Colombia: Royalty Taxation?

The Council of State ruled a dispute that, according to the plaintiffs, had prevented Colombia from receiving at least CoP$12T in taxes.

In 2005, Colombia’s National Tax and Customs Directorate (DIAN) issued a concept that allowed companies to deduct royalties’ payments from their taxes. Royalty production is ‘taken off the top’ so-to-speak and never is recognized as revenue.

Four years ago, a group of congressmen and experts in tax and environmental law came together to question the DIAN’s concept and decided to start a legal battle against the entity.

This week, the Council of State said the plaintiffs were right, and now they want the country’s General Comptroller to intervene and recover the money that the country has allegedly stopped receiving.

Attorney Myriam Gutiérrez argued that annulling the legal concept would affect foreign investment, making the country uncompetitive and adding an extra cost to industry entrepreneurs.

On the other hand, lawyer Clara María González presented a technical document to emphasize that the payment of royalties is not an expense and must be paid, regardless of whether the extracted natural resource is commercialized or not.

For economist Guillermo Rudas, the General Comptroller could study the issue to evaluate if it is worth a fiscal responsibility investigation or not, mainly because the entity already had references to an error that in twelve years of validity allegedly caused the State's finances to stop receiving more than CoP$30T.

Presidential candidate Jorge Robledo also said that DIAN’s concept prevented the State from receiving at least CoP$13T in taxes.

Through a statement, the Colombian Petroleum Association (ACP) said that the payment of royalties ranges between 8% and 25% of the income from production, and those resources “belong to the State, not to the companies that produce it, so  vit would not make sense for companies to pay taxes on a production that does not belong to them."

The Association added that what companies pay in royalties represents a cost for them, therefore it is deductible from their gross income when liquidating the income tax, meaning that their deduction is not a tax benefit, despite the fact that the Council of State wants to make it look like it.

The Colombian Mining Association (ACM) issued a statement saying that each case is different should be analyzed separately to determine if the deduction for royalties’ payment meets the requirements of Article 107 of the Tax Statute. (HCC: Mining companies also pay royalties and so are also affected by this result.)

The president of the Colombian Association of Entrepreneurs (ANDI), Bruce Mac Master, said that the decision of the Council of State may affect foreign investment in the oil sector because companies will not trust sudden changes in the regulations.

"Without a doubt, investors will feel that in Colombia there are abrupt changes that will eventually change the financial conditions of those who have made the decision to invest in the country."

Bottom-line: Companies do not deduct royalties from their income tax. They incur the cost of producing them but the revenues go to the State. Does this ruling mean that the barrels transferred to the State (or their equivalent in cash) must be treated as productive revenue, artificially inflating a company’s profits so that more tax can be collected?

As the article says, this is trillions of pesos, billions of dollars in potential back taxes plus a significant increase in State take going forward. Using 33% marginal tax rate this is like a 1/3 increase in royalties.

To be fair, it is only two weeks after the first story broke so maybe we should not be surprised to see a diversity of views about the implications.

Nor should we be surprised to see actors playing their appointed roles: Left-wing Senator and presidential hopeful Robledo calling for ‘hellfire and brimstone’ to rain down upon those nasty multinationals; industry association leaders calling for calm but concerned about the impact on investment.

We think that this is a serious issue that needs immediate clarification by MinHacienda and the DIAN, both of which have been notable by their absence from the press reports.

Tags: colombia, colombian petroleum association, energy, hydrocarbons, latam, oil and gas
Posted in LatAm, Energy, Energy