Depreciation of assets in joint venture contracts

The depreciation of assets contributed to a business collaboration contract is an issue that has been the subject of much discussion in recent years, especially when the contract to which the assets are contributed is a joint venture contract. This is because, according to article 127 of the Tax Statute ("E.T.") "the taxpayer beneficiary of the depreciation deduction is the owner or usufructuary of the asset".

The discussion begins with the issuance, by the Superintendence of Corporations, of Official Letter No. 115-175069 of December 28, 2011, where it concludes that "since the managing partner is recognized as the sole owner of the business vis-à-vis third parties, he/she will be entitled to take the depreciation expense, both of his/her own assets and of the assets of others involved in the joint business". In accordance with this, while the collaboration contract subsists, the manager will be the one who will benefit fiscally from the depreciation since he/she will be considered - before third parties - as the owner of the business. Once the contract is terminated and the assets are returned, it will be the hidden partner who will continue with the depreciation of the asset, if it generates its own income. The question then arises as to what value the hidden partner should take as a basis to continue depreciating the asset, since it does not know the depreciation method used by the manager or the amounts depreciated.

In Official Letter 115-082656 of September 19, 2012, the Superintendency indicated that the depreciation base value will be the one certified by the managing partner in the corresponding rendering of accounts, regardless of whether the asset is transferred to it as profit in the contract or as restitution of the contribution.

Then -several years later- the Dian issues the Unified Concept on Joint Venture Accounts (Concept 0376 of April 9, 2018) where it establishes that "(...) an asset corresponding to an asset (sic) must be recorded by each of the participants involved -regardless of who is the owner of the asset- in such a way that each of them may apply the same proportionality when recording and declaring, for example, the depreciation expense". This position, although it differs substantially with what is set forth in Article 127 of the E.T., is close -via Article 21-1 of the E.T.- to what is sought by the IFRS in the sense of fiscally granting the depreciation deduction to whoever is effectively using the assets for the generation of income.

This change is due to the fact that Article 18 of the E.T. indicates that, by virtue of the principle of transparency, income, costs, expenses, assets and liabilities must be distributed among the parties to the contract according to their participation in it. In this sense, since depreciation is an expense, it should be distributed in the same proportion to the distributed income in order to preserve a business equivalence between the parties.

Multiple problems arise from this situation. The first of them has to do with the limitation brought by Article 77 of Law 1819 of 2016 (incorporated today in Article 128 of the E.T.) according to which only those obliged to keep accounting records may deduct reasonable amounts for depreciation caused by the wear and tear of assets used in business or income-producing activities. This rule -although currently being sued before the Constitutional Court for violating the principle of equality between those obliged to keep accounting records and those not obliged to do so- would mean that the participants not obliged to keep accounting records (for example, because they are not merchants) would not be able to deduct any amount for depreciation. In that case, the other participant would not be able to make use of the share of the disqualified participant either, implying that such depreciation expense would be lost.

As an example of the above, consider the case of a sugar mill that enters -as managing partner- into a joint venture agreement with a natural person (not obliged to keep accounting records) owner of a property. The manager's contribution will be all the agro-industrial production of the sugar cane and the hidden party's contribution will be the use of its land. Under the assumption that they agree to share the profit on a 70/30 basis (70% the manager/30% the hidden party), the manager (under the interpretation made by the DIAN of article 18 of the E.T.) would have to distribute 30% of the income, costs, expenses, assets and liabilities to the hidden party. In this sense, since the concealed party cannot use this depreciation (of the constructions, improvements, biological assets, etc.) because it is not obliged to keep accounting records, it would be lost and could not be used by the manager either. This would lead to a situation of inequity in that the hidden party would have the income but would not have the right to take the correlative depreciation, which could not be used by the manager either.

The second problem that jumps out is the splitting of the acquisition cost as the depreciation base value when the VAT constitutes a higher value of the cost in the purchase of fixed assets. Under the above example, consider that the manager acquires a fixed asset for 119 million pesos (100m+ VAT at 19%).

If the hidden party were obliged to keep accounting records (for example, because it is a company) then it would be entitled to 30% (119m x 30%= 35.7m) of that depreciable value for the duration of the contract. In this sense, the DIAN could object to the fact that, being the manager the only owner of the business before third parties and being the only one entitled to deduct (or use fiscally) the VAT paid, then such item (VAT as a greater value of the cost) could not be transferred to the hidden party to be part of its depreciation base (fiscal cost).

Fourteen years ago, with the issuance of the judgment of April 1, 2004, the Council of State clearly indicated that in the contracts of joint ventures the participants did not necessarily have to be merchants (thus obliged to keep accounting records) and the activities carried out did not necessarily have to be mercantile. In this sense, the Dian's doctrine should comply with such pronouncement establishing that, even those who are not obliged to keep accounting records (as it happens with the non-trading hidden partners), will be able to benefit fiscally from the depreciation of the assets of the joint business, thus achieving harmony in the same business and the total recognition of the wear and tear of the assets used in the development of the business.