Before new regulations, the Colombian Tax Code stated that mergers and spin-off processes were not to be treated as transfers for income tax purposes and, as a result, they were not subject to income/capital gains tax in Colombia.
Under said insufficient and old regulations, a large number of acquisitions were implemented within the last 10 years associated to M&A transactions, which therefore resulted in tax free operations, bringing the Colombian Tax Authority's attention to the arising Colombian M&A activities.
To clearly distinguish pure reorganisation processes from acquisitions between non related parties, the Colombian government proposed a wholly new tax regime, addressed to identify the actual taxable events that could result from M&A transactions for the participating companies and their shareholders.
The Colombian Tax Code (CTC) divides the M&A events into two groups: (i) capital contributions (in cash or in-kind) and (ii) merger and spin-off processes (which, in turn, are subdivided in acquisition M&A and reorganisation M&A).
Tax treatment of capital contributions
In the first case, the CTC clarifies that any capital contribution will not be deemed as an income for the shareholder or for the recipient company, and consequently they will not be subject to income or capital gains tax, as long as several requirements are met, among others, the following:
- Shares issued for the capital contribution cannot be repurchased shares of the company;
- The assets contributed in-kind preserve their tax basis on the company, once the contribution has been performed;
- Shares issued will have the same value (tax basis) of the contributed assets; and
- Contributed assets will preserve the movable or fixed assets nature they had before the contribution.
If the aforementioned requirements are not fully complied with, the in-kind capital contribution will be treated as a taxable event, according to the general rules applicable to the sale of assets.
Cross border capital contributions
In-kind contributions made by Colombian individuals or entities to foreign entities are deemed as taxable transfers in Colombia, under the general rules applicable to the sale of assets. This implies an exit tax on the transfer of assets abroad (including intangible assets) materialized as in-kind capital contributions. This rule also provides that the in-kind contributions to foreign entities are subject to all the obligations derived from the Colombian transfer pricing regime (annual reports and studies evidencing the compliance with the arm's length principle).
Tax treatment of merger and spin-off processes
In the case of reorganisation/acquisition M&A, the new regulation states that the participating companies do not experience a taxable income, as a result of the merger or spin-off process, in addition to similar rules and requirements as the ones provided in the case of capital contributions.
From the shareholders' standpoint, several requirements have to be met, to not consider the merger or spin-off as a taxable event:
- The shareholders with at least 75% (85% in the case of reorganisation M&A) of the shares, economic and voting rights on the merged/spun off companies, must participate, after the merger/spin-off process , with shares, economic and vote rights substantially equivalent to those they had before the merger/spin-off.
- The participations received by the corresponding shareholder after the merge/spin-off process must constitute no less than the 90% (99% in the case of reorganisation M&As) of the consideration received by the same shareholder.
If the shareholders transfer their shares, economic or voting rights before the end of the second year after the fiscal year in which the merge/spin-off was completed, the said transfer will be subject to income tax according to general rules applicable to the sale of assets, increased in a 30%. The income tax triggered cannot be lower than 10% of the share value, pursuant to the valuation method applied in the merge/spin-off process. This rule is not applicable to sales transactions ordered by a governmental authority, transfers derived from an estate process and transfers resulting from a liquidation process.
Cross border M&A process
The aforementioned rules are also applicable when the merge/spin-off is performed between Colombian and foreign entities, as long as the absorbing or resulting vehicle after the merger/spin off is a Colombian entity.
Transfer of assets located in Colombia, as a consequence of the merger or spin off process of foreign entities, is considered a sale for income tax purposes and, accordingly, is subject to income tax in Colombia, pursuant to the Colombian tax rules applicable to the sale of assets. This treatment will not be applicable when the value of the assets located in Colombia does not exceed the 20% of the total value of the assets possessed by the group to which the participating companies belong, pursuant to the consolidated financial statements of the parent company of the participating companies.
It is important to bear in mind that the notion of "group" for this particular purpose was not defined by the regulations, so it is likely that several litigation cases will arise from the lack of clarity on the scope of this exception.
It is worth noticing that the aforementioned treatment for cross border M&A, is not applicable to the sale of Colombian assets performed by transferring shares on foreign vehicles that directly or indirectly own the Colombian assets. This kind of transaction, under current regulations, is not subject to income/capital gains tax in Colombia.
Lastly, it is important to point out that if – as consideration for the shares exchanged in the merger or spin-off process – the owners of said shares received cash or assets other than shares, this part of the transaction will be taxed as a sale of assets, under general rules.
Certain applicable tax rules for public M&A process
All the foregoing has to be analysed along with certain regulations for the public M&A process. In this regard, CTC provides that gains derived from the sale of shares registered in a Colombian stock exchange and possessed by the same beneficial owner, which do not exceed 10% of the outstanding shares of the corresponding entity, are not subject to income tax or capital gains tax in Colombia.
Moreover, if the public M&A process involves the distribution of dividends by means of the issuance of new shares, CTC also provides that said distribution is not subject to income or capital gains tax, including the portion that is commonly exempted when the dividends distribution is performed in cash.
Looking to the future
The archaic tax regulations with respect to M&A processes applicable before fiscal year 2013, presented several problems for the Colombian tax authorities, concerning the identification of transactions that had to be treated as taxable events. New regulations imply an innovative approach to the way the transactions should be performed for income tax purposes and a clearer legal framework for companies intending to undertake M&A activities by means of capital contributions, mergers and spin-offs.
As mentioned, these are newly incorporated provisions applicable as from 2013. Accordingly, taxpayers will have to periodically monitor further tax regulations, to verify how the new provisions should be duly understood and applied.
Martin is a partner and co-leader of the M&A practice, and leader of the tax practice of prietocarrizosa. He has advised a wealth of clients on M&A in Colombia and abroad, in both domestic and cross-border sectors, and has participated as a consultant and facilitator for local and foreign clients in joint ventures and other partnerships.
Additionally, he has advised local and foreign clients on national and international tax matters, and, thanks to his vast knowledge of international tax issues, has participated as counsel in multi-jurisdictional projects.
Martin has assisted the Colombian tax authorities in the drafting and preparation of regulatory provisions, both from a legal and regulatory perspective.
His advice to national and international clients has earned him recognition throughout the country.
Martin holds a postgraduate degree in finance law from Universidad de los Andes (1992) and graduated in law. He graduated with an honours degree in law from Universidad del Rosario in 1990.
Oscar is a member of the tax team. He advises clients on tax, commercial and corporate law matters.
Before joining the firm he worked in the tax law firm of Quiñones Cruz Ltda (2002-2004) and was an associate attorney with the firm of Holguín, Neira, Pombo & Mendoza (2004-2006).
Oscar has been an adjunct professor of civil liability in the undergraduate programme at Universidad del Rosario. He is also an adjunct professor of graduate courses in contract law, company law and environmental law at the university. He has served as a conference speaker at Universidad de la Sabana. He is a member of the Colombian Institute of Tax Law.
Martin holds a postgraduate degree in commercial law from Universidad de los Andes (2004). He also holds and a postgraduate degree in tax law (2003) and a law degree with highest honours (2002) from Universidad del Rosario.