Through Law 1819 of 2016, Congress approved the tax reform that promised to be structural and, in addition, bring to the country the global trends in taxation, in particular those guidelines established by developed countries and the OECD. This is a brief analysis of the impact of this regulation in the Oil & Gas sector
Alejandro Posada Zabala Gerente | PwC Servicios Legales y Tributarios Oil & Gas & Mining
The reform includes important modifications that impact the operations of companies in the Colombian hydrocarbons sector.
In some cases, through tax benefits with improvements in cash flow, as well as significant changes in the amortization of investments, in addition to the acceleration of the transition so that the fiscal result is based on the accounting reality, which at this time part of the International Financial Reporting Standards (IFRS). However, a bittersweet taste remains as some of the tax reform rules are contrary to the attraction of local and foreign investment, which becomes particularly relevant in the hydrocarbons sector, since the volatility of crude oil prices , lead to players in that sector see with greater suspicion the high tax burdens that can impact their financial results in Colombia. These regulatory changes occur at a time when markets indicate that there is a rebound in the price of certain commodities, such as coal, nickel and gold, as well as some stability in the price of oil.
Next, we will explain the main aspects of the tax reform that affect the hydrocarbons sector in Colombia.
The CREE was a redundant tax, and that more than generating a benefit for the elimination of charges to social security and parafiscal contributions, it generated higher compliance costs and lack of certainty in the application of the regulations that regulated it.
This tax is eliminated, which is why there is an increase in the rates of income and complementary taxes. On a consolidated level, without considering the tax on dividends, the rates would be lower for taxpayers, legal entities or branches of foreign companies. The latter, as is known, represent the vast majority of actors in the hydrocarbon exploration and exploitation industry in Colombia. Below, we show a comparative effect of rates before the reform and with the tax reform:
While there seems to be a decrease in rates, the effect should take into account that a tax on dividends was also established, which will be explained later.
The maintenance of a preferential rate (higher by five points than the previous one but still lower than the ordinary rate), for foreign companies and branches located in free zones, constitutes a fundamental support for the investment of offshore exploration, whose regulatory framework is fundamentally represented by Decrees 2682 of 2014, and 2129 of 2015.
Until 2016, dividend distributions made by Colombian companies or foreign company branches to their parent / principal houses located abroad were only taxed at the time of distribution, if the respective utility had not been taxed. at the head of the company / branch at the time of perception.
The tax reform adopted a 5% tax for the distribution of said dividends to companies located abroad, whether or not the corresponding profits have been taxed at the head of the branch or foreign company. This tax will only fall on profits obtained from 2017.
With respect to profits that were not taxed, a first tax of 35% is imposed at the time of distribution, and a 5% rate is applied to the result of using said rate. In both cases, the implementation of these rates will depend on the effect of the Agreements to Avoid Double Taxation when applicable.
Accelerated transition to the application of IFRS
For tax purposes and impacts of accounting standards on income tax One of the major changes in the tax reform is the advance of the end of the transition so that IFRS represents the tax base in terms of income tax, which implies modifications important issues such as depreciation of fixed assets, which under IFRS usually have longer useful lives than those that had been planned until 2016, to which we can add the exceptions that Law 1819 of 2016 established in terms of income , costs, expenses and equity. In any case, it should be taken into account that article 137 of the Tax Statute established maximum annual depreciation ceilings for tax purposes, which range from 2.22% to 20%, and that the Government can regulate the maximum ceilings for each type. of assets within the mentioned limits. For the moment, and without prejudice to the transition regime, the table with maximum rates per asset class that is foreseen in the same standard will be applicable.
The amortization of intangible assets also underwent significant changes for the hydrocarbons sector. In particular, the following should be taken into account:
The amortization will generally have to be carried out through the method of production units for investments that are made from 2018. Meanwhile, the method for evaluation and exploration investments to be made during the years 2017 to 2027 will be the line straight for a period of five years.
The norm on the fruitlessness is modified that no longer alludes generically to investments, but to mines or deposits, which in practice can imply that even if a well is not successful the amortization of the investment in it is not susceptible to punishment, while the fruitlessness would be preached from the entire site.
Transition rules are established for the amortization of investments made before 2017, in which case the old article 143 of the Tax Statute will apply accordingly.
Finally, it is worth mentioning that several companies in the hydrocarbon sector have the US dollar as their functional currency under IFRS. However, for tax purposes, Article 868-2 of the E.T. establishes (actually ratifies) that the financial information must be carried in Colombian pesos, from the moment of its initial recognition and subsequently.
Treatment of seismic and geophysical services
It is common for seismic and geophysical services, including interpretation and reading, to be contracted with parties residing abroad. Until 2016, these services were subject to withholding at the source of 10% regardless of whether they were provided in Colombia or abroad, and VAT of 16%, only if: i) the place of provision was Colombia, or ii ) Despite being lent abroad, there was some transfer of knowledge.
The tax reform establishes that the remuneration for such services will be subject to withholding at the source of 15% and VAT of 19% (the new general VAT rate according to Law 1819 of 2016), regardless of the place of provision but always and when consumed in Colombia.
This measure makes the importation of services from abroad more expensive, especially due to the widespread commercial custom that the remuneration for such services is tax free.
It is also worth mentioning that in the past there was doubt about whether the cost of these items of the exploratory stage should be capitalized to be deducted via amortization or if it was possible to consider it as an expense of the period, since in reality of said Services was not predicable with any certainty whether or not future income was to be obtained.
The tax reform terminates this controversy, including Article 74-1 of the E.T. within which he mentions that the “seismic, topographic, geological, geochemical and geophysical studies are included in the expenses that must be capitalized, provided that they are linked to a finding of the non-renewable natural resource”. This treatment is subject to accounting standards, since under IFRS these types of expenses are not normally capitalized, which will lead to differences between accounting and tax matters, and greater complexity for the purposes of complying with tax obligations.
Tax losses did not have a term for compensation in income tax until 2016. As of 2017, a maximum period of twelve years is established for these purposes.
However, this limitation only operates for losses obtained from 2017, the losses of previous years are maintained without limitation for compensation.
This limitation can become a cost that cannot be recovered for companies in the hydrocarbon industry, whose maturation time of their investments can sometimes exceed twelve years.
Indirect taxation As is well known, the general VAT rate increases from 16% to 19%.
Sale of crude oil for refining
Until before Law 1819 of 2016, the sale of crude oil for refining was excluded from the sales tax (VAT).
This exclusion is eliminated, which implies that as of 2017, when this type of product is sold, the respective VAT must be billed at the general rate, but in turn it will allow oil producers to recover VAT paid for production of said product through the tax discount mechanism, in its VAT returns, which in fact may allow an improvement in cash flows. Under the previous scheme, VAT was recovered via deduction of VAT paid as a cost, which was only made effective each year by submitting the respective income tax declaration for the corresponding taxable year.
Incentives In an attempt to stimulate investments in the sector, the tax reform included some incentives which we summarize below:
Tax Refund Certificate (CERT)
This is a benefit for those companies that increase their investment in the exploration of new hydrocarbon reserves, the incorporation of new recoverable reserves, and the addition of new proven reserves. The benefit consists in the granting of a CERT, which can be used to pay taxes administered by the DIAN, or it can also be sold to other taxpayers. This incentive would only be available for companies operating onshore.
This is an incentive only available to the offshore exploration industry. It allows companies to request in return the VAT paid to suppliers of goods and services in relation to the exploration, within the year following its acquisition. •
ZOMAC (areas most affected by the conflict)
In order to support the post-conflict, tax benefits are granted to companies that have their principal domicile and carry out all their activity in the areas most affected by the armed conflict (progressive rate of income tax). In addition to that, benefits are also granted for those companies with income equal to or greater than 33,610 UVT in the respective taxable year, which despite not being domiciled in these areas, make investments within them. In this case, the benefit is that 50% of the tax payable for a taxable year can be paid through investments in projects of social importance in these areas, with the prior approval of the Agency for the Renewal of the Territory, and with the approval Good prior from the National Planning Department (DNP). The above makes it possible to recover as a deduction, against the income tax, what is invested in infrastructure projects, via the amortization of the investment.
Unfortunately, although it seems that companies engaged in the hydrocarbon industry do not have access to any of these incentives, it is possible that by means of an explanatory decree it is interpreted that the exclusion applies only to the progressive rate, but not for the possibility of paying part of the
income tax through investments in ZOMACs or the recovery of a part of this tax with the investment in infrastructure projects.
Law 1819 of 2016 constitutes the regulatory body that in the last twenty years has had a more intense focus on regulating the exploration and exploitation of hydrocarbons. In that sense, it is commendable that an effort would have been made to adopt more detailed regulations on this industry that ultimately results in clearer rules of the game for its actors and the market.
The tax reform brings important specific benefits for the hydrocarbon industry with respect to which we expect more regulation, as well as incentives for exploratory activity. In particular, it should be noted that for the offshore VAT refund to become a real incentive for companies to continue in Colombia and improve their cash flows, the balances in favor generated prior to the entry into force should be taken into account of Law 1819 of 2016.
The effects of convergence to IFRS for tax purposes present great challenges for local businesses. Due to the above it is important that a transition regime has been established in this regard. It is striking, in any case, that differences were not taken into account compared to IFRS as important as the non-capitalization of seismic and geology expenses.
Finally, it is worth mentioning that in a country highly dependent on commodities and the importation of foreign capital, the establishment of regulations that punish such investments, such as the imposition of a tax on dividends, could discourage foreign investment in the country.
There are still many issues still to be regulated and clarified as of Law 1819 of 2016. But it is clear that the new regulatory framework for the industry offers some stability and conveys the intention of the State to support an industry that has not yet abandoned the crisis of prices. The success of these provisions will be measured by their effectiveness, as well as by the state’s will to make them work and be applied with equity and justice but, above all, by their stability over time given the enormous legal volatility prevailing in Colombia.