COUNCIL OF STATE

 

CONTENTIOUS-ADMINISTRATIVE CHAMBER

 

FOURTH SECTION

 

Adviser rapporteur: MILTON CHAVES GARCÍA

 

Bogotá D.C., nine (9) September two thousand twenty-one (2021)

 

Filing number: 25000-23-37-000-2016-01653-01(24282)

 

Applicant: INTEROIL COLOMBIA EXPLORATION AND PRODUCTION

 

Defendant: DIRECCIÓN DE IMPUESTOS Y ADUANAS NACIONALES-DIAN

 

 

JUDGMENT

 

 

The Chamber decides the appeal brought by the plaintiff and the defendant against the judgment of 3 October 2018, handed down by the Administrative Court of Cundinamarca, Fourth Section, Subsection A, which partially granted the claims in the application and did not order costs.

 

The operative part of the judgment under appeal provided as follows:

 

"FIRST: DECLARE the partial nullity of Resolution No. 900.001 of 5 June 2015, by which the Settlement Management Division of the Regional Tax Directorate of Large Taxpayers of the DIAN issued to the company INTEROIL COLOMBIA EXPLORATION AND PRODUCTION, Official Review Settlement for the income tax for the taxable year 2011 and Resolution No. 002.944 of 5 June 2015, by means of which the Settlement Management Division of the Regional Tax Directorate of Large Taxpayers of the DIAN issued to the company INTEROIL COLOMBIA EXPLORATION AND PRODUCTION, Official Review Settlement for the income tax for the taxable year 2011 and of Resolution No. 002.944 of April 21, 2016, through which the Sub-Directorate of Legal Resources Management of the Legal Management Directorate of the DIAN confirmed the previous one, by dismissing the appeal for reconsideration filed, in accordance with what is set out in the reasoning part of this ruling.

 

SECOND. By way of restoration of rights, MODIFY the official liquidation of the income tax for 2011 of the company INTEROIL COLOMBIA EXPLORATION AND PRODUCTION, in accordance with the liquidation made by this Corporation and that is in the motivating part of this ruling.

 

THIRD: The losing party is not ordered to pay the costs, in accordance with what is set out in the grounds...".

 

BACKGROUND

 

INTEROIL COLOMBIA EXPLORATION AND PRODUCTION, hereinafter INTEROIL, is a branch of a foreign company engaged, in general, in carrying out geological studies, geophysical surveys, exploration, drilling of wells (exploratory and development), production operation, transportation and sale of oil and other hydrocarbons.

 

On 18 April 2012, INTEROIL filed the income tax return for the taxable year 2011, in which it settled a tax liability and a balance payable of $18,960,072,000. On 30 April 2012, it corrected the return to include an adjustment in the equity line, without affecting the tax payable, nor the balance payable.

 

On 28 March 2014, the DIAN issued Special Ruling No. 312382014000037 , in which it proposed to amend the private return. It proposed to disallow $5,548,680,347 (line 55 - other deductions) because it did not withhold withholdings for payments abroad made to the parent company for administration services. It also proposed the disallowance of $3,571,354,000 (line 52-operating expenses for administration) because the investments made in the exploration stage are not deductible and should be capitalised, as they are deferred assets. Finally, it proposed a penalty for inaccuracy of $4,815,378,000 and a balance payable of $21,969,683,000.

 

On 9 September 2014, the DIAN issued an extension to the special requirement to propose the modification of the fixed assets (equity) line, increasing it by $3,571,354,000, taking into account the rejection of operating expenses, for the same amount, proposed in the special requirement.  The other values proposed in the special request were not modified.

 

After responding to the special requirement and its extension, by means of Official Revision Settlement No 900.001 of 5 June 2015, the DIAN maintained the glosses proposed in the aforementioned previous acts.

 

By Resolution No. 002944 of 21 April 2016, the DIAN confirmed on reconsideration the aforementioned official review settlement.

COMPLAINT

 

INTEROIL COLOMBIA EXPLORATION AND PRODUCTION in exercise of the means of control provided for in Article 138 of the CPACA, formulated the following claims:

 

"3.1 Declare the nullity of the Official Review Settlement No. 900001 of 5 June 2015 and Resolution No. 002944 of 21 April 2016 by which the appeal for reconsideration against the former is resolved, administrative acts that modify the Income and Complementary Tax Return for the taxable year 2011 filed by Interoil.

 

3.2 Consequently, restore Interoil's rights by declaring the finality of the Income and Complementary Tax Return for the taxable year 2011 initially filed on 18 April 2012, identified with form number 001102600792491 with electronic number 9100013404618, corrected on 30 April 2012, identified with Form No.1102602277195 and electronic file No.91000134948674.

 

3.3 Order the defendant to pay the costs and legal fees." (...)"

 

The plaintiff invoked as violated the following norms:

 

- Articles 338 and 363 of the Political Constitution.

- Articles 24, 124, 142, 142, 143, 408, 647, 730, 742 and 743 of the Tax Statute.

- Articles 11, 12, 13, 17, 21, 21, 35, 47, 55, 67 and 70 of Decree 2649 of 1993.

- Article 176 of the General Procedural Code.

 

As a concept of violation, he stated, in synthesis, the following:

 

There is no correspondence between the special requirement, the official liquidation and the act that resolves the appeal for reconsideration.

 

In the resolution that resolved the appeal for reconsideration, the DIAN argued that the payments for administrative services from the branch to the parent company constituted for the latter an income of national source, in accordance with Article 24 of the E.T. However, this charge was not raised in the special requirement, its extension, nor in the official assessment for review. In that sense, the tax administration untimely included new charges and thus violated the plaintiff's right of defence.

 

Insofar as the administrative services provided to the applicant by the head office do not correspond to technical services, technical assistance and consultancy, nor do they derive from the exploitation of any intangible asset, the payments for these services are not domestic source income for the head office and, consequently, are not subject to withholding tax, as the DIAN understood it.

 

Expenses for geology and geophysics studies are deductible and cannot be treated as deferred assets ($3,571,353,600).

 

Payments for geophysical and geological studies should be treated as expenses for the period. Treating these expenses as deferred assets, as the DIAN considers, generates an overestimation of equity, increasing the asset and violating accounting principles, such as the realisation of economic facts, over-form essence in terms of economic reality and the association of the expense with income, since the cost of exploration cannot be recognised as a deferred asset when there is no present or future income associated with it that can be totally or partially consumed over a prolonged period of time.

 

In hydrocarbon explorations that do not result in reserves suitable for exploitation, geophysical and geological activities cannot be said to generate a present or future income, as provided for in Article 67 of Decree 2649 of 1993 with respect to deferred assets. 

 

The DIAN did not recognise the validity of the method of successful efforts, which allowed the expenditures made in the exploratory phase ($3,571,353,600) to be deductible.

 

However, the final paragraph of Article 65 of Decree 2649 of 1993 allows the use of methodologies of recognised technical value, such as the successful efforts method. Thus, it allows determining the formation of disbursements that are not part of the depreciable base of the projects and that must be charged to the results in the year in which they were made, constituting tax deductions in those years.

 

Therefore, under the successful efforts method, geological and geophysical expenses incurred should only be amortised if proven hydrocarbon reserves are found, from which an economic benefit is expected to be obtained from their exploitation.

 

The DIAN erroneously considered that, in accordance with article 67 of Decree 2649 of 1993, expenses for geophysical and geological services should be considered as an asset, reaching the erroneous conclusion that all exploration and production expenses incurred by the branch should be amortised over a period of not less than 5 years, in accordance with article 143 of the E.T. (E.T.).

 

Articles 142 and 143 of the E.T., which refer to assets and their amortisation, are not applicable, since geophysical and geological expenses should not be recorded as assets, but should be taken directly to the income statement as a true expense of the period.

 

Expenses for administration and management services paid to the parent company abroad are deductible ($5,548,680,347).

 

Payments to the foreign parent company for administration and management services are deductible. They are not subject to withholding tax because they were made between related parties under the transfer pricing regime. 

 

The withholding tax on payments abroad (Article 124 of the E.T.) is a limitation on costs and expenses between related parties that does not apply in this case. The above, based on article 260-7 of the E.T, since it is a transaction to which the transfer pricing rules apply and the plaintiff complied with the obligations of that regime.

 

In judgement 7158 of 1995, the Fourth Section of the Council of State stated that article 124 of the E.T. constitutes a limitation on costs and deductions. Consequently, if the obligations of the transfer pricing regime are fulfilled, this limitation is lifted and, therefore, payments abroad are deductible even if no withholding tax is levied.

 

DIAN Official Letter 11039 of 2006 supports the applicant's position. Therefore, the deductibility of expenses for administrative services cannot be objected to.

 

Finally, it reiterated that to the extent that the administrative services provided to the branch by the head office correspond to general services that do not involve the transmission of knowledge, the application of any art or technique, giving advice on certain matters or the licensing or sale of intangible goods, they are not domestic source income for the head office and, consequently, are not subject to withholding tax.

 

 

The penalty for inaccuracy is inadmissible.

 

The plaintiff did not engage in punishable conduct because she did not intend to conceal or show a tax situation different from the real one.

 

Moreover, there is a difference of criteria. What is at issue is an interpretative assessment under which the administration considers that payments abroad for administrative services made by Interoil to its head office are not deductible. This is despite the fact that the plaintiff, which is a branch of a foreign company, complied with the obligations of the transfer regime. It was not obliged to withhold tax at source, since such payments constitute foreign source income for its beneficiary.

 

There is also a disparity of criteria regarding the disregard of deductions for hydrocarbon exploration expenses. The discussion was based on the interpretation of the rules regarding the accounting and tax treatment of such expenses, i.e. as deferred assets or as branch expenses.

 

DEFENCE TO THE CLAIM

 

The DIAN opposed the claims in the complaint, arguing, in summary, the following:

 

There is a correspondence between the special requirement, the official liquidation and the act resolving the appeal for reconsideration.

 

According to case law, there is no inconsistency between the special requirement and the tax assessment acts when the tax authority raises better arguments. What is not allowed is the inclusion of new facts or glosses different from those proposed in the special assessment.

 

In the present case, the payment made by the applicant to its parent company for administrative services constitutes domestic source income for the parent company. This, based on article 24 [numerals 7 and 8] of the E.T., since the services are rendered from abroad and the use of these services is carried out in Colombia.  Therefore, the branch should have withheld income tax.

 

The plaintiff's expenses in the exploration stage ($3.571.353.600) are not deductible.

 

The successful efforts method is not applicable in this case, since Articles 142, 143 and 159 of the E.T. establish a specific tax treatment of the deductions of investments for mining exploration.

 

According to Article 142 of the E.T., depreciable necessary investments are the disbursements made for the purposes of the business or activity susceptible to depreciation and which, in accordance with the accounting technique, must be taken as costs in mining exploration.  And article 143 of the E.T. refers specifically to how amortisation can be made when it comes to the costs of exploration of non-renewable natural resources.

 

The disputed discussion is not about the evidentiary assessment referred to by Interoil, but about the interpretation of article 142 of the E.T, which refers to the accounting technique only to indicate that the investment is amortisable, when it is recorded in the accounts as an asset, deferred or cost. At no point does this rule refer to accounting to establish the conditions required for amortisation, which are set out in Article 143 E.T.E. 

 

In conclusion, given that the projects carried out by the plaintiff are at the exploration stage and that their technical feasibility has not been demonstrated, it cannot record the investments made in the income statement. It must capitalise the investments made in the balance sheet, in an asset account, until it is decided whether the project is viable or not.

 

The deduction for payments abroad to the parent company ($5.548.680.347) is not applicable.

 

Ruling C-596 of 11 June 2006 declared article 85 of Law 223 of 1995, which modified article 124 of the E.T., to be constitutional, according to which for the deductibility of administration and management expenses abroad, income tax withholding at source must be made. The foregoing, regardless of the quality of economic links.

 

The requirement demanded by the Administration (withholding) does not constitute a limitation to the costs and deductions originated in operations with related parties, but a requirement established by the legislator for the deductibility of payments abroad.

 

Article 260-7 E.T. did not invalidate Article 124 of the same law, nor did it exclude the requirement to withhold tax at source. This requirement is not a limitation to the costs and deductions in transactions with related parties, as it only aims at the effective collection of income tax.

 

The penalty for inaccuracy is appropriate.

 

The penalty for inaccuracy must be maintained because the plaintiff included in her return deductions to which she was not entitled.

 

There is no difference in criteria, since the inclusion of deductions for expenditure in the exploration stage and expenses for payments abroad constitutes a clear disregard of the tax rules. It is not a question of the application of confusing or difficult to understand rules, which allow the inference of a difference of criteria between the Administration and the taxpayer.

 

JUDGMENT UNDER APPEAL

 

The Court partially annulled the contested administrative acts. The reasons were as follows:

 

There is correspondence between the special request and the tax assessment acts.

 

The principle of correspondence (article 711 of the E.T) was not violated. This, because in the special requirement it was proposed to reject the expenses related to the payment to the head office for administrative services, because the requirement of withholding at source (article 124 of the E.T) was not accredited. And this rejection was maintained in the official review liquidation and in the resolution that confirmed it.

 

Although the resolution that resolved the appeal for reconsideration included as an argument the territoriality of the income (article 24 of the E.T.), there is no violation of the principle of correspondence. What does exist is a better argument regarding the rejection of the aforementioned deduction.

 

The deductions for expenses incurred in the exploration stage ($3.571.353.000) are not applicable.

 

In accordance with articles 142 and 159 of the E.T, 65, 66 and 67 of Decree 2649 of 1993, the accounting and tax treatment that should be given to geophysical and geological expenses generated in the oil exploration stage is that of deferred assets, since they are necessary expenses that are amortised to be deductible in taxable periods subsequent to their realisation or causation.

 

The studies carried out in the exploratory phase cannot be treated as an immediate cost or expense and be recorded in the income statement of the plaintiff, since they correspond to deferred charges, whose investment is susceptible to be recovered by amortisation.

 

According to Article 69 (second paragraph) of Decree 187 of 1975, expenses for exploration, prospecting or installation of oil wells which are not productive can be amortised with income from other productive operations of the same nature. Consequently, the unproductive nature of the studies carried out does not determine the use of the method of successful efforts, since the expenses declared should have been treated in accordance with Articles 142, 143 and 159 of the E.T., which are special rules on the matter.

 

It is appropriate to disregard the deductions for payments of administrative services to the main house ($5.548.680.000).

 

In accordance with Article 124 of the E.T., for the deductions for payments made by the branch to the parent company for administrative services to be deductible, it is a requirement that income tax be withheld at source on such payments.

 

Among the limitations that can be lifted with respect to transactions between related parties, in accordance with Article 260-7 of the E.T., Article 124 of the E.T. cannot be found, because the provisions of that provision are not a limitation on a deduction, but a requirement for the applicability of a tax benefit.

 

 

 

The penalty for inaccuracy should be maintained but the principle of favourability is applicable.

 

The penalty for inaccuracy must be upheld because the applicant included deductions to which it was not entitled, from which it derived a lower tax payable, and there is no difference in criteria but rather a disregard of the rules on deductions. However, in application of the principle of favourability, the penalty is reduced to 100% (Law 1819 of 2016). Consequently, it determined the penalty for inaccuracy at $3,009,611,000.

 

 It refrained from ordering costs, as it considered that there was no evidence to prove that they had been incurred.

 

APPEAL

 

The applicant appealed the decision of first instance, arguing as follows:

 

The principle of correspondence provided for in article 711 of the E.T. was violated.

 

The DIAN disregarded the principle of correspondence and the applicant's right of defence. The above, because although the gloss is the same, i.e. the rejection of deductions for payments for administrative services to the main office, the DIAN's argumentation in the act that resolved the appeal for reconsideration, relating to the territoriality of the income, is different from that set out throughout the administrative proceedings, on the failure to comply with the requirement to withhold tax at source (of article 124 of the E.T.).

 

The deduction for expenses in the exploration stage ($3.571.353.600) is appropriate.

 

Articles 142 and 143 of the E.T. define depreciable investments and their amortisation term. For the hydrocarbon sector, the cited norms foresee that the amortisation of exploration and exploitation costs must be made based on the "system of technical estimation of the cost of operating units or by straight-line amortisation over a term of no less than five (5) years".

 

Thus, the depreciable investments for the hydrocarbon sector are the costs associated with exploration and exploitation (Article 104 of the E.T.), not the expenses (Article 107 of the E.T.). Therefore, geology and geophysics expenses are not amortisable.

 

It is not known that the successful efforts method is acceptable according to Colombian accounting technique.  Article 17 of Decree 2649 of 1993, stating that "whenever there are difficulties in reliably measuring and verifying a realised economic fact, the alternative that is least likely to overstate assets and revenues or understate liabilities and expenses should be chosen", admits the successful efforts method as one of the two options allowed by the accounting technique to record, in the same year and without being taken to assets, the expenses related to exploration activities in the hydrocarbon industry.

 

The recording of exploration expenses as deferred charges is only one of the options allowed in these cases, conditioned, moreover, that the requirements of articles 47 and 67 of Decree 2649 of 1993 are met, i.e. that the costs and expenses can be separately identified, their technical feasibility is demonstrated, that there are defined plans for their production and sale, and that their future market is reasonably defined. When this is not the case, i.e. when there is no certainty about the productivity of the exploration project, as in the case of Interoil, precisely because of the uncertainty of the exploration result, the option of the deferred charge is not possible and could proceed to direct recording in the year of realisation of the expense in the income statement.

 

Deductibility of payments to the parent company for administrative services.

 

Income taxpayers subject to the transfer pricing regime are not subject to the limitations on the deductibility of costs and expenses incurred with related parties abroad (Article 260-7 of the E.T.).

 

Therefore, the plaintiff is not subject to the limitation provided for in article 124 of the E.T. and was therefore not obliged to make withholdings on payments to the parent company for the administration services provided by the latter.

 

The appealed ruling disregards the useful effect of the transfer pricing rules, which is to avoid the erosion of the taxable income tax base in transactions with related parties.

 

Moreover, it interprets article 124 of the E.T. in isolation. The Council of State has recognised that article 124 of the E.T. contains a limitation to costs and expenses between related parties.

 

Finally, the argument regarding the requirement to deduct withholding tax on payments to the parent company abroad on the understanding that the income is from a national source violated the plaintiff's right of defence.  The foregoing, taking into account that this argument was only raised in the act that resolved the appeal for reconsideration and was not discussed in administrative proceedings.

 

The penalty for inaccuracy does not apply

 

The factual situation established in article 647 of the E.T. does not arise, as in this case there was no omission of income or inclusion of non-existent operating expenses, as the income, costs and expenses are real. What exists is a discussion on the interpretation of the applicable law.

 

Indeed, according to article 142 of the E.T., it is the accounting technique that defines what should be understood by depreciable assets in order to apply the tax treatment indicated in that article. For this reason, in accordance with the provisions of article 7 of the Procedural Manual of the Accounting Regime and the doctrine of the Technical Accounting Council and the Superintendence of Companies, the plaintiff recorded as an expense, in the income statement, the expenditures made in the exploration stage. However, the DIAN considered that article 142 of the E.T. does not refer to the accounting technique, but states that depreciable investments should be treated as deferred assets and not as expenses.

 

There is also a difference of criteria in relation to the interpretation of Articles 124 and 260-7 of the E.T., since, in judgments 2319 of 1990 and 7158 of 1995, the Fourth Section of the Council of State considered that Article 124 of the E.T. is a limitation to the deductibility of costs and expenses between related parties, a criterion that was accepted by the plaintiff and rejected by the DIAN in the contested acts.

 

CLOSING ARGUMENTS

 

The applicant reiterated its arguments in the application and in the appeal.

 

The defendant reiterated its position in its defence.

 

The Public Prosecutor's Office asked to uphold the judgment under appeal which upheld the official rejections and re-stated the penalty for inaccuracy on the following grounds :

 

The principle of correspondence was not violated

 

Both in the special requirement and in the official liquidation of review and the resolution that resolved the appeal for reconsideration, the rejection of the deductions for payments of administrative expenses made by the plaintiff the parent company abroad for lack of withholding at source was maintained, based on article 124 of the E.T., an aspect that was specifically verified by the Court and was not refuted by the plaintiff.

 

The deduction for expenses in the exploratory phase ($3.571.353.600) is not applicable.

 

According to case law, Article 142 of the E.T.T. refers to the "accounting technique" only to indicate that the investment is depreciable, when it is recorded in the accounts as an asset, deferred or cost. At no time does it refer to accounting to establish the conditions required for depreciation, which are set out in Article 143 of the same law.

 

Article 69 of Decree 187 of 1975 provides that expenditure on oil exploration projects which are not productive may be amortised with income from other productive operations of the same nature.

 

To consider that these exploration expenses could be deducted in the same period of their occurrence as a cost, violates the principle of association with the respective income which could not be generated until the productivity of the respective well, which is why it was necessary to amortise them in accordance with the cited rules.

 

Expenses paid to the parent company for administrative services should not be accepted.

 

The requirement of Article 124 of the E.T. on withholding tax for the deduction of foreign payments between related parties is a requirement that does not limit the recognition of costs and deductions.

 

The limitations to costs or deductions against related parties, referred to in article 260-7 of the E.T. are found in articles 85 and following ibidem, and refer to related parties who are not taxpayers of income and other operations in certain areas, activities and concepts. This rule has a different purpose than that provided for in the aforementioned Article 124 of the E.T.

 

The penalty for inaccuracy is applicable

 

In this case, there is no interpretation of the rules that regulate the glosses formulated by the DIAN that gives rise to differences in criteria. What is present is the disregard of the applicable law, because despite the content of articles 142 of the E.T and 69 of Decree 187 of 1975, the plaintiff considered to carry an investment as an expense and not to depreciate it. The same occurred with the erroneous interpretation that the withholding at source of article 124 of the E.T. constitutes a limitation on deductions.

 

CONSIDERATIONS OF THE COURT

 

In the terms of the appeal filed by the plaintiff, the Chamber will define: a) whether the principle of correspondence provided for in article 711 of the E.T. was violated; b) whether the deductions for expenses for geophysical and geological services incurred in the oil exploration phase should be disallowed; c) whether deductions for payments for administrative services rendered by the parent company abroad should be disallowed; and e) whether there is a penalty for inaccuracy should be imposed.

 

The Chamber modifies the judgment under appeal, on the following grounds:

 

The principle of correspondence was not violated

 

The applicant claims that in the decision that resolved the appeal for reconsideration, the rejection of deductions for payments made by the branch to the parent company abroad was confirmed because they are domestic source income.  That this charge was not raised in the special requirement or in the official review liquidation, and therefore the plaintiff's right of defence and Article 711 of the E.T, according to which the review liquidation must be based exclusively on the taxpayer's return and on the facts contemplated in the special requirement or in its extension, were ignored.

 

After analysing the special requirement and the official review liquidation, it is found that the proposal to amend the private return and the amendment made in the tax assessment act were based on the same fact or gloss: the rejection of the deduction for payments abroad made to the parent company for the so-called administrative services rendered to the branch. The legal basis for the disallowance was the non-compliance with the requirement of article 124 of the E.T., in the terms set forth in Ruling C-596 of 1996, since the plaintiff did not withhold tax at source at the time of the payment to the parent company abroad.

 

For its part, the decision that resolved the appeal for reconsideration confirmed the rejection of the deduction and specified that the income received by the parent company is of national source (article 24 of the E.T.), which corroborates the obligation of the plaintiff to make the withholding at source.

 

It is noted, then, that the Administration did not change the facts or the gloss that led to the amendment of the return. When ruling on the appeal for reconsideration, on the basis of the same rule (art. 124 E.T.), the DIAN insisted on the rejection of the deduction, because payments for administration to the parent company that are subject to withholding tax, i.e. those of national source (24 of the E.T.), are deductible. Furthermore, in the complaint, the plaintiff opposed the rejection, arguing that the income of the parent company for the payments in question are not of national source, so that it was not denied the right of defence.

 

In view of the foregoing, the appeal is unsuccessful.

 

The deduction for expenses for geological and geophysical studies in the exploratory phase ($3.571.353.600) is not applicable. Reiteration of case law.

Interoil declared $3,571,353,600 as administrative operating expenses for geological and geophysical studies carried out in the exploratory phase of an oil project.

The DIAN disallowed the deduction because the expenses should be recorded as a deferred charge amortisable over up to five years, according to articles 142 and 143 of the E.T. and the Court upheld the disallowance for the same reasons as alleged by the DIAN.

The appellant argues that it is not possible to record as deferred assets previous exploration expenses, when there is high uncertainty about finding hydrocarbon reserves and generating a profit. And that under the successful efforts method, expenditure incurred on typical activities within the exploration phase for which no determinable future benefit is foreseen can be expensed.

 

According to Article 23 of the Petroleum Code, exploration is the first stage of the petroleum activity and comprises "all surface geological and drilling work to ascertain whether or not the land covered by the concession contains petroleum in commercially exploitable quantities".

Article 142 of the Tax Statute, before the amendment of Article 84 of Law 1819 of 2016, stated that "the necessary investments made for the purposes of the business or activity, if they are not deductible in accordance with other articles of this chapter and other than investments in land, are deductible in the proportion indicated in the following article". And it adds that "necessary investments depreciable by this system are understood to be the disbursements made or incurred for the purposes of the business or activity susceptible to depreciation and which, in accordance with accounting technique, must be subtracted as assets, for depreciation in more than one year or taxable period; or treated as deferred, whether they are preliminary installation or organisation or development expenses; or costs of acquisition or exploitation of mines and of exploration and exploitation of oil or gas fields and other natural products."

For its part, article 67 of Decree 2649 of 1993 specifies that resources other than those regulated in exhaustible and intangible assets that correspond to: i) prepaid expenses, such as interest, insurance, leases and others incurred to receive future services; and ii) deferred charges, which represent goods or services received from which economic benefits are expected to be obtained in other periods, must be recognised as deferred assets.

 

In accordance with Article 142 of the E.T., depreciable necessary investments constitute a deduction in income tax and are defined as expenditures made for the purposes of the production activity, which are susceptible to depreciation, notwithstanding the fact that, according to accounting technique, they must be recorded as assets for depreciation in more than one taxable period; as "deferred" when they are preliminary expenses as in this case of oilfield exploration.

 

Regarding depreciable investments in the oil industry, this Section, in a ruling of 10 October 2018, stated the following:

 

"(...) In the case of the oil industry, depreciable investments may be represented in costs and expenses necessary for the exploration and exploitation of oil fields, which are amortised in order to be deductible in taxable periods subsequent to their realisation or causation. 

 

In accordance with Article 142 of the Tax Statute and the accounting technique, 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 will be 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 retained in the assets.

 

But once the deferred asset starts to help generate income, it can be incorporated as an expense. This results in a decrease in the value of the deferred asset and the recognition of the corresponding expense. 

 

Thus, deferred assets by accounting and tax provision are part of the taxpayers' equity, regardless of whether they are anticipated disbursements, because while the expense is used over time, the rest of the items will maintain the company's asset category.

 

This means that oil investments do constitute an asset, to the extent that they have not been amortised, and are therefore included in the determination of liquid assets (...)" (emphasis and underlining).

 

In the same line of jurisprudence, in a judgment of 22 April 2021 , reiterated on several occasions, the Chamber stated the following:

 

"According to the criteria of this Chamber, the accounting technique established in Decree 2649 of 1993 means that amortisable investments in the hydrocarbon exploration stage are recorded for accounting purposes as deferred assets, which are likely to increase the equity of taxpayers. Consequently, the provisions of Article 142 of the Tax Statute are applicable.

 

[...] The Chamber clarifies that such investments [referring to seismic, geological and geophysical studies in the hydrocarbon exploration stage] must be recorded as deferred assets in accordance with article 67 of Decree 2649 of 1993, which states the following:

 

[...]

The transcribed norm ordered that goods and services from which economic benefits were expected in future periods should be recorded as deferred assets for accounting purposes, and therefore did not establish in an obligatory manner that there should be future profits, as the plaintiff points out, but that it was subject to the existence of both profits and losses. Decree 2650 of 1993, which determined the dynamics of the accounting accounts, thus provided as follows:  

 

" [...]

 

CLASS GROUP ACCOUNT

1. ASSET 17 DEFERRED 1715 EXPLORATION COSTS TO BE AMORTISED

 

D E S C R I P T I O N

 

This account records the value of the costs incurred in the development of unsuccessful or non-commercial exploration work and which, due to their non-exploitable nature, are subject to amortisation.

This account is for the exclusive use of economic entities that carry out hydrocarbon exploration and exploitation activities.

 

D I N A M I C A

DEBITS CREDITS

a. For the value of the transfer of sub-account 150825 Exploration projects, once the potential for oil stocks or oil non-existence has been determined. a. For the sale or transfer of the asset. b. For the sale or transfer of the asset. For the sale or disposal of the asset.

b. For the value of the total cost of drilling that is technically defined as dry, because there is not enough crude oil to extract. b. For the crossing with sub-account 179805 Exploration Costs to be Amortized, upon completion of the respective amortization.

c. For the value of the cost of drilling in wells that, although stocks are proven, are not commercially exploitable due to their quality, difficulty to exploit or quantity.     

d. For the value of the inflation adjustment  

CLASS GROUP ACCOUNT

1. ASSETS 17 DEFERRED 1720 OPERATING AND DEVELOPMENT COSTS

 

D E S C R I P T I O N

 

This account records the value of costs incurred in the drilling of development wells that can be amortised, such as labour costs, logging services, cementing, inspections, land clearing, construction of access roads to the producing well, among others.

 

This account is for the exclusive use of economic entities that carry out hydrocarbon exploration and exploitation activities.

 

 

D I N A M I C A

DEBITS CREDITS

a. For the value of the costs transferred from sub-accounts 150825 and 150830, as the case may be, susceptible to be amortised in future periods, once the well has been drilled. a. For the sale or transfer of the asset. For the sale or disposal of the asset.

b. For the value of the inflation adjustments. b. For the crossing with sub-account 179810, at the end of the respective amortisation.

 

[...]" (Underlining by the Court)

 

In this order of ideas, the accounting technique specifically ordered the recording of the value of the investments in hydrocarbon exploration studies in the deferred assets or deferred charges account, regardless of the success or not of the activity, so it is not appropriate to deduct the total expense as the plaintiff did.

 

Regarding the tax treatment of hydrocarbon exploration activities, this Chamber explained the following in its ruling of 3 July 2002:

 

"[...] Such is the case [referring to the deduction in more than one taxable period] of the deduction for amortisation of investments, enshrined in article 58 of Legislative Decree 2053 of 1974, now articles 142 and 143 of the Tax Statute, [...] regulated by article 69 of Decree 187 of 1975 [...].

 

The investment made in the hydrocarbon exploration stage, even when it must be recorded for accounting purposes as a deferred asset, constitutes a deductible expense and not a fixed asset, which is due to the fact that the recovery of the investment is achieved not through the disposal of the costs and expenses, but through their gradual deduction".

 

In the same way, this Chamber in its ruling of 7 April 2005, concluded the following :

 

"On the subject matter of the present case, the Corporation has ruled on repeated occasions, in the sense of recognising that the expenses for exploration and exploitation in the hydrocarbon industry, cannot be assimilated to the concept of fixed assets even when according to the accounting statute and tax rules it is recorded as a "deferred asset", but rather constitute a deductible expenditure, whose recovery is foreseen through the gradual deduction of the expense, through the mechanism of amortisation of the investment.[...]. "

 

According to the above criteria, the deduction for amortisation of investments established in Articles 142 and 143 of the Tax Statute is applicable to the hydrocarbon exploration expenditures made by the plaintiff, because the aforementioned articles together with Article 69 of Decree 187 of 1975 requires that the deduction of the expense is made gradually. In addition, they must be recorded as a deferred asset for accounting purposes, so that the aforementioned articles of the Tax Statute are applicable as a special rule over article 107 of the said statute.

 

It is also clarified that although there is no conflict between the rules set out by the plaintiff, Decree 2649 of 1993 established in Article 136 that in the event of a contradiction between the accounting and tax rules, the latter would prevail. 

 

Based on the above jurisprudential criterion, which is reiterated, the expenses for geology and geophysics studies incurred by the plaintiff correspond to disbursements made in the exploratory stage of the development of its income-producing activity - pre-operational - and should have been recorded as deferred assets and amortised within the legal time limits, since they are necessary investments for the start-up of its projects, as provided for in Article 142 of the E.T. (E.T.).

 

Therefore, Interoil should have amortised the exploratory expenses in the terms provided for in article 143 of the E.T., for deferred charges, because, in addition, according to article 67 of Decree 2649 of 1993, there is a reasonable expectation of an economic benefit, a profitability, that allows its recovery.

 

It is not possible, as the plaintiff did, to record the expenses incurred in the exploratory phase as immediate expenses in the income statement, in application of the "successful efforts" method, because those expenses must be treated as deferred charges according to the special rule, which refers to exploration expenses, which must be recorded as deferred assets (Article 142 of the E.T.) and treated by the straight-line amortisation system, over a period of not less than 5 years, as provided for in Article 143 of the E.T.

 

Regarding the expression "in accordance with the accounting technique they should be recorded as assets (...); or treated as deferred (...) or costs" in the final part of the article. ) or costs" in the final part of the second paragraph of article 142 ib, on a previous occasion, this Section specified that it is not that "the aforementioned rule assigns to the accounting technique all the regulation referring to amortisation, including the form, term and procedure to carry it out, because the regulatory text clearly alludes to the accounting technique only to indicate that the investment is only depreciable when it is recorded for accounting purposes as an asset, deferred or cost, but at no time does it refer to accounting the conditions required for its depreciation, which are specifically indicated in article 143 of the aforementioned article". 

 

Therefore, the Section stated the following:

 

            "... 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.

 

Finally, the Chamber refrains from ruling on the appellant's argument that Article 142 of the E.T. only refers to costs and not to deductions. This is because this argument was not alleged in the complaint and the appeal is not the opportunity to add to it, as it violates the right of defence of the respondent, who did not have the opportunity to comment on this point.

 

The charge is not upheld.

 

The payments made by the branch to the parent company abroad for administrative services ($5.548.680.347) are not deductible. Reiteration of case law .

 

The DIAN disallowed deductions of $5.548.680.347 for payments made by Interoil to its foreign parent company for administration services. This was because it did not withhold tax at source (article 124 of the E.T) and the Court upheld the disallowance for the same reason.

 

The appellant insists that it is subject to the transfer pricing regime, so that, in accordance with article 260-7 of the E.T., its operations are not subject to the limitations on costs and expenses established in the Tax Statute for related parties. Therefore, in order for the deduction to proceed, it was not required to withhold tax at source.

 

Article 124 of the Tax Statute, as amended by Article 85 of Law 223 of 1995, establishes the requirements for deductibility of payments to the parent company:

 

ARTICLE 124. PAYMENTS TO THE PARENT COMPANY ARE DEDUCTIBLE. Affiliates or branches, subsidiaries or agencies in Colombia of foreign companies are entitled to deduct from their income, by way of cost or deduction, the amounts paid or recognised directly or indirectly to their parent companies or offices abroad, for administrative or management expenses and for royalties and exploitation or acquisition of any kind of intangible assets, provided that they withhold income tax at source.

 

Payments in favour of said parent companies or offices abroad for other different concepts are subject to the provisions of Articles 121 and 122 of this Statute".

 

Thus, the legislator allowed the deduction of payments to the parent company abroad for administration, management, royalties, exploitation and acquisition of intangibles, demanding as a requirement the practice of withholding at source, without providing for any exception.

 

And, for concepts other than those indicated, the deduction was subject to the general requirements for foreign expenses set forth in articles 121 and 122 of the Tax Statute; among these: the causal relationship, the practice of withholding at source if what was paid constitutes taxable income in Colombia, and the limitation of costs and deductions to 15%, except for the exceptions set forth in those rules.

 

On the requirement of withholding at source established in the law on administration payments made to the parent company, when studying the exequibilidad of Article 124 of the E.T., the Constitutional Court stated that :

 

"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".

 

For this reason, the Constitutional Court declared the withholding requirement to be executory, provided that it is understood that the payments made to parent companies or offices abroad for administrative or management expenses and for royalties and exploitation or acquisition of any kind of intangibles, which are deductible from their income by way of cost or deduction, are those of national source".

 

Therefore, payments for administration to the parent company that are subject to withholding, i.e. those of national source, are deductible.  Otherwise, they are not subject to withholding and are not deductible.

 

Subsequently, in 2002, Law 788 added Article 260-7 of the Tax Statute to the Tax Statute, as part of the rules that introduced the transfer pricing regime. The aforementioned provision states that:

 

 

ARTICLE 260-7. COSTS AND DEDUCTIONS. Added by Article 28 of Law 788 of 2002. The provisions of Articles 90, 90-1, 124-1, 151, 152 and numbers 2 and 3 of Article 312 of the Tax Statute shall not apply to taxpayers who comply with the obligation set forth in the first paragraph of Article 260-1 of the Tax Statute in relation to the operations to which this regime applies.

 

The operations to which the transfer pricing rules apply are not covered by the limitations on costs and expenses provided for in this Statute for related parties.

  

This provision only applies to taxpayers subject to the transfer pricing regime, the latter -transfer pricing- being understood in the explanatory memorandum of the aforementioned law as "the principles to avoid the artificial management of prices between related entities, carried out by a multinational group or by one or more tax administrations, which results either in injury to a tax authority by depriving it of taxes to which it is entitled, or in double or multiple taxation for the multinational group".

 

From the above rules, it can be seen that in the case of administration payments to the parent company, the deduction is only applicable to payments subject to withholding tax, i.e. those from national sources, regardless of whether or not the transaction is subject to the transfer pricing regime.

 

In effect, as indicated in the aforementioned article 124 and clarified by the Constitutional Court, in the deduction of payments to the parent company, the withholding was not foreseen as a requirement that is applied in consideration of the source of the income; rather, it constitutes the prerequisite for the expense to proceed, insofar as the rule requires that the value requested as a deduction be subject to taxation through withholding at source.

 

Regarding the application of the withholding tax requirement to all income taxpayers, regardless of whether or not they are subject to the transfer pricing regime, the Chamber, in the ruling reiterated above, held as follows:

 

"[...]

The rule that regulates in a special way the costs and deductions for taxpayers subject to that regime, that is, article 260-7, relieves them from certain provisions that prohibit deductions, and from the limitations of costs and expenses for related parties; but it does not exclude them from the application of article 124 of the Tax Statute. Nor is it evident that the regulations of these norms -articles 124 and 260-7 of the E.T.T.- conflict or contradict each other.

 

First, because article 124 is not among the provisions that article 260-7 authorises not to apply in the transfer pricing regime. And, secondly, because the regulation of the deduction to the parent company is not a limitation to costs and expenses, which is what these taxpayers are exempted from.

 

This is because article 124 establishes a requirement for the deduction to proceed, insofar as it allows the payment to the parent company to be included in the income tax return, and its raison d'être is that it allows the tax to be collected in advance in these operations with non-residents in Colombia, which guarantees the payment of the tax.

 

It should not be lost sight of the fact that the purpose of article 260-7 of the Tax Statute is not to exempt taxpayers subject to the transfer pricing regime from compliance with the requirements for costs and deductions, but only from certain prohibitions on costs and deductions, and from the limitations on costs and expenses foreseen for related parties.

 

For this reason, the effect that this rule has on payments to the parent company made by these taxpayers is that the prohibitions indicated in articles 90, 90-1, 124-1, 151, 152 and 312 -numerals 2 and 3 - do not apply to them, nor do the limitations on costs and deductions, such as that provided for in article 122 of the Tax Statute, which restricts expenses abroad to 15% -except in those cases in which withholding is mandatory, among others-.

 

Therefore, as the law did not exempt these taxpayers from complying with the requirements for deductions, they must comply with the requirements established for cost and expense operations that are applicable under the transfer pricing regime. To this end, the assumptions required by the rule must be met in order to be accepted as a deduction.

 

For these reasons, taxpayers subject to the transfer pricing regime must comply with the requirement to deduct payments to the parent company, consisting in the practice of withholding at source". (Emphasis and underlining).

 

In the specific case, both parties accept that according to Article 124 of the E.T, branches of foreign companies can deduct from their income, the amounts paid to their parent company abroad, for administration or management expenses and that, according to this rule, in order for this deduction to proceed, it is necessary that withholding at source on income tax and the complementary remittance tax be made in respect of these payments. Moreover, it is undisputed that the applicant is subject to the transfer pricing regime. 

 

The difference between the parties lies in the fact that for the plaintiff, article 124 of the E.T. constitutes a limitation on costs and deductions, so that, in accordance with article 260-7 of the E.T., it was not obliged to withhold tax at source, since its operations, which are subject to the transfer pricing regime, are not covered by the limitations on costs and expenses provided for in this Statute for related parties. On the other hand, for the DIAN and the Court, article 124 of the E.T. does not constitute a limitation on costs and expenses between related parties, but a requirement for the deductibility of the deduction.

 

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.

 

The nature of the income is not analysed, i.e. whether it is of national source or not, because on appeal, the applicant did not say anything to dispute that it was of national source, as stated in the contested acts. 

 

In view of the foregoing, the charge is not upheld.

 

Penalty for inaccuracy

 

In the specific case, the penalty for inaccuracy must be lifted because there is a difference of criteria regarding the applicable law (Article 647 of the E.T.).

 

This is because there is a reasoned difference of interpretation between the parties as to the scope of the expression "in accordance with the accounting technique" in article 142 of the E.T. (E.T.). In effect, for the plaintiff, the accounting technique allows it to use methods of recognised technical value, such as successful efforts, while for the DIAN, the reference to the accounting technique referred to in Article 142 of the E.T. is only to indicate that the investment is only depreciable when it is recorded for accounting purposes as an asset, deferred or cost.

 

There is also a reasoned difference of criteria between the plaintiff and the DIAN on whether the requirement of withholding at source, referred to in article 124 of the E.T., constitutes a limitation on costs and deductions between related parties. This is because, as the plaintiff argued, at some point, the jurisprudence of this Section considered that the requirement in question does constitute a limitation, a criterion that differs from that put forward by the tax authority, according to which the withholding at source is a requirement for the deduction to proceed, which is supported by the judgment that declared the exequibilidad of that rule (C-596 of 1996), the official doctrine of the DIAN and the case law.

 

The above reasons are sufficient to lift the penalty for inaccuracy in the present case.

 

In view of the above, the rejection of the expenses for geological and geophysical studies and the expenses for payments to the parent company abroad is maintained and the penalty for inaccuracy is lifted.

 

Consequently, the partial nullity of the contested acts is maintained (first paragraph) and the reinstatement of rights is modified (second paragraph) in order to re-settle the balance payable by the applicant, determined in the official review liquidation, excluding the penalty for inaccuracy, as follows:

 

Concept Private tax return Official review liquidation C.E.

Balance payable for tax $18.960.072.000 $21.969.683.000 $21.969.683.000 $21.969.683.000

Penalties 0 $4.815.378.000 0

Total balance to be paid $18,960,072,000 $26,785,061,000 $21,969,683,000 $21,969,683,000

 

For the rest, the judgment under appeal is upheld.

 

Order as to costs

There is no need for an order for costs in this instance, since in accordance with Article 188 of the CPACA, in proceedings before this jurisdiction, an order for costs, which according to Article 361 of the CGP includes legal aid, is governed by the rules set out in Article 365 of the General Code of Procedure, and one of these rules is numeral 8, according to which "costs will only be incurred when it appears from the file that they were incurred and to the extent that they have been proven", a requirement that is not met in this case.

In the light of the foregoing, the Council of State, Chamber for Contentious Administrative Proceedings, Fourth Section, administering justice in the name of the Republic of Colombia and by authority of the law,

 

 

 

ADJUDGES

 

1. AMEND the second paragraph of the judgment under appeal, which, consequently, shall read as follows:

 

SECOND: By way of reestablishment of the law, SET as the balance payable by the plaintiff for income tax for the year 2011, the sum of $21,969,683,000, in accordance with the liquidation practiced in the motivating part of this ruling.

 

2. For the rest, to uphold the judgment under appeal.

 

3. 3. RECOGNISE Carla María Lilian Reyes Correa as the attorney-in-fact of the DIAN in accordance with the power of attorney contained in folio 467 of the file.

 

4- Not to award costs in this instance.

 

 

The above ruling was studied and approved in session of the date.

 

 

(With electronic signature) (With electronic signature)

MILTON CHAVES GARCÍA STELLA JEANNETTE CARVAJAL BASTO

      President of the Section

 

            (Signed electronically)

MYRIAM STELLA GUTIÉRREZ ARGÜELLO       

 

               (Signed electronically)

JULIO ROBERTO PIZA RODRÍGUEZ

                     Save my vote I clarify my vote

 

SALVAMENTO DE VOTO / EXPLORATORY PHASE IN THE OIL ACTIVITY - Notion / DEFERRED ASSETS - Accounting treatment / DEDUCTION IN INCOME TAX ON NECESSARY AMORTIZABLE INVESTMENTS - Propriety / INVESTMENTS IN HYDROCARBON EXPLORATION STUDIES - Accounting and tax treatment. Reiteration of case-law / DEDUCTION FOR GEOLOGICAL AND GEOPHYSICAL STUDY EXPENSES IN THE EXPLORATORY PHASE - Permissibility.

 

With all due respect for the majority decision, I have not cast my vote in the judgment in the case in question, insofar as it concluded that the deduction for investments in geology and geophysics did not apply. (...) Regarding the exploration activity, it should be specified that "it basically consists of discovering and locating the places where oil deposits exist, for which there is no exact scientific method, but it is necessary to carry out a multitude of preliminary tasks to study the land. the methods used, depending on the type of land, will be geological or geophysical. (...) After carrying out the studies on the ground, which may suggest the presence or not of oil-bearing rocks reachable by prospecting, the depth at which they would be found, etc., the decision can be taken on whether or not to drill an exploratory well".  The point under discussion is whether, according to the accounting technique, geophysical and geological expenses on areas where technical feasibility has not been determined, should be expensed or charged as a deferred charge considering the accounting dynamics for investments in non-renewable resources. The Chamber's position is that these expenses are deferred charges since the accounting dynamics of account 1710 includes the costs and expenses incurred by the economic entity in the organisation, exploration, construction, installation, assembly and start-up stages. (...) Public accounting then indicates that expenses for which there is no certainty of a probable reserve cannot be charged to deferred assets, because only expenses that imply the generation of future benefits can be charged to deferred assets. These clarifications, although only applicable to public entities, which the plaintiff does not have, serve as criteria to establish the principle of certainty of generation of future income in the exploration activity of the hydrocarbon sector, as required by article 67 of Decree 2649 of 1993 and applied by the company. As such, and as the recognition of amortisable investments and tax deferred charges is subject to the criteria defined in accounting matters, it considered that the ruling should have weighed the guidelines provided by public accounting, in order to take geological and geophysical expenses to expenditure.

 

FORMAL SOURCE: DECREE 2649 OF 1993 - ARTICLE 67

 

COUNCIL OF STATE

 

ADMINISTRATIVE CONTENTIOUS CHAMBER

 

FOURTH SECTION

 

DISSENTING OPINION

 

 

Councillor: MILTON CHAVES GARCÍA

 

Bogotá D.C., nine (9) September two thousand twenty-one (2021)

 

Case number: 25000-23-37-000-2016-01653-01(24282)

 

Applicant: NTEROIL COLOMBIA EXPLORATION AND PRODUCTION

 

Defendant: DIRECCIÓN DE IMPUESTOS Y ADUANAS NACIONALES-DIAN

 

 

DISSENTING OPINION

 

With all due respect for the majority decision, I dissent from the judgment in the case in question, insofar as it concluded that the deduction for investments in geology and geophysics did not apply.

 

On this occasion, the plaintiff pointed out that "In hydrocarbon explorations that do not result in reserves suitable for exploitation, it cannot be said that geophysics and geology activities generate a present or future income, as provided for in article 67 of Decree 2649 of 1993 with respect to deferred assets". 

Regarding the exploration activity, it should be specified that "it basically consists of discovering and locating the places where oil deposits exist, for which there is no exact scientific method, but rather it is necessary to carry out a multitude of prior tasks to study the terrain. the methods used, depending on the type of terrain, will be geological or geophysical. (...) After carrying out the studies on the ground, which may suggest the presence or not of oil-bearing rocks reachable by prospecting, the depth at which they would be found, etc., the decision can be taken on whether or not to drill an exploratory well". 

The point under discussion is whether, according to the accounting technique, geophysical and geological expenses on areas where technical feasibility has not been determined, should be expensed or charged as a deferred charge considering the accounting dynamics for investments in non-renewable resources. The Chamber's position is that these expenses are deferred charges since the accounting dynamics of account 1710 includes the costs and expenses incurred by the economic entity in the organisation, exploration, construction, installation, assembly and start-up stages.

 

Decree 2649 of 1993, which regulates accounting in general and sets out the accounting principles or standards generally accepted in Colombia, invoked by the plaintiff, on deferred assets provided:

 

 Article 67. DEFERRED ASSETS. The resources, other than those regulated in the previous articles, that correspond to:

1. anticipated expenses, such as interest, insurance, leases and others incurred to receive in the future services and,

2.         Deferred charges, which represent goods or services received from which economic benefits are expected in other periods. Costs incurred during the organisation, construction, installation, assembly and commissioning stages should be recorded as deferred charges. Amounts incurred for research and development may be recorded as deferred charges only when the product or process that is the subject of the project meets the following requirements:

(a) The attributable costs and expenses can be separately identified;

(b) Its technical feasibility is demonstrated;

(c) There are definite plans for its production and sale; and

(d) Its future market is reasonably defined.

Such sums may be deferred in relation to the various products or processes in which they have alternative uses, provided that each of them meets these conditions.

(...)

Now Decree 2650 of 1993, when establishing the dynamics of the chart of accounts, stated that "Group 17 - Deferred" records "those other expenses commonly referred to as deferred charges, which represent goods or services received, from which economic benefits are expected to be obtained in other future periods", and in the dynamics of the accounts, it specified the following groups:

- 1710 Deferred charges: records costs and expenses incurred by the economic entity in the stages of organisation, exploration, construction, installation, assembly and commissioning.

- 1715 Exploration costs to be amortised: records the costs incurred in the development of unsuccessful or commercial exploratory work which, due to their unexplorable condition, are subject to amortisation, and which in their dynamics include dry wells, non-commercial wells and other exploration costs.

- 1720 Exploitation and development costs: This account records the value of costs incurred in drilling development wells and which are subject to amortisation, such as labour costs, logging services, cementing, inspections, land clearance, construction of access roads to the producing well, among others, and includes exploitation and development costs, to record the costs of drilling and exploitation, drilling in development fields, production facilities and well services.

 

Accounts 1715 and 1720 are exclusive to the hydrocarbon exploration and exploitation sector.

 

Now, for this case it is necessary to consider that Resolution 356 of 2007 defined the technical criteria of the national public accounting system, which in line with the general accounting principles is made up of a general catalogue of accounts and accounting procedures and instructions.

 

The manual of procedures of this resolution, in its chapter IV, when defining the accounting procedure and disclosure of investments and expenses related to non-renewable resources, specified the following:

5.         INVESTMENTS IN NON-RENEWABLE NATURAL RESOURCES.

Investments in non-renewable natural resources in exploitation are comprised of the costs incurred in the exploration stage, which are directly related to the discovery of specific reserves, provided that the costs are associated with areas that are producing, the costs incurred in the development stage, until the production stage begins, and the costs of abandonment.

The exploration stage comprises activities related to the search for reserves of non-renewable natural resources. It includes carrying out studies, as well as drilling and excavation of deposits. Studies and projects carried out at this stage are recognised as an expense. :

7.         OTHER EXPENDITURES INCURRED IN THE EXPLORATION STAGE

Studies in the exploration stage, i.e., those aimed at determining whether or not the areas analysed contain non-renewable natural resources in commercially exploitable quantities, are recognised as an expense, since it is not feasible to directly relate these expenditures to the acquisition or discovery of specific and identifiable reserves, for the period between the beginning of the study and its execution. For this purpose, sub-account 521106-Studies and projects is debited from account 5211-GENERALS and the appropriate asset and/or liability sub-account is credited.

Expenditures related to the drilling and excavation of fields in the exploration stage are recorded to subaccount 191010-Exploration Expenses in account 1910-DIFFERRED CHARGES, until it is established that they are producing or non-producing areas. If they are producing areas, the balance of sub-account 191010-Exploration expenses is reclassified to the corresponding sub-account of account 1840-INVESTMENTS IN NON-RENEWABLE NATURAL RESOURCES IN EXPLORATION and must be subject to amortization affecting the cost of production. Otherwise, it is recorded as an expense in sub-account 521158-Exploration expenses, of account 5211- GENERAL.

Public accounting indicates that deferred assets cannot be charged with expenses for which there is no certainty of a probable reserve, because the deferred charge can only include expenditures that imply the generation of future benefits, clarifications that although only apply to public entities, which the plaintiff does not have, serve as criteria to establish the principle of certainty of generation of future income in the exploration activity of the hydrocarbon sector, as required by article 67 of Decree 2649 of 1993 and applied by the company.

 

As such, and as the recognition of amortisable investments and tax deferred charges are subject to the criteria defined in accounting matters, the company considered that the ruling should have weighed the guidelines provided by public accounting, in order to include geological and geophysical expenses in the expenditure.

 

Yours faithfully,

 

(Signed electronically)

MYRIAM STELLA GUTIÉRREZ ARGÜELLO