The Privatization and Project Finance Adventure: Acquiring a Colombian Public Utility Company
hTe P rivatization and Project Finance Adventure: Acquiring a Colombian Public Utility Company
Mario A. de Castro 0
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The Privatization and Project Finance
Adventure: Acquiring a Colombian
Public Utility Company
Mario A. de Castro*
It is a bright sunny summer day and you are sitting in your office
wondering why you are not on the golf course or at home with your spouse
and kids. Suddenly the telephone rings; it is a client with an urgent
The client is considering bidding on a public utility privatization
project in Colombia. The client's concerns run the gambit from
privatization law questions to choosing local counsel. How do you
effectively advise the client on the laws and business customs of an entirely
foreign jurisdiction, while keeping in mind U.S. transactional
consequences? The international project finance adventure has begun.
Colombia is an exciting new arena for the international practitioner
structuring project finance and privatization transactions.'
The sectors of
* Mario Andrade is the Tax & Legal Services partner of Deloitte & Touche Consultants.
(the Deloitte Touche Tohmatsu Colombia practice). He is a licensed Colombian attorney
(L.L.B., Javeriana University), who also holds an L.L.M. in International Law and a Master
of Science in Public Finance from the Autonomous University of Mexico. Mario A. de
Castro is a Senior Consultant with Deloitte & Touche, L.L.P.'s International Tax Services
practice in Detroit, Michigan, where he is a member of that office's Latin America tax and
foreign investment group. He is a U.S.-trained attorney (J.D., Temple University and B.A.,
Tulane University), admitted to practice law in the State of Florida and in Colombia. Prior
to joining the Deloitte & Touche practice in Detroit, Mr. de Castro spent two and a half
years with Deloitte & Touche Consultants Ltd. in Bogota, Colombia.
Note: The views and opinions expressed in this article are solely those of the authors and
do not reflect Deloitte Touche Tohmatsu's official position. Errors, omissions, and/or
generalizations are attributable only to the authors. Additionally, because of the constant
state of change in the Colombian law, laws and norms cited herein are controlling only as of
The Privatizationand ProjectFinanceAdventure
the economy that are attractive targets for most multinationals (MNCs)
entering Colombia are the energy, oil and gas, mining, water, and
In most cases, MNCs in these gectors consider investments in
Colombia when the Colombian authorities announce a plan for the
privatization or capitalization of state-run companies that have a monopoly
on business.3 Often the MNC becomes aware of the privatization,
concession, or capitalization4 project via an official announcement by the
'Despite much internal political upheaval during the 1990s (in this context it is
important to note that, for the past 35 to 40 years, Colombia has been experiencing an
undeclared civil war), foreign investment in Colombia has increased steadily. At the end of
1992 foreign investment was registered at U.S.$3 billion; a year later this figure increased
by U.S.$61.5 million and in 1994 it neared U.S.$8 billion. Diego Herrera Caipa, La
Inversi6n Extranjeraen Colombia Crece Como Espuma, LA REPUBLICA, Aug. 12-18, 1997,
at 6. According to a 1998 government report for the first trimester of the year, new foreign
investment (composed of new capital, plus retained earnings, minus capital reimbursements)
stood at U.S.$1.1 billion. In terms of growth, from the 1997 first trimester to 1998 direct
net foreign investment grew by 155 percent. INVERsI6N EXTRANJERA EN COLOMBIA:
INFORME DEL PRIMER TRIMESTRE DE 1998 (COINVERTIR) (Julio 1998). See COLOMBIA:
INTERNATIONAL TAX AND BusINEss GUIDE 2-4 (Deloitte Touche Tohmatsu eds. 1997)
("Foreign investment rose in 1996, as it had in previous years. According to statistics from
the Central Bank, non-oil foreign direct investment increased from U.S.$5.7 billion in
December 1994 to U.S.$9.4 billion in November 1996. According to the Foreign Investment
Agency, foreign investment in the oil sector stood at U.S.$1 billion in 1995"). See also
GLOBALIZACION DE LA ECONOMIA Y COMERCIO EXTERIOR: INFORME DEL MINISTERIO DE
COMERCIO EXTERIOR AL CONGRESO JUNIO 95-JuNio 96 (Colombian government report on
private and public sector foreign investment). But see Jacob M. Schlesinger, La Inversi6n
de CapitalPrivadohacia Amirica Latina se Estabiliza,in WALL ST. J. AMERICAS (included
in EL TIEMPO, Sept. 12, 1997, at 2 B) (recent studies by international investment banks and
funds indicate that private capital investments in Colombia are beginning to level off).
2 The bulk of foreign investment during 1997 was directed toward the energy sector.
Inversi6n Extranjerahasta Mayo Crecio 68 percent, LA REPUBLICA, Sept. 17, 1997, at IA,
' The decision to put a state owned company on the auction block is not so much a desire
on the nation's part to embrace free market economics, but is rather an attempt to eliminate
the mammoth-like debt of the state enterprise. See Tara K. Guinta, Building Blocks to
Forginga Robust TelecommunicationsInfrastructure,27 INT'L L. NEWS 1, 18 (Spring 1998)
("Inefficiencies run rampant in nationalized industries, which generate deficit which, in turn,
prevent economic growth and prosperity for nations and their citizens."). This was the case
in the decision to capitalize the Bogota Energy Company in the summer of 1997. See
Deyanira Tibana Mufioz, Nuevos Socios ParaSalvarEnergia, EL TIEMPO, Aug. 8, 1997, at
ID-2D (the financial demise of the Bogota Energy Company was of such magnitude that
failure to capitalize would lead to eventual bankruptcy). More recently, the decision to
capitalize The Electric Company for the Atlantic Cost of Colombia (known as
"CORELCA") during the summer of 1998 was driven by the fact that it have outside
liabilities of close to U.S.$1.2 billion, which it could not cover on its own. PROCESO DE
REESTRUCTURACION Y CAPrrALIZACION DE CORELCA Y LAS ELECTRIFICADORAS DE LA
COSTA ATLANTicA/Doc. COMPEs 3013 (Ministero de Hacienda y Cr~dito P6blico,
Ministerio de Minas y Energia, DNP: UINFE: DIMEN/ Departamento de Planeaci6n
Nacional de Colombia, Julio 14, 1998).
1Under the current Colombian political climate, privatization schemes are organized
preferably under the rubric of capitalization processes, where foreign capital is brought in by
Colombian government calling for bids or an invitation informing the
MNC that it is qualified for the particular project or a specific aspect of the
When a client is interested in participating in the bid process, it will
most certainly, unless it has participated in other bids in Colombia,
approach counsel and its other advisors with assumptions of how the bid
should be structured, from both a Colombian and U.S. angle. In these
instances, the only option for counsel and other advisors is to listen and
take note. The following key questions must be considered under this
scenario: what type of restrictions exist under current privatization laws;
what form of business association should be used; what is the tax treatment
regarding business associations, dividend treatment, technical services and
assistance contracts, and repatriation of profits; do foreign exchange
regulations hinder the availability of using inter-company loans and foreign
currency operations; how should the due diligence review be performed;
and how should local counsel be chosen?5
II. ISSUES AND CONCERNS
A. Colombian Privatization Law Issues
Compliance with Colombian privatization and related law is a must
when crafting a public utility privatization or a capitalization transaction.
In this regard, two pieces of legislation should be studied: Law 226/95 and
1. Law 226: ColombianPrivatizationRegulation
Law 226/956 regulates privatization in Colombia. The law provides a
procedural map for privatization and capitalization transactions,7 while
an 4NC or other foreign investor to purchase a significant share of the stock of the
government entity's stock. See Privatizaciones, LA REPUBLICA, Sept. 2-8, 1997, at 6-7
("The privatization model... that characterizes these processes in Colombia is private
shareholder participation in traditionally state owned enterprises, a model of private sector
participation in a mixed economy setting.. ."). Usually the foreign investor will purchase
between 48 to 57 percent of the public entity's stock. Id. at 6. Public policy reasons for this
strategy are twofold: (i) the public entity receives a fresh foreign capital injection to pay off
existing debt and reorganize, and (ii) the government retains some control or semblance of it
over the entity, even if only in the form of preferred non voting class stock. The latter is
important from a political standpoint, given that it is in the government's best interest to
preserve some appearance of sovereignty over its traditionally controlled operations.
5See THE INTERNATIONAL LAWYER'S DESKBOOK (Lucinda A. Low et al. eds., 1996)
[hereinafter LAW. DEsKBooK] (setting out issues and concerns that must be considered when
doing business in foreign jurisdictions); JAMES-OTIS RODNER S., LA INVERSI6N
INTERNACIONAL: EN PAiSES EN DESARROLLO (1993) (legal and economic analysis of issues to
be considered when conducting foreign investment in developing nations).
6 Colombian Law 226/95 [hereinafter Law 226]. See iEnergia. PODER & DINERO, Oct.
1997, at 220, 225-226 (illustrating the complexity of Law 226 application in the
setting out to democratize' the ownership and operation of state-run
entities. Law 226 mandates that once a public service is privatized,
necessary steps must be taken to guaranty that the service provided is
continued throughout the newly privatized or capitalized entity's life.9
Democratization of ownership under Law 226 is the (initial) offering
of public utility shares to the public utility's employees (in Spanish, El
Sector Solidario)0. The statutory language states, "Processes involving
any disposition must be channeled through mechanisms guaranteeing
adequate public notice and agreement and procedures promoting massive
[public] participation in stock property.""
The Colombian Constitutional Court interprets this language to apply
to the sale of state-owned assets, as well as to shares of stock. 2 The
Court's interpretation is based on Article 60 of the Colombian Constitution.
Article 60 provides that when the State sells or transfers its participation in
a public entity it must, first, in the spirit of democratic processes offer its
stake in the entity in the form of stock to the entity's employees. 3 This
position, although highly debatable given the exact language of the law
which talks of state-owned shares of stock, has not been challenged
successfully to date, 4 due to its constitutional underpinnings.
Democratization under Law 226 is achieved once the labor sector has
been offered a chance to participate in the ownership of state-owned assets.
Typically, based on the capitalization process performed in the Bogota
Electric Company in September 1997, labor will only be allocated a one
capitalization process of the Bogota Electric Company (the largest Colombian utility
company to ever be capitalized to date)).
' In some cases, Law 226 takes precedence over other Colombian administrative contract
law principles. Law 226, art. 2.
9Ida.t art. 5.
'Old. at art. 3.
"Id. at art. 2.
1n re Unconstitutionalityof Law 226/95,Articles 15 and 24, Colom. Const. Ct., Op.
C343/96 (Aug. 5, 1996); In re Unconstitutionalityof Law 226/95,.Article 20, Colom. Const.
Ct., Op. C-392/96 (Aug. 22, 1996).
13Colom. Const., art. 60.
,4In the Colombian legal system, unlike the U.S. system, a party may bring an action
challenging the constitutionality of a portion of a law without a specific case and
controversy giving rise to judicial redress or relief. Thompson v. Zurich Ins. Co., 309 F.
Supp. 1178, 1181 (D.C. Minn.). Court holdings under a civil law paradigm, as in
Colombia's case, serve only a persuasive and interpretive function in most cases. In re
Effect of Jurisprudence,Council of State Op., Dec. 4, 1944 (appellate level administrative
law court holding that laws are created only by the Colombian Congress and the
administrative agencies empowered to do so); Colom. Civ. C., art. 17 (stating interpretive
nature of court holdings under Colombian law). See generally RAYMOND GUILLIEN & JEAN
VINCENT, 239 DICCIONARIO JURiDICO (1995) (law in a civil jurisdiction is understood to be
legislation, related administrative regulations, and the constitution). However, in the area of
privatization and administrative law, Constitutional Court holdings are binding on agencies
and entities managing and organizing privatization projects.
percent or nominal participation in the new entity. s As such, the foreign
investor should not be scared off by the law's spirit.
Substantively, the scope of Law 226 covers total and partial sales to
individuals of stocks or bonds obligatorily convertible into shares
(BOCEAS), 6 belonging to the state and to any level of participation in the
capital of any state entity.' 7 Total or partial sales of state- owned stock or
BOCEAS are conducted under the utmost scrutiny for public policy
reasons. 8 This is because these assets are owned with public moneys.' 9
Procedurally, Law 226 transactions are structured in the following
manner: first, the national government decrees that it will privatize or
capitalize a state owned asset;2" second, the appropriate ministries design a
program for the privatization or capitalization process based on technical
studies, directed by the Finance Ministry;2 third, the process is approved
by the government and public notice is affected (this notice may be given
via tombstone advertisements), initially directed toward labor;22 fourth,
steps are taken to guarantee that the process is democratic, through
limitations on the negotiability of shares and sanctions for transactions
affected within set time frames.'
15JONATHAN ARNOLD & STEPmEN EDKINS, EMERGING MARKETS EQUITY RESEARCH:
COLOMBIA - ELECTRIC UTILITIES, COLOMBIA ELECTRICITY PRIMER - GET CONNECTED 24
(Santander Investment Securities Inc. 1997).
6 BOCEAS are debt/equity instruments that may only be used by joint stock
corporations. The use and issuance of this instrument is regulated by the Superintendency
of Securities (the Colombian governmental agency regulating the securities markets)
pursuant to Super. Sec. Res. 400/1995.
Additionally, Colombian commercial law establishes two forms of joint stock
corporations. A joint stock corporation may be a generic corporation (Sociedad An6nima),
see Colombian Commercial Code [hereinafter Colom. Com. Code], arts. 373-460, or a
limited partnership issuing shares (Sociedaden Comanditapor acciones),see Colom. Com.
Code, arts. 343-352. See Colombia Law Digest, in MARTINDALE-HUBBELL INTERNATIONAL
LAW DIGEST: ARGENTINA- VENEZUELA LAW DIGESTS, COL-9 (1995) (providing survey of
Colombian business associations). The basics of these two business association forms are
discussed in section B of this article.
17Law 226, art. 1.
"1Transparency issues are a concern, given unfortunate trends of corruption associated
with many governmental processes in Latin America. See John Otis & Jeb Blount, Law &
Order, LATIN TRADE, June 1997, at 48-57 (survey of Latin American corruption and
governmental efforts to curb it).
2,90ILda.wat2a2r6t., 6a.rt. I.
21Id. at art. 7. The technical studies will include a valuation and appraisal of the shares
of stock to be transacted (this phase will factor in the market value of assets and liabilities
and asset profitability). Id.
21Id. at arts. 8-9.
'Id. at art. 14.
2. Law 142: Public Utility Regulation
Law 142 defines the scope of public utility regulation in Colombia. It
also establishes rules for different agents operating in the sector.
Fundamentally, the law establishes parameters for entities operating in the
public utility sector.
First, the public utility sector comprises entities providing aqueduct,
sewage, waste disposal, power, national and international long distance
telephone, or gas distribution services.24 If an entity does not render any of
these services it will not qualify as a public utility service company.5
Second, public utility services may only be provided by corporations
structured as Public Utility Companies (Empresasde Servicios Pzblicos or
ESPs).26 These entities are joint stock corporations.2 7
Third, ESP shareholders may be classified as private sector, public
sector, or mixed economy entities.28 ESP classification depends on capital
participation. For example, a public sector ESP is one composed of 100
percent state stock ownership,29 a private sector ESP is one in which private
stock ownership exceeds 50 percent,30 and a mixed economy ESP is one in
which state participation equals 50 percent or more of the ownership.3"
Fourth, an ESP may provide more than one public utility service.32
Nonetheless, regulatory agencies in this sector may limit the ESP's
business to only one service. 3 This restriction on the type of services that
may be rendered by an individual ESP is done to provide for economies of
scale and to prevent horizontal monopolization.34
Fifth, private, mixed economy and public sector ESPs are entitled,
beginning in 1994, to a seven-year corporate and dividend income tax
holiday. This tax holiday applies only to realized revenue that is
capitalized or designated for special maintenance and system upkeep
reserves for five years or more.35 On July 2, 1998, the Colombian tax
authorities issued DIAN Opinion 052058. This opinion, having the effect
of a formal ruling, extends a current income tax holiday on revenues
realized by electric and gas power generators to private sector holidays
under Law 223, Article 97. Prior to DIAN Opinion 052058 Law 223,
24 Colombian Law 142/94 [hereinafter Law 142], arts. 14.18-14.28.
2256 IIdd.. aatt aarrtt.. 1154..12.0.
21Id. at art. 17.
2 8Id.at art. 14.5-14.7.
2390IIdd.. aatt aarrtt.. 1144..57..
3321I1dd.. aatt aarrtt.. 1184..6.
351d. at art. 24.2; Colombian Tax Code [hereinafter CTC], art. 211 (modified by Law
223, art. 97).
Article 97, as discussed below, was interpreted according to its plain
language to apply only to public and mixed economy entities engaged in
electric power generation.
DIAN Opinion 052058 applies retroactively. As such, the interested
taxpayer wishing to benefit from the tax holiday may use it in 1999 for the
1998 tax year and it may, where applicable, amend prior corporate income
tax returns and petition the Colombian IRS for tax holiday treatment under
Law 223, Article 97.
This tax holiday is a graduated one that began in 1996 with a 100
percent income tax, income tax on dividends, and remittance tax exemption
that tapers down to a zero-percent exemption in the year 2003. More
specifically, the tax holiday operates as follows:
In order for a taxpayer to benefit from the electric generator tax
holiday it must allocate profits to equipment and asset maintenance and
overhauling reserves. These reserves should be kept intact for a period of
five years or more, in order to avoid Colombian IRS scrutiny.
Law 223, Article 97, does not provide a time period within which the
equipment and asset maintenance and overhauling reserves must be
maintained. In effect, reserves act as reinvestment or capitalization
reserves. However, the Colombian Tax Code in other instances provides
this requirement for avoidance of profit remittance tax and offshore
dividend payment income withholding tax applicability. Given that there is
no case law on point, either in the form of tax court or Colombian IRS
rulings, the taxpayer who intends to use the electric power generator tax
holiday is advised to adopt this five year policy.
Another benefit under this tax holiday is that the taxpayer may enter
into and leave the tax holiday period at will. For example, in 1996,
Colombia Electric Power Generation Co. realized $100 in power
generation profits, of which all $100 was paid offshore in the form of
dividends and subject to appropriate income and dividend income
withholding taxes, at the rate of 39.55 percent. In 1997, the same company
realized $150 in profits from its electric generation activities and it
allocated $100 of these profits to a special equipment and asset
maintenance and overhauling reserve. In this tax year the company pays
$50 of the $150 in profits as dividends to its offshore shareholders and
subjects that $50 to income and dividend income withholding tax. The
$100 allocated to the special maintenance and overhauling reserve will be
exempt from income tax within the 90 percent bracket established under
the tax holiday. Therefore, $90 is not subject to any taxation and $10
would be subject to only a 35 percent corporate income tax (provided,
however, that they are not paid offshore in the form of dividends, in which
case they would then be subjected to a 7 percent dividend income
withholding tax). In 1998, the same company realized $200 in profits, all
of which were distributed to its offshore shareholders in the form of
dividend payments and were subject to appropriate corporate income tax
and dividend income withholding taxes. The effect of Colombia Electric
Power Generation Co.'s operations under the tax holiday for 1996 through
1998 is that the company bypasses favorable tax income tax and dividend
income withholding tax treatment for 1996, takes the tax holiday in 1997,
and elects not to take it in 1998. This illustrates how Law 223, Article 97,
provides the taxpayer with flexibility as to how it implements its tax
planning policy in this respect.
While the July 1998 Colombian Tax Authority ruling, discussed
above, creates an added tax incentive for the client interested in entering
into an energy project finance investment, it is important to note that the
Colombian Constitutional Court on May 8, 1998, in In re the
Constitutionality of Law 233/95, Art. 9736 held that the tax holiday only
applies to public and mixed economy companies. This confusion in the
law is not uncommon in Colombia. The Colombian Congress is actively
trying to resolve this current confusion by way of a 1998 Tax Reform Bill
submitted for consideration in August and September 1998, wherein the
energy generation tax holiday, if approved, will follow the Constitutional
Court's holding and discard the Tax Authorities' interpretation.
Intertwined with this tax holiday is an exemption granted to ESPs from the
presumptive income tax or asset tax regime,37 which is discussed below.
B. Possible Colombian Business Association Forms
Once hurdles posed by Law 226 and Law 142 are understood and
passed, the client must choose what type of business entity to establish for
operating and bidding purposes. However, Law 142 limits the client to
forming a joint stock corporation. 8
Under Colombian commercial law the joint stock corporation may
take one of two forms: (
) a basic corporation (In Spanish, Sociedad
"In re the Constitutionalityof Law 233195, Art. 97, Colom. Const. Ct. Op. C-1 88/98
(M.P. Dr. Jose Gregorio Hemandez Galindo).
37 Law 142, art. 24.3.
3 1Id. at art. 17.
An6nima or SA), or (2) a limited partnership issuing shares (In Spanish,
Sociedad en Comanditapor Acciones or LPIS). The basic elements of
these two Colombian corporate forms follow.
1. The SA
SAs must comprise a minimum of five shareholders39 and should be
incorporated by a unanimous decision reached at the common fund
meeting, held by the initial shareholders. At this meeting initial
shareholders decide to incorporate and agree to be held liable up to
respective capital contributions.40
The SA's capital is divided into shares of equal value.4 Each share is
be represented by a negotiable instrument.42 Additionally, upon
incorporation the company is to subscribe no less than 50 percent of its
authorized capital and pay out no more than one-third of the value of each
share of capital to be subscribed.43 The SA must adhere to this proportion
only at the moment of incorporation."
Another key element of the SA is the compulsory legal reserve. 45 This
reserve must be composed of at least 50 percent of the company's
subscribed capital.46 An SA's legal reserve is created by designating 10
percent of the annual profits to the reserve until the 50 percent requirement
is met.47 Once the legal reserve has adequate funds, the company need not
continue to contribute to it, unless the company reduces the reserve at some
2. The LPIS
The basic elements of the LPIS mirror those of the SA.49 However, a
difference between the SA and LPIS is that the latter will have at least one
shareholder that will be subject to unlimited liability for the company's
19 Colom. Com. Code, art. 374. Colombian corporate law dictates that at no point in an
SA's life may more than 95 percent of the company's subscribed shares be held by one
shareholder, otherwise the SA will be deemed to be in technical dissolution. Id. at art. 457
40Id. at art. 373.
41 Id. at art. 376.
44 Super. Corps., Op. OA-19573/Oct. 3, 1980.
41 Colom. Com. Code, art. 452.
471Id. The legal reserve may be funded in quotas of more than 10 percent of each year's
profits. Super. Corps., Cir. D-001/Jan. 2, 1980.
48 Colom. Com. Code, art. 452.
49Id. at arts. 343-352. See In reLPIS ShareholderRequirements, Colom. Sup. Ct., Civil
Op. 20/97 (P.M. Rafael Romero Sierra) (holding that the LPIS must comply with the five or
more shareholder rule).
gestoror socio colectivo.
This shareholder is known in Spanish as the socio
In order to effectively spread the risk of exposure across several
levels, Colombian law permits the LPIS socio gestor to be a business
entity." In this regard, counsel may recommend the use of another LPIS,
whereby one or more of the shareholders are SAs or other types of
Colombian business associations.
Given the LPIS socio gestorrequirement, why would a client opt for
creating this type of entity? A client may want to elect an LPIS for U.S.
tax purposes, given that U.S. tax law treats an LPIS as if it were a U.S.
partnership or a pass through entity,52 provided the taxpayer elects to be
treated as such. 3
Once the client decides which form of business association will be
used as the vehicle for carrying forward the privatization process, counsel
and other advisors must take into consideration the following Colombian
tax law 4 rules for pro forma and planning purposes.
SOColom. Com. Code, art. 323. The scope of this unlimited responsibility for LPIS
business activities is akin to that of a general partner's liability under U.S. partnership law.
Uniform Partnership Act, sec. 15.
s' Super. Corps., Op. SL-MD-1034/Jan. 22, 1991.
s2U.S. Internal Revenue Code [hereinafter "IRC"], sec. 701. See 1997 U.S. MASTER TAX
GUIDE, par. 417, p. 131 (CCH eds. 1996) ("While a partnership is not subject to tax, its
'taxable income' is the key feature by which the partnership passes through its income or
loss to partners. . . Each partner generally must account for his distributive share of
partnership income, while the partner's basis generally decreases by the amount distributed
to him by the partnership.").
11 While U.S. tax law permits the taxpayer to elect whether the LPIS will be treated as a
partnership or a branch, Treas. Reg. § 301.7701-3(a), under Colombian tax law,
passthrough entities do not exist. See CTC, arts. 12 - 14 (Colombian tax law provisions
indicating that business associations in Colombia, regardless of form, are taxed as entities).
Note that U.S. tax law adopted the election rule via the "check-the-box" rules in December
1996, in Treas. Dec. 8697, 61 Fed. Reg. 66584-66593 (Dec. 18, 1996). See JOSEPH
ISENBERGH, INTERNATIONAL TAXATION: U.S. TAXATiON OF FOREIGN PERSONS AND FOREIGN
INCOME 26:9-26:20 (2d ed. 1999) (providing overview of check-the-box rules); James H.
Barret & William P. Ewing, InternationalImplications of Check - the - Box Regulations,72
FLA. B. J. 34 (May 1998) ("For over 30 years, the classification of entities as partnerships or
corporations depended upon all the facts and circumstances concerning the entity pursuant
to a test known as the "four factors test". On December 18, 1996, the IRS replaced the "four
factors test" with regulations known as the "check - the- box" regulations that allow
taxpayers to elect whether entities are to be taxable as corporations or partnerships."). Prior
to this development U.S. tax law followed Morrissey v. Commissioner, 296 U.S. 344, 56
S.Ct. 289 (1935). The Morrissey court held that what an entity is called will not control
how it should be treated for U.S. tax purposes. In essence substance should rule over form.
See WILLIAM L. CARRY & MELVIN ARON EISENBERG, CORPORATIONS: CASES AND
MATERIALS 96 (6th ed. 1988) (providing synopsis ofMorrissey v. Commissioner).
I' The client and U.S. counsel are well advised to seek specialized local tax counsel or
advisors when preparing the pro forma for any privatization or capitalization operation in
(a) Income Tax
Income tax in Colombia is levied, as in most countries, when income
is realized from the exploitation of tangible or intangible goods or when
services are rendered in a permanent or transitory manner within the
Colombian territory." Income tax is also triggered by the general
disposition of any tangible or intangible items, provided the item, such as
stock, for example, was present in the Colombian territory at the time of
the transaction. 6 Additionally, in Colombia all business entities are taxed
on world-wide income, derived from profits and capital gains realized,57 at
a flat rate of 35 percent.5 Income tax is calculated based on financial
statements adjusted for inflation."
Moreover, as indicated in the discussion of Law 142, ESPs are entitled
to two income tax benefits. Private, mixed economy and public ESPs are
entitled to a seven-year income tax holiday, and all ESPs are exempt from
presumptive income tax (the Colombian asset tax).60
581Id. at art. 240. Colombian tax law has a system of alternative minimum income tax
and asset tax provisions. The alternative minimum income tax is simply that tax credits
taken for a particular tax year may not exceed the value of the basic income tax due.
Moreover, income tax liability after taking into account tax credits may not be less than 75
percent of the tax liability calculated under the presumptive income tax system (asset tax),
see infra note 60, before calculating in tax credits. Law 383/97, art 29.
s See infrasec. I(C)(
)(d)(vi). (discussing inflationary accounting).
60 Law 142, arts. 24.2-24.3. The presumptive income tax regime is used to calculate
income tax liability in circumstances where a taxpayer may be operating at a loss for a
particular year. This system presumes that the taxpayer's taxable income is not less than the
sum resulting between 5 percent of the taxpayer's net worth or 1.5 percent of its gross assets
on the last day of the tax year.
(b) Remittance Tax
Remittance tax is levied when income or capital gains generated in
Colombia by non-residents or branches of foreign companies are remitted
abroad,6 at i rate of 7 percent.62 This tax, however, may be avoided if the
investor reinvests" its profits in Colombia for five years or more.' If
profits to be remitted abroad are reinvested for a period of less than five
years, then remittance tax on such profits may be deferred until their
(c) Dividend Income Tax
The dividend income tax is a withholding tax that applies to dividends
paid offshore by Colombian entities.66 This tax is set at a rate of 7 percent67
and is applied in conjunction with income tax withholding at a rate of 35
percent, or an effective withholding tax at a rate of 39.55 percent.68
However, as with remittance tax, dividend income tax withholding
may be avoided when dividends are capitalized for a period of five years or
more.69 Likewise, capitalization of dividends for a period of less than five
years allows the taxpayer to defer the withholding of this tax.7" At no point
is income tax at 35 percent avoided.
2. Other Taxes andRelated Issues
(a) Value Added Tax
Value added tax (VAT) is an issue for the investor at the most basic
level. Most public utilities are excluded from VAT. As such, VATs paid to
suppliers of goods and services cannot be offset against other VATs. The
result in this instance is that VAT is assumed as a major value of goods and
services, thus reducing net profits. However, VAT paid in the acquisition
of capital assets may be taken as a tax deduction for corporate income tax
61CTC, art. 319. Foreign branches are presumed under the law to automatically remit
abro62ad any profits realized in Colombia.
1d. at art. 321.
63 Reinvestment of profits in Colombia occurs when profits are simply commingled
within a company's equity. Law 488/98, arts. 9-10.
"CTC, art. 319.
6Id. at art. 245.
69 Id. See supranote 63 (reivestment and capitalization of profits deemed to be effective
commingling of these within Company equity).
71Law 488/98, art. 18.
Additionally, VAT will be triggered at 16 percent (this rate will be
reduced to 15% effective November 1999) on the rendering of consulting
and advisory services and technical services and assistance, depending
whether the service is performed in Colombia or offshore.72 This will
affect the investor interested in a privatization process in Colombia. This
is because, as discussed below, these services may be used as a vehicle for
profit repatriation and for creating costs and expenses for the newly
privatized public utility company.
(b) Special Withholding Taxes: Technical Service & Assistance Contracts
Technical services and assistance contracts in Colombia play a special
role in the privatization and foreign capital investment game. These
contracts provide a means for importing know-how into the country via
inter-company arrangements73 and for repatriating profits offshore, as
In Colombia, technical services and assistance agreements are given
special treatment, depending on the circumstances and facts of the
transaction. If these services are rendered offshore or in Colombia by
nonColombian residents or domiciliaries, then they are subject to a 10 percent
income and remittance at-source withholding tax.7'
The client's tax burden (although somewhat heightened), if it chooses
this mechanism for profit repatriation, is offset via a complete income tax
deduction for payments in Colombia, provided at-source withholding taxes
are properly practiced" and the contract is registered with the Colombian
importation authorities (known as INCOMEX).7 6
Technical services and assistance contracts may also be entered into
between two Colombian entities. In this case the withholding tax for
income tax purposes is set at 10 percent77 for professional non-construction
services. Why would a local technical services contract be needed?
Local technical services and assistance contracts may be required in
the event that technicians must be in Colombia providing services on an
ongoing or long term basis (six months or more). In this circumstance it is
best to establish a local branch or subsidiary in Colombia to perform the
services that would ordinarily be provided directly under the auspices of an
offshore entity. Failure to establish a Colombian entity when technicians
and other related professionals are visiting the newly acquired company for
long periods of time and possibly subcontracting out specific services to
locals, will trigger permanent establishment problems under Colombian
(c) International Financial Leasing under Colombian Tax Law
International leasing operations are an attractive mechanism in
privatization and project finance operations. They are effective methods of
importing vital equipment into target countries, such as Colombia, and
serve as a means of profit repatriation.
Under Colombian tax law, financial leasing operations come in three
forms: (i) pure financial leases; (ii) financial operating leases; and (iii)
infrastructure leases. Each form has specific tax law rules. Additionally,
international lease payments are exempt from withholding taxes for income
and remittance tax purposes when conducted for infrastructure projects.79
An analysis of the various forms of Colombian financial leases follows.
i. The Financial Lease
The Colombian tax law mandates that, from December 31 of the prior
tax year until the commencement of the lease agreement, lessees with gross
equity of approximately U.S.$6.84 million" must classify their lease
operation for tax and accounting purposes as a financial lease.8 For
accounting and tax purposes, financial lease agreements have a treatment
(set forth below) with which one should comply once the contract is
First, at the beginning of the contract, the lessee should register an
asset and a liability for the total value of the leased asset.82 This should be
done for an amount equal to the present value of the lease payments and
purchase options agreed to, calculated as of the date of the contract's start
date and at the agreed interest rate.83 The amount registered by the lessee
7SColom. Com. Code, art. 474.
79 CTC, art. 25 (c).
" This value is adjusted on a yearly basis. For example, in 1996 the gross equity cap
was approximately U.S.$5 million.
S CTC, art. 127-1, PAR.3.
2 1d. at art. 127-1 (2) a.
should coincide with the amount registered by the lessor as a monetary
asset in the leased good's account.'
Second, the value registered as an asset by the lessee, except the
portion corresponding to the VAT tax deduction, will be treated as a
nonmonetary asset." A depreciable86 or amortizable asset, under the law,
registered as a non-monetary asset, shall be depreciated or amortized
pursuant to the asset's useful life. 7 In the event the leased asset is not
depreciable or amortizable, the lessee will not be allowed to do so in its
Third, the lease payments for the lessee should be broken down to
correspond to a capital advance and to the portion comprising interest or
financial costs.8 9 The part corresponding to a capital advance will be
charged directly against the liability registered by the lessee for the lesser
value of the liability.' ° The portion of the lease payments corresponding to
interest or financial costs is a deductible expense for the lessee.9 In this
regard, the financial lease contract should stipulate the value of the asset at
the moment of the lease's commencement, including VAT, as part of the
agreed value of the periodic lease payments corresponding to financial and
Fourth, upon exercising the purchase option, the asset value agreed to
by the parties involved shall be registered against the lessee's liabilities, so
as to clean out the account with zeros.93 Any difference resulting from this
exercise will be adjusted against the results of the operation. In the event
the lessee does not exercise its option to purchase the lessee for tax
accounting purposes will have to adjust its equity and income statements.
This adjustment will result in the deduction of the total value of the balance
to be depreciated for the non-monetary asset registered by the lessee in the
1SId. at art. 127-1 (2) b.
CTC, art. 134, allows for depreciation to be conducted via the straight-line method.
Colombian law also permits the use of declining-balance and sum-of-the-years digit
Also, CTC, art. 140, indicates that depreciation may be accelerated method. This
depreciation method may be implemented when an asset is used beyond usual work shifts,
without altering the asset's useful life. The taxpayer may accelerate depreciation by 25
percent for each extra shift that the asset is used or in proportional fractions thereof.
Minimum asset useful life schedules in Colombia are as follows: real Estate, 20 years;
machinery and equipment,'10 years; vehicles and computers, 5 years. Decree 3019/89, art.
87 CTC, art. 127-1 (2)b.
corporate income tax return for the tax year in which the lease agreement is
Fifth, the amounts determined via the aforementioned process shall be
used by the lessee to determine and declare the asset's equity value and
realize the asset's depreciation calculation (when applicable) for:
inflationary adjustment purposes; determining the liability's balance and its
amortization; and calculating the amount of deductible financial costs.95
ii. The Operating Leases
The rule for operating lease agreements, under Colombian tax law, is
Financial leasing contracts for immovable goods (real estate not including
land) with a contract life equal to or greater than 60 months, machinery,
equipment and office equipment with a contract life equal to or greater than 36
months, vehicles for productive use and computer equipment with a contract
life equal to or greater than 24 months are deemed to be operating lease
agreements. The aforementioned means that the lessee should register as a
deductible expense the total sum of the lease contract's price, without
registering in the asset or liability side of its books any amount for the leased
Only those leases listed in subpart 1 of this article which present as of
December 31 of the prior tax year gross equity less than approximately
U.S.$4.5 million [for 1999, 8,012,300,000 Colombian Pesos] shall benefit
from the treatment set forth in subpart 1. All others shall be treated under
subpart 2 of this article.96
Furthermore, under an operating lease the holding gain for inflation is
mitigated. This is because the interest and principal on the asset are fully
deductible,97 given that classification of the operation is based on lessee
iii. Infrastructure Leasing
Leasing agreements with a life of 12 or more years intended for the
development of infrastructure projects in the transportation, energy,
telecommunications, potable water, or basic sanitary sectors shall enjoy
operating lease treatment. Such treatment has the following accounting
and tax consequences: the leasing payment may be registered as a complete
deductible expense; neither an asset or liability has to be registered for the
leased equipment, unless the purchase option is exercised; the leased
equipment may not be amortized at a schedule less than what is indicated
in the lease contract; and in concession agreements the lease term shall be
9 4 1d.
996' CCTTCC,, aarrtt.. 112277--11 ((21))e..
equal to that agreed to in the contract celebrated with the State for
infrastructure projects. 9
VAT needs to be contemplated when discussing financial lease
structures, given that the operation encompasses the importation of a
capital asset into Colombia, as is the case with infrastructure projects. The
importation of the capital asset into Colombia takes the form of a
temporary importation' 0 that will be subject to VAT upon entering the
Colombian territory. Colombian tax law allows the lessee to use VAT paid
for capital and fixed assets throughout the life of the temporary importation
to offset corporate income tax at the end of the term of the temporary
import (through an income tax deduction), so long as the purchase option is
exercised and the asset is nationalized into the Colombian territory.' '
(d) Stamp Tax
Stamp tax is a document tax that must be considered and calculated
into any pro forma created for any commercial activity to be developed in
Colombia. This tax is levied on written contracts with a contract price
exceeding approximately U.S.$40,000, at a rate of 1.5 percent.' 2
(e) Registration Tax
Registration tax is paid at the departmental level over total gross
revenues realized from operations that are registered with the Chamber of
Commerce or with the local real estate registration office. 3 Rates vary
between 0.3 percent and 1 percent. When documents are subject to
registration tax, no stamp tax must be paid.0 4
(f) Monetary Correction
Clients need to be aware that Colombia's economy is an inflationary
one. As such, inflationary adjustments (monetary correction) must be
made to certain assets, pursuant to controlling tax law.0' 5 Investors often
model elaborate financial structures only to find out before the closing of a
deal that income statement and balance sheets are not0r6eflective of the
transaction's reality due to incorrect monetary correction.
99 Law 223/95, art. 89.
" International lease operations may only be conducted under the rubric of temporary
importations. Cen. Bank Ext. Res. 21/93, art. 12.
to DIAN Op. 087713, Nov. 13, 1996; DIAN Op. 090072, Nov. 26, 1996; Decree
2076/92, art. 5.
0, Law 223/95, art. 519; Law 488/98, art. 116.
103 Law 223/95, art. 226; Decree 650/96, art. 1.
Colombian tax law dictates that inflationary adjustments should be
conducted for the following:
) Non-monetary assets held in foreign currency;
(2) All other non-monetary assets;
(3) Non-monetary liabilities; and
(4) Net equity. 107
Inflationary adjustments are calculated by taking the value of
nonmonetary assets and multiplying it by a percentage known as the
percentage adjustment for the fiscal year (in Spanish, Porcentajede Ajuste
del Aho Gravable or PAAG)"' This percentage is calculated according to
the increase registered by the Consumer Price Index." 9 The adjusted value
of the non-monetary assets is recorded as a credit in the Monetary
Correction Account (MCA) and as a debit in the non-monetary assets
Accumulated depreciation corresponds to fixed assets in the prior year
and must be adjusted by the PAAG."' It is a credit in the accumulated
depreciation account balance and a debit in the MCA.
Non-monetary liabilities are adjusted by the PAAG."2 This adjusted
value is registered as a greater value of the non-monetary liability and as a
debit in the P&L statement.
Foreign currency debt may lead to one of the following two situations:
) If there is revaluation of the Colombian peso versus the U.S.
dollar, a profit should be registered as a result of the difference in exchange
against a reduction in the liabilities account.
(2) If there is devaluation of the Colombian peso versus the U.S.
dollar, then a cost or expense should be registered as a result of the
difference in exchange against the increase in the liabilities accounts.
A company's net equity worth at the beginning of each tax year
(January 1) must be adjusted by the PAAG."3 The value of this adjustment
is registered as a debit in the MCA and as a credit in an account known as,
the Net Equity Worth Account.
The MCA will appear, as follows:
t Debit I Credit
adjusted Accumulated adjusted
,7Decree 2075/92, art. 5. Law 488 relaxed inflationary accounting rules by no longer
mandating that profit and loss statements be adjusted for inflation. Law 488/98, art. 27.
10 CTC, art. 331.
I'Od. at art. 339.
adjusted net equity worth
If a credit is registered in the MCA due to a greater value of the
nonmonetary assets--in comparison with the non-monetary liabilities and the
net equity worth--this credit balance will be considered a profit for tax and
accounting purposes. As such, it results in greater income tax liability.
This effect generates more profits, as well as dividends to be distributed to
a client's shareholders.
The debit balance is considered a tax-deductible expense, if a debit
balance is registered in the MCA due to a greater value of non-monetary
liabilities and the net equity worth over the non-monetary assets.
Therefore, total income tax liability, net profits, and dividend distribution
Inflationary adjustments should be performed on a monthly basis, so
long as the PAAG is correctly factored into the calculations conducted.
II. INJECTING FINANCE INTO COLOMBIA AND PROFIT REPATRIATION
A. Injecting Finance Under Colombian Foreign Exchange Law
Once basic privatization, corporate, and tax concerns are understood,
the next issue to consider is financing the project." 5 Infrastructure projects
in Colombia are typically done via direct foreign investment, debt vehicles,
and inter-company transactions.
Direct foreign investment is the most effective and permitted
method" 6 of injecting capital into Colombia. This method of injecting
capital is subject to Colombian foreign exchange and investment controls.
These controls consist of informing the Colombian Central Bank as to
It4 Normally, adjustments to non-monetary foreign currency liabilities are registered as
income (due to revaluation) or as an expense (due to devaluation in the P&L account).
115 See PHILIP WOOD, 2A LAW AND PRACTICE OF INTERNATIONAL FINANCE 14-1 -14-22
(1984); RALPH H. FOLSOM ET AL., INTERNATIONAL BUSINESS TRANSACTIONS: A PROBLEM
ORIENTED COURSE BOOK 738-850 (2nd ed. 1991); PAUL B. STEPHEN III. ET AL.,
INTERNATIONAL BusINESs AND ECONOMICS: LAW AND POLICY 503-512 (1993); BEYOND
SYNDICATED LOANS: SOURCES OF CREDIT FOR DEVELOPING COUNTRIES (John D. Shilling ed.)
(World Bank Technical Paper No. 163, 1992) (sources providing general background into
project finance operations and related issues, such as structuring privatizations). See also
Guillermo Campos, PipingFinance into Brazil, INT'L TAX REV. (June 1997) (Authorized
Reprint) (illustration of project finance methods).
116Conpes Res. 5/91, art.4.
when the investment is entered, modified, and repatriated via registration
requirements." 7 If the investor does not comply with Central Bank
registration requirements, the investor will not be legally permitted to bring
in the capital or remit it abroad when desired.
Capital injections into Colombia under the rubric of direct foreign
investment should not correspond to inter-company transactions with the
offshore parent company. If a capital injection is understood by the
Colombian authorities to be related to some type of quidpro quo with the
parent company, the effective transfer of foreign currency into the target
will not be permitted under Colombian law."'
Direct foreign investment under Colombian law is understood to be:
the importation of capital assets into the territory," 9 the transferring of
foreign exchange into the country that may be freely convertible into
Colombian pesos, ' in kind contributions in the form of technology or
other intangibles,12' resources in Colombian Pesos, " reinvested
earnings, t2' and the transferring of foreign currency into Colombia destined
for the purchase of real estate assets. 24
Another acceptable method of pumping capital into Colombia is
through the use of debt. Pumping money into an infrastructure project via
debt vehicles is often preferred. Financing may be done with back-to-back
loans, direct loans via syndication structures, sole lenders, multilateral
organizations, and/or through a combination of all of these vehicles.
What level of debt a client should choose is, however, difficult to
assess. Due to inflationary adjustments affecting actual capital, it is best to
over leverage the purchase. Over leveraging the deal has great advantages.
A large amount of debt will enable the investor to remit payments out
of the country via interest payments with no tax consequences attached.
The investor will also be allowed a corporate income tax deduction for
these payments. This is useful given that such payments may double as a
profit repatriation tool within limited parameters.
Financing a project under current Colombian law is, however, limited.
Foreign indebtedness transactions are limited to operations between foreign
financial entities that are registered before the Central Bank.'" This means
that direct inter-company loans are forbidden. If an investor intends to
finance the purchase of an asset in Colombia through inter-company loans
with the holding company, then it will have to frame the transaction
,' Cen. Bank Ext. Res. 21/93, art. 37.
118 Id. at art. 39; Conpes, Res. 5/91, art. 16.
,,20 ICdo.napteasr,t.R7e(sb.).5/91, art. 7(a).
through a back-to-back loan mechanism. Often this tool will increment the
cost of doing business by a substantial amount because the bank acting as
intermediary for the transaction will charge a commission based on a
spread of the total value of the operation.
Foreign indebtedness operations have similar Central Bank
registration requirements to direct foreign investment strategies. Debt
operations in Colombia are effectively registered with the Central Bank
through a 10 percent deposit requirement that must be placed with the
Central Bank.126 The deposit is made on the initial loan draw-down and is
placed by the borrower for a six-month period in Colombian pesos.127 This
deposit is interest-free. However, the deposit may be returned to the
borrower via petition to the Central Bank before the end of the deposit
period with a penalty charge. The penalty charge varies depending on the
months remaining in the period.'28 Given devaluation of the Colombian
peso, it is more cost effective to petition for the deposit refund shortly after
placing it with the Central Bank.
Upstream inter-company charges are another effective method of
bringing capital into the newly privatized entity. Under this method the
Colombian entity charges an offshore affiliate for services rendered on
latter's behalf. In order to support the transactions, the Colombian entity
invoices the offshore affiliate. These transactions have a negative aspect.
The downside of upstream inter-company charges is that the
Colombian entity may have to assume VAT liability. Additionally,
payments made to it will constitute taxable income for Colombian
B. Permitted Profit Repatriation Strategies under Colombian Law
The pPrriovfaitterefporaetrigiantioinnveasntdorpwrivilaltwizaantitotno amreaxailmmiozset psryonfoitnsyamnodursepcaotnricaetpets2.9
these quickly, in order to hedge foreign currency and economic volatility.
Furthermore, another key variable in this process is tax minimization
within Colombia's tax paradigm. 3 '
The perfect profit repatriation strategy encompasses efficiency and
cost effectiveness values, from a country risk hedging and tax minimization
repatriation strategy will be comprised of the following: (
services and assistance agreements (offshore or onshore); (2) related
company offshore management and administrative agreements; (3)
backto-back loans; (4) international lease agreements; (5) capital reductions; (6)
international loans; and (
dividend and royalty
1. Technical Services and Assistance ContractsPerformedby Offshore
repatriation tools, whether performed offshore or onshore. These contracts
have a relatively low tax cost in comparison to other methods, especially if
they are performed offshore, as seen above in the tax issues section of this
article. Another attractive characteristic of these contracts is that they also
function as effective know-how transferring vehicles.
2. Related Company Offshore Managementand Assistance Contracts
Related company offshore management and assistance contracts are
very effective profit repatriation tools. They carry no income or remittance
tax consequences, but there is no deductibility for payments
The only real tax cost of these contracts is that they are
130 Once the payments taking the form of any of the profit repatriation methods set forth
herein arrive in whatever foreign jurisdiction chosen the client may face U.S. Subpart F
Income issues, under I.R.C. §§ 951-964. The Subpart F rules apply only if a foreign
corporation is a controlled foreign corporation ("CFC") (a CFC is an entity with at least 50
percent of its stock, by vote or by value, is owned by U.S. persons (both individual and
corporate), counting only persons owning more than 10 percent of the voting stock). I.R.C.
§§ 951, 957, 958. Subpart F rules, when triggered, tax U.S. shareholders on their ratable
shares of several categories of corporate income, regardless of whether distributed or not.
These categories of corporate income include (a) dividends, interest, royalties, and other
passive income, (b) income from the sales of goods where the foreign corporation either
buys from or sells to or on behalf of a related person, (c) income from services performed
for or on behalf of related persons, and (d)income from shipping operations. See BoRIs I.
BITrKER & LAWRENCE LOKKEN, FUNDAMENTALS OF INTERNATIONAL TAXATION 68-26 -
6872 (1998-99 ed.) (providing detailed discussion of Subpart F rules and the changes in this
area ofthe law over the past year and a half).
,.T,he Colombian Constitutional Court held in In re Payments and Related Deductions
to Home Offices, Const. Ct. Op. C-596, Nov. 6, 1996 (M.P. Dr. Hemando Herrera Vergara),
that related company payments for offshore management and assistance services contracts
are nondeductible, given that they are not deemed to be Colombian source income. See
Andrade & de Castro, supra note 73, at 556 (discussing deductibility of intercompany
payments under Colombian tax law).
subject to a VAT at 16 percent. Additionally, these contracts may be
created via simple invoices. This invoicing method allows parties to avoid
the stamp tax, otherwise triggered with the existence of a written contract.
The effectiveness of this profit repatriation method from an operation
perspective is limited. This method may only be used for management and
assistance services rendered offshore. If the services come onshore
payments for them will be subject to harsh withholding taxes set at an
effective rate of 39.55 percent, plus a VAT at 16 percent and local
municipal taxes, wherever the service is rendered.
3. Back-to-Back Loans
The back-to-back loan is an effective profit repatriation tool.
However, it is subject to foreign exchange controls, as discussed above.
From a tax perspective, the back-to-back loan represents a tax-free profit
repatriation tool, 32 provided that the loan is deemed to be intended for
activities in the interest of Colombia's economic and social development.
Consequently, given the special tax treatment that may be afforded to
the back-to-back loan, it may be structured in a manner so that the interest
rate set is slightly higher than usual. This will allow the client to include
some profits mixed in with the interest payments.
Despite the effectiveness of this profit repatriation tool, it carries,
added costs, such as a transaction fee that will be charged by the offshore
correspondent bank acting as the operation's intermediary. Furthermore,
this strategy should not be abused, given that unreasonable interest
payments for the loan may trigger scrutiny from the Colombian tax
The international lease arrangement is an interesting profit repatriation
tool. It is a mechanism that allows the investor to bring in capital assets.
As a profit repatriation vehicle the international lease agreement carries
with it tax consequences, set forth in the tax issues section of this article.
This method is attractive for the same reasons as the back-to-back loan
structure. As such, the interest component of the financing component may
be grossed up in a reasonable manner to allow for some profit factor to be
sent offshore virtually tax-free.
Capital reduction as a profit repatriation strategy is efficient and
conservative. This profit repatriation tool represents no tax consequences
for the client, as a Colombian company. However, it is subject to
Colombian corporate law limitations.
132 CTC, art. 25 (5).
The Superintendent of Corporations.. must approve capital reductions
under Colombian law. Approval for the capital reduction is granted if the
entity requesting the reduction lacks outside liabilities, or if the reduction
will not result in company assets representing less than an amount double
its outside liabilities."' Additionally, if outside liabilities include
outstanding labor obligations, then Labor Ministry must also approve the
capital reduction. 35
These government approvals are costly from a time-efficiency
perspective. Informally, the Superintendent of Corporations indicates that
if the basic criteria for capital reduction are met, then it will grant the
request, typically within ten days. However, if Labor Ministry approval is
also required and layoffs are eminent within the newly acquired public
utility company, then the government most likely will not approve the
request and it may not even respond to the request until after ten months of
Upstream international loans are a method of profit repatriation,
whereby a loan is made upstream to an offshore, unrelated party with
profits realized in Colombia. This structure takes the form of a typical debt
instrument and carries no tax consequences, as long as interest payments
are not made. However, this tool is a short term one.
The client's principal corporate purpose in Colombia is to provide a
public utility service and not to act as an international lender. It is prudent
to use this tool on sporadic occasions, otherwise the client is surely to draw
the attention of the Colombian regulatory authorities, thus increasing its
exposure to unwanted and costly scrutiny.
7. Offshore Dividendand Royalty Payments
Offshore dividend and royalty payments are the most conservative
method of profit repatriation. This method is also the most costly vehicle
for getting profits out of Colombia. As discussed above in the tax section,
offshore dividend and royalty payments are subject to a harsh effective
withholding income and remittance tax rate of 39.55 percent. Nonetheless,
this profit repatriation vehicle is a vital part of any repatriation strategy.
C. The Due Diligence Review
The due diligence phase of the privatization or capitalization process
is vital. It is in this phase that the client and its advisors become genuinely
"3Colom. Com. Code, art. 145. The Superintendent of Corporations is a regulatory
agency in charge of regulating and supervising the activities of most business association
forms allowed in Colombia.
114Colom. Corn Code, art. 145.
familiar with the entity they wish to acquire. The main purpose of the
review should be to understand the legal, accounting, and financial state of
affairs of the public utility company that is being acquired. As such, the
most important function for the bidder's advisors is to coordinate with it in
a timely manner and to communicate findings of unanticipated risks,
liabilities, and other material matters that may affect the decision to bid. 36
U.S. counsel and other advisors, however, must be sensitive to
differences in cultural attitudes that may exist from country to country
during this phase.'37 While Colombia's culture is a Western-oriented one,
it is a Latin American culture with strong Mediterranean ties. This means
that information and document gathering often proceeds at a slower and
slightly more bureaucratic pace than what U.S. practitioners are
accustomed to. For example, part of a due diligence review in Colombia
should include verification with the government that the entity to be
acquired does not have overwhelming labor litigation exposure. Attaining
the appropriate Labor Ministry and Administrative Court documents could
take more than just a couple of hours, even days. Overcoming such a
problem is really a matter of patience and planning ahead for such delays,
otherwise this and other similar problems will only frustrate counsel and its
When undertaking a due diligence review in a Colombian privatization
or capitalization bid the objectives should be the following:
) Identify, understand, and quantify risks and liabilities, such as
discrepancies in accounting and financial reporting, outstanding tax
liabilities and litigation with the tax authorities, improper monetary
correction accounting, compliance levels with environmental protection
regulations, labor issues (involving potential pension fraud and union
problems), 3 ' and other potential matters that may lead to litigation (such as
corruption issues, potential tort issues, and contractual matters).
(2) Verify the veracity and completeness of the government's
representations and warranties in its role as the seller of the public utility,
as set forth in the bid rules issued and other documents made available.
(3) Identify problem areas in the bid process and assist the client in
making recommendations to the government entity and its advisors
organizing the process that may be beneficial to the client in attaining a
competitive edge in the competition. In making such recommendations,
136Wilson Chu, Cross-BorderM&A, 6 Bus. L. TODAY 8, 12 (Jan.-Feb. 1997).
'37 Id. at9.
38Colombian labor issues should be studied carefully when conducting due diligence
reviews. This is because most public utilities, if not all, are unionized in Colombia. Also,
these unions often have strong ties to local and national government concerns. As such, if
the client wins the privatization bid it may be difficult, if not impossible, to implement
personnel lay-offs within the first months after winning the bid to streamline operations for
efficiency purposes because labor ministry authorization will be required.
counsel and other advisors should craft these in a manner that will seem to
benefit other bidders equally.'39
Once these objectives are adequately and reasonably met, the next task
is to draft the due diligence report for the client. 141 This report under the
current business climate in Colombia should be as exhaustive as possible,
keeping in mind time and cost constraints. The due diligence report should
encompass all findings by counsel, as well as other advisors, in one
document, if possible.
D. Picking Local Counsel
Another key ingredient of the project finance privatization and
capitalization puzzle, is choosing local counsel. Every legal and otherwise
related matter is unique, especially when dealing in the context of a
jurisdiction with a different legal tradition. 41 . Often U.S. counsel is not
sensitive to these issues. The client is ultimately best served -- its
expectations may even be exceeded -- if counsel becomes sensitive to
foreign legal and related advisory matters.
With this in mind, U.S. counsel should seek local counsel and related
advisors by outlining the client's needs before interviewing and selecting
counsel and other advisors,'42 and identifying the type or types of lawyers
and advisors the client will need, keeping in mind the following issues:
"3R9emember that, although the bid process is competitive in most countries like
Colombia, the underlying spirit of the competition is a democratic one. This democratic
spirit must be fostered by all bidders, not just the organizers. This spirit is what ultimately
precludes the process from being corrupted, at least in a perfect scenario.
"4For literature on drafting reports and legal opinions on international transactions see
LEGAL OPINIONS IN INTERNATIONAL TRANSACTIONS: FOREIGN LAWYER'S RESPONSE TO U.S.
OPINION REQUESTS (Michael Gruson et al. eds.) (1989); Neil Flanagin, Opinionson Foreign
Law, in NEGOTIATING AND STRUCTURING INTERNATIONAL COMMERCIAL TRANSACTIONS:
LEGAL ANALYSIS WITH SAMPLE AGREEMENTS 95-108 (Shelly P. Bettram & David N.
Goldsweig eds.) (1991) [hereinafter NEGOTIATING & STRUCTURING]; Third Party Legal
Opinion Report (includingLegal Opinion Accord) ofthe Section ofBus. Law American Bar
Association (1991), THE Bus. LAW. (199 1).
"' See Elliot R. Lewis, Selecting and Working with Foreign Counsel, in LAW.
DESKBOOK, supra note 5, at 394-410 ("In these times of rapid movement toward a global
economy, companies are expanding beyond traditional borders. Economic globalization is
the result of significant legislative accomplishments and economic developments... With
these developments comes the necessity for lawyers to be prepared for transactions and
dealings worldwide."); James R. Silkenat, The Needfor ForeignLegal Counsel:Location,
Selection andEvaluation, in NEGOTIATING & STRUCTURING, supra note 140, at 81, 83 ("The
laundry list of issues to spot in selecting foreign counsel is very long.. .[T]he following
criteria are usually ... relevant: 1. English language ability... ; 2. skill and integrity of the
firm; 3. identity of the responsible foreign lawyer handling your matter; 4. contacts with
government... ; 5. costs... ; 6.. .accessibility; 7. representation of other multinational
corporations; 8. familiarity with the kind of . .business transaction involved. .. ").
"4Lewis, supra note 5, at 394 ("[Y]ou may need.. .time to sketch out the parameters of
your international matter."). As indicated herein, U.S. counsel should research in a
preliminary matter the applicable law involved in an international project finance and
privatization deal. This is true for jurisdictions like Colombia, where applicable laws may
Latin America continues to be very client-oriented in the manner in
which business is conducted, even when getting questions answered from
public sector entities on the privatization auction block; therefore it matters
who you know. However, a word of caution: U.S. counsel and advisors
should stay away from overzealous local advisors promising to get things
done through favors and so-called "greasing the wheel" tactics, especially
in light of U.S. Foreign Corrupt Practices Act restrictions. 43
While it may be useful to know the Spanish language on a functionally
literate level when communicating with local advisors, one must make sure
that local advisors can communicate well in spoken and written English,
for this will facilitate client and advisor meetings.
Generally, laws in Latin America, especially in Colombia, are in a
constant state of change. Therefore, it is vital to have a solid team of
technocrats on the local advisory team, that is, solid tax, customs,
commercial, corporate, trade, and privatization attorneys and accountants.
While this recommendation is obvious on its face, it is worth mentioning
nonetheless. Oftentimes the technocrat is not as well-connected as the
more gregarious advisor, but well-connected advisors in Latin America, as
in other parts of the world, may not be the most competent associates.
Finally, if U.S. counsel and its client do not have contacts for local
advisor purposes, in a jurisdiction such as Colombia, traditional
international legal directories and listings are useful resources. Another
valuable on-the-ground resource for local legal, financial, and accounting
advisors may be a local branch or affiliate of the client's U.S. accounting
and consulting firm. In this regard, U.S. counsel and its client should be
aware that today's international professional services market is becoming a
one-stop shop. Prestigious international accounting and consulting firms in
change on a more than regular basis. While an exhaustive study of the foreign jurisdiction is
not required, an overview of the controlling law is suggested. This task will enable
information to be conveyed to the client in an optimal manner in order to assist it in its
143See Michael R. Geroe, Complying with U.S. Antibribery Laws, 31 THE INT'L LAW.
1037 (1997) ("The Foreign Corrupt Practices Act of 1977 (the FCPA), as amended,
punishes U.S. businesses and businesspeople who provide any payment or promise to
foreign officials in exchange for obtaining or retaining business."). FPCA issues should
always be considered, not only when instructing local advisors, but also when the client is
itself operating on the ground in a foreign jurisdiction, given the law's extraterritorial
powers. Id. at 1038, n. 6 (citing Department of Justice statement on the antibribery
provisions of the FCPA (Feb. 1992) (DOJ Statement)). See also, 0. Thomas Johnson Jr.,
The Foreign CorruptPracticesAct, in LAW. DESKBOOK, supra note 5, at 224-236 ("The
third element of the FCPA's antibribery provision is that there must be an 'offer, payment,
gift or promise' of 'money or [a] thing of value'." This element presents no interpretative
difficulty. Its intent is to sweep broadly to prohibit any offer or promise of a bribe and to
make clear that the bribe itself can consist of 'anything of value'."); ELLEN S. PODGOR,
WaITE COLLAR CRIME IN A NUTSHELL 133 (1993) (providing overview of FCPA). See
generally, GUIDELINES: PROCUREMENT UNDER IBRD LOANS AND IDA CREDITS 1.15, at 7
(The World Bank Revised Sept. 1997) (providing general view of anti-corruption policy
and World Bank bidding guidelines).
many parts of the world, such as Colombia, have competent legal practices.
SEC-restricted entity rules preclude accounting firms from providing
large multinational clients145 that are publicly traded on U.S. stock markets
with legal advice, other than traditional tax and international tax consulting
advice on both a domestic (U.S.) and international level. These firms may,
however, through their legal practices in foreign jurisdictions, provide
clients with a check as to traditional services by local counsel. This check
is a value-added service to traditional tax consulting that often proves vital
in furthering a client's interests.
Taking on a privatization or capitalization project in Colombia is not
simple, but the excitement of advising the client and being part of an
infrastructure project in this country, as in any of the so-called emerging
markets in today's global economy, surely makes missing a couple of
months on the golf course worthwhile. While time with the family during
the two to five months in preparation for the client's bid will not be
recuperated, the experience will make for many war stories, and in fact, bid
day may provide an occasion for including the family on a late-summer
On a less nostalgic note, the following should be kept in mind:
) The client will need a Colombian joint stock corporation, in this
regard an LPIS is advisable, as it is very functional for Colombian and U.S.
business and tax purposes.
(2) The LPIS will need 5 shareholders or more. In order to spread the
risk of exposure, the shareholders should be made up of limited liability
entities, whether located offshore or onshore.
4'4 See generally,John Gigeaut, Squeeze Play, ABA J., p. 42, Feb. 1998 ("[S]torm clouds
have been gathering since the early 1990's, when the Big Six [now Big Five] accounting
firms plunged into the practice of law in Europe. A more relaxed regulatory atmosphere
there has allowed them to engage in all kinds of legal practice, either on their own or
through affiliated law firms. The Big Six have gone beyond tax law and into contracts,
mergers and acquisitions, and even into litigation.").
141 The SEC-restricted entity rules exist in order to preserve the independence and
objectivity of public accountancy firms when analyzing financial statements and conducting
external audit processes. These rules exist to safeguard such processes from biases. This
objective is best presented in sec. 602.02.e.ii. of the Codification of Financial Reporting
Policies, as amended in Release No. FR-34, Mar. 2, 1989, 54 F.R. 9770, in SEC
HANDBOOK: RuLEs AND FORMS FOR FINANCIAL STATEMENTS AND RELATED DIscLOsuREs (As
OF NOVEMBER 1, 1995) (CHH Publishers, 1995), stating, "A legal counsel enters into a
personal relationship with a client and is primarily concerned with the personal rights and
interests of such client. An independent accountant is precluded from such a relationship
under the Securities Acts because the role is inconsistent with the appearance of
independence required of accountants in reporting to public investors."
(3) Make sure you, and especially local counsel and other advisors,
understand privatization, capitalization, and public utility law issues.
(4) There are no pass-through entities under Colombian tax law; all
entities are taxed at a rate of 35 percent and an income tax on dividends tax
of 7 percent will be triggered when paying dividends offshore.
(5) The investment into Colombia may be done via a direct capital
investment, debt vehicles, or inter-company transactions.
(6) The optimal profit repatriation strategy should include (a) technical
services and assistance agreements (offshore or onshore) performed by
offshore entities; (b) related company offshore management and
administrative agreements; (c) back-to-back loans; (d) international lease
agreements; (e) capital reductions; (f) upstream international loans; and (g)
offshore dividend and royalty payments.
) The due diligence review and report should be as exhaustive as
possible and all advisors should cooperate in order to give the client the
best picture ofwhat it might acquire.
(8) Pick local counsel carefully and if needed, use two groups of local
counsel, a technical group for tax, foreign exchange and investment issues
and a less technical, but strongly connected group, for assisting with
needed information and contacts on the ground.
Colombia, given that Colombian tax legislation is in a constant state of change and modification. For example, in 1997 the Colombian government passed two major tax reforms , Decree 80 /97 and Law 383/97, and in late 1998 it promulgated Law 488 /98.
Decree 80 /97, known as the Economic Emergency Decree, was passed into law on January 13 , 1997 , by executive order and was the first 1997 tax reforms. However, this tax reform was judicially repealed by the Colombian Constitutional Court in In re Economic Emergency, Colom . Const. Ct., C-122, Mar. 12 , 1997 .
The second tax reform, which has not been challenged in court to date , is Law 383/97. This piece of legislation was passed into law in July 1997 by the Colombian Congress and is currently controlling . See Mario Andrade & Mario A. de Castro , The 1997 Colombian Tax Reform in Retrospect: Issues and Concernsfor Foreign Investors, 16 TAX NoTES INT'L. 1531 (May 11 , 1998 ) (providing summary of Law 383/ 97 ).
The third and most recent tax reform , Law 488 , which complements Law 383 in many ways , was passed into law on December 24 , 1998 , and became effective on January 1 , 1999 . At the date of this article's publication, Law 488 has not yet been challenged in court . See Mario Andrade & Mario A. de Castro , Many Changesfor ForeignInvestors in Colombia's New Tax, 7 LATIN AMER L &B REP . 11 ( Jan . 31, 1999 ) (providing analysis of Law 488/ 98 ).
1s CTC, art. 24, INC. 1.
57 Id. at arts. 12 - 14 .
72 Law 383/97, art. 33 .
7'Although beyond the substantive scope herein, the subject of inter-company arrangements and transfer pricing is relatively new in Colombia. Yet, transfer pricing issues should be considered by counsel once the client is successful with its privatization bid, given that the Colombian tax authorities (the "DIAN") are quickly moving into the direction of creating formal transfer pricing regulations . See Mario J. Andrade & Mario A. de Castro , Colombian TransferPricing:A Statutory Analysisfor InternationalPractitioners ,8 J. INT'L TAX 552 (Dec . 1997 ) (survey of interrelated legislation acting as country's main transfer pricing source law).
7 Law 488 / 1998 , art. 15. See Mario J. Andrade & Mario A. de Castro , Colombia's Tax Reform Includes Benefits for Service Contract Payments, 2 PRAC'L LATIN AMER . TAX STRAT . 15 ( Feb . 1999 ) (discussion of service contracts under Colombian tax law ).
75 CTC, arts. 121 , 124 .
76 Decree 259/92, arts. 1 -3 (adopting guidelines set by Andean Pact Decision 291). INCOMEX registration is required for technical services and assistance contracts performed by offshore entities, whether the services are provided offshore or onshore, because these transactions are treated as if they were the importation of technology into Colombia .
77 CTC, art. 392 .
1-4 Law 223 /95, art. 230 .
105CTC, arts . 329 - 350 ; Decree 2075 /92.
" See Erik Haindl et al., Income Tax Issues, in COMPREHENSIVE TAX REFORM: THE COLOMBIAN EXPERIENCE 17 (International Monetary Fund Publications , March 1995 ) (providing a general overview of Colombian monetary correction ).
12 6 Id. at art. 30 .
127Id.; Cen. Bank Reg. DCIN - 09/Feb. 3 , 1998 , at 3.1- 3 . 2 (as modified).
128 Cen. Bank Reg. DCIN - 09/Feb. 3 , 1998 , at 3.1- 3 . 2 (as modified).
129 in terms of where the profits are repatriated, Colombian law does not place any restrictions on foreign investors. Therefore, the client may be advised to pick anyone of the multiple tax havens located offshore, such as the Cayman Islands . See generally, Marylouise Dionne, Tax Havens-An Introduction, 17 TAX NOTES INT'L. 430 (Aug. 17 , 1998 ); Siraj Kkhan, Malta: A Little-Known Tax Haven, 17 TAX NOTES INT'L. 432 (Aug. 17 , 1998 ); Harold I. Steinbach & Heath A . Grayson , Taxing Hardly: Locating a Business in a Tax - Free Jurisdiction, 7 Bus. L. TODAY 32 ( Sept .-Oct. 1997 ) (illustrating issues and concerns of picking an offshore jurisdiction to conduct international business ); George C.J. Moore , Selecting An OffshoreJurisdiction:Why Turks & Caicos , 15 INT'L L. Q. (THE FLA. B .) 8 ( Win . 1996 ) (presenting tips for picking offshore jurisdictions for conducting international business ).