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