Volume 4, Number 35, Page 3

Colombia: Tax Aspects of the Energy Sector

by Alfredo Lewin Figueroa

Some of the recent developments (1995-1997) in Colombia’s tax law applicable to the energy sector evidence that the normative instability in Colombia continues to seriously affect investment projects. This article addresses some of the main issues discussed in the XIV Conference on Colombian Energy held in August 1997 in Bogotá.

There is no one law, whether it be a tax law or a chapter of a law, clearly stating tax regulations at a national, departmental and/or municipal level which apply to the activities or projects related to the energy sector. Nor is there a law with respect to any of the sub-sectors (coal, gas, petroleum, electricity, etc.).

The instability of the norms and the problems with their interpretation, originating in large part due to confused legal wording, are commonplace within the entire Colombian legal system, including taxation. This seriously affects activities and projects in the energy sector which, given their nature, the companies involved and contract issues, are long-term and involve significant amounts of money.

A classic example that clearly illustrates the instability of the normative regulations is the modification of Law 142 of 1994 (Article 24) upon issuance of Law 223 of 1995 (Article 97) and which today is reproduced in Article 211 of the tax laws. These laws address the exemption of income tax and other indirect taxes in favor of public domicile utility companies and those for the transmission and domicile distribution of electric power. These laws are marked by a lack of clear legal wording and technique, as they fail to take into consideration other dispositions contained in the tax laws currently in force.

In Law 142 of 1994, the exemptions clearly stated regarding income tax and other indirect taxes are not only applicable to state entities and mixed capital companies but also to private companies. But according to Article 97 of Law 223 of 1995, these exemptions only benefit, in principle, official entities and mixed capital companies. Despite this tangled legal wording, one could argue that in the case of income derived from the transmission or distribution of domicile electric power, the exemptions are also applicable to private companies.

According to Law 142/94, the exemptions benefit all domicile public utility companies which are municipal. Law 223/95 only refers to certain types of domicile public utility services; on the other hand, it does not restrict the benefit only to municipal companies.

Regarding the exemption on income earned on the transmission or domicile distribution of electric power, it does not appear, by the wording of Article 97 of Law 223, to be conditioned on the capitalization of profits or appropriation of reserves, nor upon their being state-owned or of mixed capital.

With respect to income tax exemption derived from the generation of electric power and those exemptions derived from domicile public services of gas, the exemption contemplated in Article 97 of Law 223/95 is for eight years, but its quantity decreases yearly. Regarding Law 142/94, the exemption on the domicile utility companies was 100% and lasts seven years, provided that the profits were capitalized or were set in reserve for the rehabilitation, extension and reposition of old systems.

The exemption clearly stated in Article 97 of Law 223/95 (today Article 211 of the tax law) that benefits income earned from the transmission or domicile distribution of electric power and the 20-year exemption contemplated for income earned by electricity generating companies based on coals, thermic and solar energy are inefficient. Although companies will benefit from the exemption if they comply with all requirements, investors (partners or shareholders) would be taxed on dividends or shares they obtain because the profits from which dividends are obtained were not taxed to the company.

The same is true for the exemption contemplated on income earned from electricity generating companies that restructure or establish themselves with the sole objective of generating and commercializing electric power by using water resources and have an installed capacity of less than 25,000 kilowatts.

Under Article 52 of Law 223/95, the production of crude petroleum, free or associate gas, coal and ferronickel is taxed with a special contribution in effect through the end of this year. There is an exception for well sites discovered after June 30, 1992 and before Jan. 1, 1995 and under which production or exploitation began after Dec. 31, 1994 (i.e., Cupiagua, currently the most important oil field in Colombia). These sites must pay the special contribution through Dec. 31, 2000.

The applicable tariffs are as follows:

a) Crude Petroleum:

• Light petroleum 7.0%
• Heavy petroleum with one grade less than 15 grades API 3.5%

b) Free or associate gas 3.5%

c) Coal 0.6%

d) Ferronickel 1.6%

The taxable base for crude is the total value of barrels produced according to their export FOB price. The taxable base for free and/or associate gas is the total production value, excluding that assigned for the generation of thermic energy or for domestic residential use, in accordance with the price upon opening of the well. The taxable base for coal and ferronickel is the total export FOB value. One must conclude that the explorers and exporters are not subject to the special contribution for these products.

With respect to IVA or VAT (Value Added Tax) on heavy machinery imports, one must refer to Article 6 of Law 223/95 which modified the preceding regulation that exempted heavy machinery imports for basic industries such as the generation and transmission of electric power. Now, based on the law stated above, only temporal imports of heavy machinery are exempted from VAT payment.

Article 15, Law 383 of 1997 establishes that with respect to the municipal tax on industry and commerce corresponding to the generation of electricity, the Industry and Commerce Tax will continue to be liquidated pursuant to Article 7, Law 56 of 1981. This means that the owner entities may be taxed up to a fixed amount for each installed kilowatt. With respect to the transmission and connection of electric power, Law 383/97 clearly states that the municipal tax for Industry and Commerce is based on the municipality where the substation is located; the tax on the transportation of gas is based on city limits.

With respect to the purchase and sale of electric power by non-generating companies whose consignees are not end-users, the Industry and Commerce tax is based on the municipality corresponding to the seller’s domicile.

In accordance with Article 89 of Law 223/95, lease contracts signed under a term equal to or greater than 12 years and for the purpose of developing infrastructure projects in the energy sector, among others, will be considered operating leases. Consequently, the lessor may register as a deductible expense the total installment payment without having to register, in assets, the asset subject to this rent. This may have a significant effect on the application of inflation adjustment systems. Nevertheless, it would be incorrect to assert that for every case a lease contract is the best option. The system of applications for inflation adjustments, both accountable and taxable, is an aspect that needs to be assessed thoroughly on a case-by-case basis.
Law 99 of 1993 established a 6% tax on gross energy sales by hydroelectric power-generating companies whose nominal installed power exceeds 10,000 kilowatts. The tax is 4% in the case of power stations.

Recent initiatives by Congress will affect the energy sector, including legislation 218/97, which is being proposed in the Senate. The purpose of this legislation is to establish tax exemptions for thermic and coal generation and to assess a surcharge for reliability of the national electric system. The legislation would also establish compensation mechanisms for changes that may occur regarding environmental legislation, as well as taxes and other contributions that affect both the projects and companies dedicated to the generation of power based on coal plants. Regardless of the technical benefits of this legislative initiative, from a judicial standpoint it raises constitutional problems, which were raised by the Sponsor Senator in the Third Commission of the Senate of the Republic (See Congress Gaceta No. 203 of June 13, 1997).

Two distinct mechanisms may serve to prevent the unfavorable effects typically associated with the permanent instability of taxable norms. The first mechanism is contained in Article 240-1 of the tax law and provides essentially for the possibility of subscribing a stability contract with the national government for a term of up to 10 years. The taxpayers who sign such a contract must accept a tax tariff on income tax and other indirect taxes exceeding by 2% the general tariff in force. The government commits itself to not apply a tariff increase on income tax and other indirect taxes that would be established during the term of such a contract, nor to any state income tax or contributions that would be established after the signing of the contract.

The other mechanism to protect against instability is the inclusion of a specific clause in the corresponding contracts signed by the national government or public entities. This clause would provide that if taxes increase or new ones are created during the term of the contract, the national government, or if such is the case, the public entity, must assume the corresponding economic difference. In the absence of a clear and definitive clause on this matter, it is uncertain whether a contractor may have a successful claim before the contracting entity for compensation due as a result of tax norm variations. Absent such a clause, they would be subject, in a best-case scenario, to a lawsuit before a court, based on the principle of economic or financial equilibrium of contracts.

Alfredo Lewin Figueroa is a senior partner with Lewin & Wills Attorneys at Law in Santafé de Bogotá.