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Daniel Duque
Brigard Urrutia, Bogota
dduque@bu.com.co

 

The Colombian Government (the 'Government') issued Decree Nos 560 and 772 to establish temporary measures for bankruptcy procedures amid the Covid-19 outbreak and its adverse macroeconomic impact. The decrees set forth a simplified filing procedure; enable debtors to make direct payments to certain small creditors; provide rules for debt capitalisation, debt restructuring and debt discharge; and establish special tax benefits, among other provisions aimed at protecting the going concern and employment. In this article, we examine the main tax rules created for the context of bankruptcy procedures and their relevance in assisting debtors to overcome the crisis.

Capitalisation of debt

Creditors can opt to capitalise their receivables as shares or subordinated loans ('risk notes'). As defined by the highest corporate body (eg, shareholder assembly), issued shares or risk notes can grant to their holders all sorts of economic rights, special voting rights and even the right to a preferential and minimum dividend or payment.

Pursuant to section 4(1) of Decree No 560 of 15 April 2020, notes are to be booked by the debtor as equity for accounting purposes. Accordingly, if the entity is ultimately liquidated, repayment is conditioned to the payment of all other outstanding debt, except for reimbursements to shareholders ('subordinated debt'). This mandatory equity recognition aligns with the International Financial Reporting Standards (IAS 32 – Financial Instruments) given that the debtor has an unconditional right to avoid delivering payment to the note holder unless, of course, the entity is liquidated.

For tax purposes, there is no specific rule on when to register a note as a financial liability or equity instrument. The Tax Code provides, however, that debts are current liabilities that the debtor expects to settle in the future (section 283). Regarding international related parties' financing, transfer pricing rules state that if a loan does not meet market criteria (principal amount, term, risk rating, collateral, solvency and interest rate etc), it should be deemed as equity (section 260-3). The Tax Office affirmed that the main criterion to classify debt as a liability is the obligation to repay or reimburse the funds (Ruling 1169 of 2019).

On these grounds, absent an obligation to repay, risk notes will generally be deemed as an equity instrument for tax purposes. Therefore, any payment over the principal is considered as a non-deductible dividend subject to dividend tax (up to ten per cent). A lack of deduction could entail a higher income tax going forward or a diminished tax shield.

This dividend nature could be beneficial as withholding tax is only triggered when distributed, as opposed to interest withholdings that apply on a linear basis (accrued interest regardless of payment), which affects cashflow. Nevertheless, increasing the debtor's equity could have an adverse effect going forward if a wealth tax is reintroduced in 2022 that levies legal entities and not just individuals, as the current (2020 and 2021) wealth tax does.

At any rate, it is important to review on a case-by-case basis what sort of preferential economic rights and minimum and preferential payments are to be assigned to note holders, as they could eventually alter the nature as an equity instrument for tax purposes (eg, a put option or payments of 'interest' on a regular basis absent any profit).

Finally, the decree mentions that the capital increase can be registered with the Chamber of Commerce cost-free. It is unclear if the Government's idea was only to waive the registration charge (approximately $10) or the registration tax calculated at 0.7 per cent over capital and 0.3 per cent over the share premium (amount exceeding the share's face value). It is reasonable to expect that the measure was aimed at reducing the registration tax burden. Absent further regulations, it is possible that Chambers of Commerce, as responsible agents, will be inclined to continue collecting the registry tax in a manner that will certainly affect debtors' finances.

Debt discharge

When the debtor's liabilities exceed the businesses' fair market value, the reorganisation agreement allows the discharge of such excess (section 4(2) of Decree No 560).

Such a discharge will increase the debtor's equity and therefore should be registered as taxable income. Depending on the nature of the account payable's underlying transaction, such a discharge would typically be subject to either ordinary income tax (32 per cent for 2020) or capital gains tax (ten per cent) as confirmed by the Tax Office in Ruling 1669 of 2018.

To overcome this issue, Decree No 772 of 3 June 2020 established that, until 2021, any reduction, discount or discharge of capital, penalties or interest obtained by a debtor under a bankruptcy procedure will be subject to the ten per cent capital gains rate instead of the statutory income tax rate (32 per cent rate for 2020 and 31 per cent for 2021).

Although the capital gains rate of ten per cent is attractive, in practice, it is not always beneficial because of the general prohibition of using net operating losses (NOLs) to offset capital gains. However, Decree No 772 lifts this limitation and allows debtors to use NOLs to offset capital gains that accrue under a bankruptcy procedure, as previously explained.

Tax benefits

Withholding tax

For fiscal year 2020, debtors in a bankruptcy procedure are not subject to withholding and/or self-withholding taxes, which usually range between 2.9 per cent and 12.6 per cent. This provides a significant relief for the debtor's cashflow, especially in those industries where the profit margin is low, and withholdings end up in the balance in favour of being claimed as a refund in a burdensome process after filing the annual income tax return.

VAT withholding

For fiscal year 2020, debtors in a bankruptcy procedure are subject to a 50 per cent VAT withholding tax. This could potentially affect the debtor's cashflow because, in theory, the debtor should receive the VAT upfront and could use this resource until the return is to be filed every two or four months. In practice, however, payment is not usually completed upfront, and the debtor is required to finance the VAT. Moreover, in the current economic crisis, payment defaults are common, and the debtor could be forced to pay the Tax Office VAT that the debtor probably will not even collect.

Therefore, under market practice and the current economic situation, this seems like a fair measure to distribute the obligation to pay VAT, regardless of the actual payment to the debtor.

Income tax advancement

Taxpayers are required to pay, as an advancement of next year's income tax, up to 75 per cent of the current tax liability or the last two years' average after subtracting withholdings. Due to the adverse effect on cashflow, Decree No 560 waives the 2020 advancement for debtors in a bankruptcy procedure.

Presumptive income

In Colombia, there are two ways to determine the income tax due: (1) the ordinary system (based on a taxpayer's ordinary revenue); and (2) taxpayer's presumptive income. Income tax will be assessed and paid on the higher of the ordinary income and presumptive income. For 2020, presumptive income is 0.5 per cent of the prior year's net assets, and as from 2021, zero per cent.

Decree No 560 establishes that the debtor is not required to calculate presumptive income tax for 2020.

This is a positive benefit, especially for those debtors in intensive capital industries where presumptive income tax is a high burden.

The Government has rapidly realised that Colombia is on the verge of an economic crisis as a result of Covid-19 and oil prices, and has swiftly adopted measures to counter such a situation and protect businesses and employees. The simplified bankruptcy procedures and the tax benefits established in Decree Nos 560 and 772 are clear examples of measures that could provide cashflow relief and ultimately reduce the tax burden.

Going forward, we expect that such measures will be complemented by exempting entities, and waiving those individuals in the bankruptcy procedure from a new wealth tax in 2022 that could seriously affect non-productive assets. Of course, this will ultimately depend on the Government's finances, which have been seriously affected by the crisis, and the reliefs provided to foster the economy.

 

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