Tax treatment of debt capitalizations

The facts of the case are summarized as follows: Global issued shares in the amount of 1,000 million pesos which were subscribed by its shareholder Partime S.A.S., to whom Global owed a similar amount. When these shares were subscribed, payment was made by offsetting, since debtor and creditor had reciprocal accounts payable and receivable for equal amounts.

As a proven fact, it was determined that neither the contributor nor the recipient complied with the requirement established in numeral 5 of article 319 of the Tax Statute ("ET") which imposes the obligation -for the purpose of achieving the fiscal neutrality of the operation- to establish in the minutes, as a sacramental formula, that "the contributor and the recipient company shall expressly declare to be subject to the provisions of said article".

The legal problem to be solved consisted in determining whether the capitalization of credits should be treated as a contribution in money or as a contribution in kind. If it is determined that its nature corresponds to a payment in money, which is simply extinguished by the mechanism of compensation, there would be no obligation to leave the sacramental formula established above, since paragraphs 2 to 4 of article 319 of the ET would not be applicable, which are only applicable to the contribution in kind, since they establish that the tax cost and the nature of the assets contributed must remain the same and that the shares released will keep the tax cost of the assets contributed. However, if it is determined that the tax treatment of the capitalization of claims is that of a contribution in kind (of the account receivable that the contributor has with the recipient), the sacramental formula would be applicable and, therefore, since it has not been established, tax neutrality could not be applied.

In the first instance ruling, the Administrative Court of Cundinamarca -leaving aside the litigious debate raised by the parties- declared the nullity of the resolutions issued by the DIAN because the operation "had a neutral effect, being the compensation of a debt for the shares received, reason for which there was no variation in the income account or in the net worth of the taxpayer". Upon appeal of the ruling by the DIAN, for lack of consistency, the Council of State established that "the operation carried out by the taxpayer is framed within the assumption of tax relief of numeral 1 of article 319 of the Tax Statute, to the extent that the cash contributions received by the company are related to the issuance of new shares, without the requirement established by numeral 5".

In conclusion, the Council of State determined that the tax treatment of the capitalization of credits is that of the cash contribution, and not that of the contribution in kind. In this sense, the capitalizations of credits, not involving a contribution in kind, are exempted from complying with the provisions of paragraphs 2 to 4 of article 319 of the ET, and therefore also from paragraph 5 that establishes the sacramental formula. As this is the situation, the capitalizations of credits are subject to the imperative of tax relief established in paragraph 1 of article 319 of the ET which establishes that "The company receiving the contribution will not realize income or loss as a consequence of the contribution, when in exchange for the same there is an issuance of new shares or social quotas".