial statements; such valuations would not be, generally speaking, a deductible cost when selling a business.

However, Colombian tax law contains a special provision that recognizes a presumptive cost in the sale of created intangibles. Article 75 of the Colombian Tax Code establishes that the cost of created intangibles is equal to 30% of its sale price, and this cost is deductible for tax purposes. By using this presumptive cost, and by distributing the total price of the transaction between the goodwill and the other assets that are being transferred, it is possible to obtain tax savings and (or) deferrals both for the vendor and for the purchaser of a business.

Colombian tax law does not contain special rules or procedures for assigning a value to goodwill. There is, however, the general rule contained in the aforementioned Article 90. Thus, even though it is not necessary to obtain a third-party appraisal of the goodwill or, in general, of the assets involved in a business acquisition, such an appraisal is sometimes used in major acquisitions, not only for commercial but also for tax reasons.

The purchaser of the assets would obtain a step-up in the tax basis of the assets, and would not inherit any of the seller's personal tax rights or liabilities.

From a commercial standpoint, the purchaser would have to bear obligations and hidden liabilities of its predecessor if the assets are acquired as part of a going concern (establecimiento de comercio) and not as a simple purchase of assets.

A commerce establishment (establecimiento de comercio) is a group of assets organized by a businessman for an enterprise. Trade marks, intellectual property, inventories, facilities, leasing contracts, furniture and fixtures, form part of a commerce establishment (Article 515 of the Commerce Code).

Value added tax

As a general rule, VAT is levied on the following events (Article 420 of the Tax Code):

• importation of goods to Colombian territory;

• sale, within Colombian territory, of tangible, movable goods; and

• rendering of services within Colombian territory.

There are certain exemptions granted by the law in specific regulations. Certain goods (raw food, vegetable products, drugs, oil, gas, electricity, and others) and services (health care, transportation, financial leasing, and others) are excluded from VAT.

The general rate is 16%. There are higher and lower rates applicable to certain goods and services.

As the tax is designed to reach the added value of goods and services in circulation, it is the end-user who normally pays the cost of the tax. Suppliers of goods and rendered services are legally accountable for VAT, acting as true tax collectors: they are allowed to set off the VAT they pay on raw materials, supplies and merchandise with the VAT they collect from customers, and pay the excess of the latter over the former to the government.

As a general rule, VAT does not apply on the sale of fixed assets, or on the sale of intangible assets. Thus, in the case of acquisitions of businesses, VAT is usually triggered only on the inventory, unless the law expressly excludes it from VAT.

As the tax is designed to reach the added value of goods and services in circulation, the end-user is the one that usually pays the cost of the tax. Thus, the purchaser would be able to credit the VAT paid on the purchase of inventories against the payment of the VAT charged to its clients.

Industry and commerce tax

This is a municipal tax. Each city makes its own rules within the limits set by Law 14 of 1983. Law 14 defined as city taxpayers those who carry out, within the jurisdiction of each city, industrial, commercial or service activities. City taxes are paid on revenue at rates usually ranging from 0.2% to 1.2%. This tax would apply to the sale of movable assets, not to the sale of fixed assets. Again, generally speaking only the inventories sold in this kind of transaction would be subject to the tax.

Registration tax

The sale of going concerns has to be registered at the Chamber of Commerce. This registration would be subject to a tax whose rate ranges between 0.3% and 0.7%. The basis would be the price for which the ongoing concern is being sold.

The transfer of real estate is also subject to registration tax because the public deeds through which real estate is transferred have to be registered at the Registry of Public Instruments.

Stamp tax

As mentioned before, this tax is only payable if no registration tax is payable, so these comments are applicable only in the event that the assets are not transferred as part of a going concern. The purchase agreement would be subject to stamp tax at a 1.5 % rate on the obligations contained therein. There are ways in which the impact of the stamp tax may be reduced.

Tax-free reorganisations

Mergers and spin-offs are mechanisms that are used rather frequently for reorganising companies in Colombia. To a certain extent, their popularity originated because they are tax-free events under Colombian income and VAT rules. According to these rules, the reallocation of assets between companies that occur because of mergers and spin-offs are not considered to be transfers of assets for income tax or VAT purposes.

In the case of mergers, the absorbing company or the new company that is created because of the merger will be liable for all the taxes, advance tax payments, withholding taxes, penalties and interest of the merging companies. In the case of spin-offs, the spun-off company or companies will be jointly and severally responsible with the preexisting company for all the taxes, advance tax payments, withholding taxes, penalties and interest payable by the latter for tax periods before the spin-off.

Jaime Alberto Vargas Cifuentes
		Deloitte Cra 7 No. 74-09 AA 075874 Bogotá Colombia Tel: +57 1 546 1810/5461815 Fax: +57 1 217 8088 Email: jvargascifuentes@deloitte.com Jaime Vargas joined Deloitte Asesores & Consultores at the beginning of 2003 and is the partner in charge of the tax and legal practices of Deloitte in Colombia. Until 2003 he was a partner of Arthur Andersen and led its Colombian tax practice. From 1995 to 2000 he worked for Baker & McKenzie, where he became a partner and became the leader of Baker & McKenzie's Colombian tax practice. From August 1998 to June 1999 he worked for the office of Baker & McKenzie in Chicago, where he took part in advising clients on matters related to international tax subjects of the US and Latin America in general. During this same time he took courses in international taxation in the Kent School of Law of the Illinois Institute of Technology. Before joining Baker & McKenzie, he was a senior in the tax division of Andersen & Cía. (Colombia) and Supporting Attorney of the Fourth Section of the Council of State, where he was in charge of projecting judgments on tax matters.