Interoil Colombia Exploration and Production S.A. paid it foreign parent for cost related to exploration and administrative services, and for tax purposes these costs had been deducted in the taxable income. In total $3,571,353,600 had been declared as operating expenses for geological and geophysical studies carried out in the exploratory phase of an oil project and $5.548.680.347 had been declared for administrative services rendered from its parent company abroad
Following an audit the tax authorities issued an assessment where these deductions was denied.
In regards of cost related to exploration, these should have been recorded as a deferred charge amortisable over up to five years, according to articles 142 and 143 of the Tax Statute. In accordance with Article 142, these investments are recorded as deferred assets and are also declared for tax purposes. (…) According to the general accounting regulations – Decree 2649 of 1993 – deferred assets are part of the company’s assets, and correspond to anticipated expenses or goods and services from which benefits are expected to be obtained in other periods. These items are recorded as assets until the corresponding economic benefit is fully or partially consumed or lost. In other words, as deferred assets are utilised, they are transferred to amortised expense. Expenses that have not been used by the company must be kept in the assets. But once the deferred asset starts to help generate income, it can be incorporated as an expense.
In regards of deductions of $5.548.680.347 for payments made by Interoil Colombia to its parent company abroad for administration services, these were denied because Interoil Colombia did not, as required by law, withhold tax at source.
Decision of the Administrative Court
In a split decision the appeal of Interoil Colombia was dismissed and the assessment upheld.
Disallowed deductions for payments related to exploration
“… as there is a precise regulation within the tax regulations on the form and requirements needed to make the amortisation of investments deductible, the application of accounting rules is not appropriate, in accordance with the provisions of article 136 of Decree 2649 of 1993 and in application of the special rules that are applied in preference to the general rules.
Likewise, with regard to the method for the amortisation of investments, the Section pointed out that :
“Article 143 E.T. contains, in a perfectly independent and separate manner, the requirements for the amortisation of each of the situations set out therein. Thus, in subsection 1° it refers to the investments described in article 142 and, with respect to these, it orders that ‘they may be amortised in a term of no less than five (5) years, unless it is demonstrated that, due to the nature or duration of the business, the amortisation must be made in a shorter term’.
“It then sets out, in paragraphs 2 and 3, special cases of amortisation different from the general one, for which it determines particular requirements. Subsection 2 refers to when it is intended to amortise ‘Costs of acquisition or exploration and exploitation of non-renewable natural resources’, in which case, amortisation may be made ‘based on the system of technical estimation of the cost of operating units or by straight-line amortisation, over a period of not less than five (5) years’; and paragraph 3 refers specifically to ‘contracts where the taxpayer contributes goods, works, installations or other assets such as concession, shared risk or joint venture contracts’, in which case, the term for amortisation is limited to the duration of the contract until the moment of transfer, and, for the latter, it orders that the amortisation be carried out ‘by the straight line or balance reduction methods, or by another method of recognised technical value authorised by the National Tax and Customs Directorate’.
The application of the successful efforts method is therefore rejected, taking into account that, as stated above, articles 142 and 143 of the E.T. are applicable, which indicate how the expenses incurred by the plaintiff in the exploratory stage should be treated. It is reiterated that the cited rules mention the accounting technique regarding the registration of the investment, either as a deferred asset or cost, and do not refer to the accounting to determine the conditions of amortisation, which are clearly described in Article 143 of the E.T.
In this way, the Court finds that the accused acts are in accordance with the law in that they rejected the deduction for operating expenses for $3,571,353,600 and took this value as a deferred asset that can be amortised so that once the expected income is generated, it is incorporated as an expense and recognised as such.
In this sense, article 69 of Decree 187 of 1975, which refers to the amortisation of investments or losses, foresees that in cases in which the explorations are unsuccessful or non-productive, the expenses in exploration, prospecting or installation of wells or mines can be amortised with income from other productive exploitations of the same nature. In other words, in the event that the project associated with the expenditure for geological and geophysical studies proves to be unsuccessful, the claimant can amortise these values with the income from other productive exploitations of the same nature.”
Disallowed deductions for payments related to administrative services
“Payments made to parent companies or offices abroad for administration or management expenses, as well as those recognised for royalties and exploitation or acquisition of intangibles, are deductible from their income as a cost or deduction, provided that the respective withholding at source of income tax and remittances has been made on such payments, and furthermore, that the same constitutes national source income for the person who receives it.
Therefore, if the payments to the parent companies are taxable in Colombia and, therefore, are subject to withholding tax, they will be deductible for whoever pays them, obviously in the case of income considered to be of national source; on the contrary, if the payments referred to are of foreign source and, therefore, are not taxable through the withholding mechanism, they will not be deductible from the income of the subsidiary or branch, subsidiary or agency in Colombia”.
“In accordance with the previous jurisprudential criterion, which is reiterated, the Chamber concludes that the requirement of withholding tax for the deductions of article 124 of the E.T, is applicable to all income tax payers, whether or not they are subject to the transfer pricing regime, as it is a requirement for the deductions to proceed.
Since it is not disputed by the parties that Interoil did not withhold withholding tax on the payments for administrative services to the parent company, the deduction of the expenses for administrative services paid by the branch to the parent company abroad is not applicable.”
Colombia vs. INTEROIL COLOMBIA EXPLORATION AND PRODUCTION S.A., September 2021