The indirect tax regime enacted in Colombia under Law 1943 of 2019 set the stage for taxing the transfer of a vehicle that directly or indirectly owns assets in Colombia.
If the first point of contact in Colombia is ownership in a company, then this is an indirect transfer of the shares of the Colombian entity. If the first point of contact in Colombia is a branch, then the operation is treated as the indirect transfer of the assets of the branch.
When the purchase price is known at the time of the sale, a profit or loss can be determined at that moment. For example: Company A holds shares in Company B, who in turn owns a Colombian entity C. Tax cost A in B is 70; tax cost B in C is 60. If Company A sells Company B for 100, then the indirect sale of C is triggered. Sale price 100, tax cost 60 (what B has in C), the gain would be 40.
If C was a branch instead of a company, then A would be selling the assets of that branch and the tax cost will be the cost the branch has in those assets. Let’s say that C has real estate, equipment, inventory, and intangible property. If A sells B for 100, then the gain in C would be established by allocating the purchase price among the assets and determining a gain, subject to local rules which include capital gain treatments, ordinary income, recapture of deductions, clawbacks, among other effects, as the individual assets are considered to be transferred.
The catch is that in many mergers and acquisitions (M&A) transactions, most of the time the purchase price is not as simple to determine. You have other factors which impact and many of them are not known on the day of the sale. You may have price adjustments based on EBITDA mark-ups between signing and closing or between signing and a future given date; you may have escrows, an earnout which set on a three year term with annual payments, which is a usual mechanism between seller and buyer when part of the purchase is based on the potential incremental value or future cashflows of the business being bought. You may also have a purchase price where payments are made in many years, based on the annual profits of the business and certain thresholds, with or without a cap.
The regime in Colombia
When faced with these situations, how do you apply the indirect transfer regime? Rules in Colombia fall short of a full answer.
Rules state that when a contingent payment exists, the seller must file a return at the time the condition is met. The rule does not clarify how to breakdown the tax base in these cases or how to treat multiple conditions either.
The tax authorities are of the opinion that an indirect seller can only file one return per sale and if a condition generates a change, then an amendment must be done. However, amendments reflect mistakes or omissions being corrected, not price adjustments. Also, you can only amend a return within one year if you are going to reduce the tax, or three years if it is an increment, with a penalty. This makes no sense and forgets that M&A operations have more complexities and may take several years to be completed.
When conditions exist, a price adjustment must be reflected in a new, separate return that the seller must file. If multiple conditions are set each year, then multiple returns should be filed[i].
The question on the tax cost has a different answer because the transfer of ownership occurs on the day of sale. Take a purchase price with a down payment of 100 and additional payments of 100 each year for three years if EBITDA increases in 2% each year. Tax basis is 250. The first return will show income of 90. What tax cost should be included?
Under Colombian International Financial Reporting Standards (IFRS) and tax rules, the assets are sold, and the cost realised. The total cost must also be registered: 90 income, 250 cost. The return would show a loss which in truth is only a differed tax cost that must be allocated in other returns when the conditions are met. The actual profit of the sale would be known in year four.
Authorities could argue that an estimated price of 400 should be reflected on year one, and then amend the return if the full potential sale price is not achieved. However, taxation is based on the current capacity to pay taxes, so it could be unconstitutional (or at least unfair) to collect a theoretical tax which may never come to be.
For M&A operations uncertainties such as these create risks, undue taxes and potential claims with authorities and between parties. As the seller and the Colombian entity are jointly liable for unpaid taxes, and eventually the buyer may also be jointly liable, it is in the interest of promoting investments in Colombia that these rules are expanded or amended, to regulate such situations in a fair and clear treatment which is aligned with the reality of the business world.
A request for a change in the authority’s position to reflect the above was filed and is under review, in the hope of achieving rectification of the current view.
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