Tax neutrality in corporate reorganizations

One of the fundamental pillars of Law 1607 of 2012 was the consecration of the tax regime for business reorganizations, and especially the tax neutrality regime in merger and spin-off operations. Until then, there were only a couple of rules in the Tax Statute that indicated that in the merger and spin-off processes there would be no fiscal alienation (for income and VAT purposes) between the intervening entities and that losses would be offset in proportion to the assets of the intervening entities. Nothing was indicated with respect to the tax effect that this type of operations could have with respect to the partners or shareholders of the intervening companies.

Although much has been written on the subject (almost all of it trying to unravel and give an understanding of this regime), little substantial and critical analysis has been made. The most accurate criticisms can be found in the writings of Paul Cahn-Speyer Wells and Mauricio Piñeros Perdomo.

The aforementioned law created a very complex and unnecessarily extensive system that could perfectly well have been replaced by one that simply taxed transactions entered into without a valid economic motive (i.e., transactions whose sole purpose was tax savings), as well as mergers and spin-offs whose final shareholding composition does not keep a proportional symmetry with the initial one (i.e. operations in which the shareholding composition of one of the intervening parties is higher or lower than the one that would result from the calculation made on a simple rule of three applied to the sum or division of the intervening patrimonies).

The doctrine has also criticized the fact that this tax neutrality regime is not extended to share swap transactions, since in these transactions the realization of income would not really be obtained until the shares are sold or the company is liquidated, at which time a certain value would be assigned to the shareholder.

Notwithstanding the above, perhaps the greatest criticism of the doctrine to this new tax neutrality regime is the lack of definition of the taxpayers and taxable bases in income tax matters, which undoubtedly could lead the Constitutional Court to decree the partial unconstitutionality of the same for violation of the principle of legality and certainty in tax matters.

We can see several examples of the above, as follows:

Article 319-7 of the Tax Statute states that "Mergers and acquisitive spin-offs or organizational Reorganizations that do not comply with the requirements set forth herein, constitute alienation for tax purposes (...) in accordance with the applicable provisions on the alienation of fixed assets". What does it mean that "they constitute alienation for tax purposes", will they be taxed for whom, for the intervening entities or for their shareholders?

Article 319-4 paragraph 2 of the Tax Statute indicates that mergers of foreign companies (acting as absorbers) with Colombian companies (acting as absorbed) constitute alienation for tax purposes and therefore are taxable. The question remains; taxed for whom: for the Colombian absorbed company, for the foreign absorbing company, or for the shareholders of the integrated entity?

Article 319-6 paragraph 1 of the Tax Statute indicates that the spin-off of assets other than business units and commercial establishments is taxed under the tax rules for the disposal of assets. Again, the regulation does not indicate for whom this operation would be taxed. If it were understood that it would be for the transferor, this would be illogical because through such operation -instead of an increase in assets- a decrease in assets is being generated.

Likewise, the law does not define what would be the taxable base of such alleged taxable event; would it be the value of the asset that does not meet such conditions or would the taxable base be the value of all the assets divided?

These legal loopholes lead to the conclusion that the tax neutrality regime for mergers and spin-offs is partially unconstitutional for violating the principle of legality and tax certainty established in our Political Constitution.