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The National Law Center is a non-profit 501(c)(3) Research and Educational Corporation. © Copyright, 1996
Baker & McKenzie
Maria Gabriela Sosa (Caracas)
(58-2)953-0833
The opening of the oil sector has raised several questions regarding the tax treatment applicable to persons engaged in hydrocarbon production and related activities. Under the current Income Tax Law ("Income Tax Law"), earnings derived from the production of hydrocarbons and their by-products, as well as from connected activities -- refining, transportation, exportation-- ("Ordinary Hydrocarbon Producers"), are subject to taxation at the rate of 67 percent ("Ordinary Regime"). The companies organized pursuant to association agreements for the purpose of undertaking vertically integrated projects to exploit, refine, industrialize, emulsify, transport and market extra-heavy crude oil, natural bitumen and off-shore natural gas ("Strategic Associations") are excluded from the Ordinary Regime, and the earnings thereof are subject to an income tax of 34 percent.
Because they are excluded from the Ordinary Regime, Strategic Associations do not enjoy the investment tax credit established in Article 57 of the Income Tax Law discussed below. It is also not entirely clear whether they are entitled to the investment tax credit established in Article 58 of the Income Tax Law since it expressly excludes persons not earning income from "hydrocarbons and related activities" subject to the Ordinary Regime. It is not clear whether the failure to limit the exclusion to persons earning income from "hydrocarbons and related activities" taxed under the Ordinary Regime was a legislative error or the result of a conscious attempt to exclude Strategic Associations from the benefit of the investment tax credit. In our view, the failure was probably due to legislative oversight since granting an investment tax credit to Strategic Associations would be consistent with the constitutional principle of tax equality, particularly in view of the fact that there would appear to be no public policy favoring the exclusion of Strategic Associations from investment tax credits.
The dividends received by these Strategic Associations are not taxed. The dividends, including stock dividends, to be received by taxpayers other than individuals engaged in hydrocarbon production and related activities are subject to a 20 percent tax, if the dividends come from companies engaged in commercial activities other than hydrocarbon production and related activities. It is not clear whether dividends paid by Strategic Associations are taxable. Although Strategic Associations produce hydrocarbons, since they are not subject to the Ordinary Regime it may be argued that they are not engaged in hydrocarbon production and related activities. If this is the case, the dividends paid to Ordinary Hydrocarbons Producers would be taxed at 20 percent. The confusion in this area of law has created uncertainty that can only be clarified by amending the Income Tax Law.
State companies engaged in hydrocarbon production and related activities are exempt from taxes on extraordinary earnings derived from studies, information, know-how and technical instructions, formulae, data, recordings, films, specifications and similar assets contributed to the projects contemplated by a Strategic Association.
Ordinary Hydrocarbon Producers are entitled to an investment tax credit of 8 percent of the new investments they make in fixed assets (Article 57 of the Income Tax Law) and an additional reduction of 4 percent when the new investments concern:
(i) exploration, drilling and related facilities for production, storage, and transportation to the shipping port or refining location in the country, all included;
(ii) secondary recovery of hydrocarbons;
(iii) use, conservation and storage of natural gas, including liquefied natural gas;
(iv) value added to hydrocarbons and expenses for research.
To determine the amount of the new investments, retired assets, amortization and depreciation of the fiscal year, and an average of 2 percent of the net fixed assets for the previous fiscal year based on beginning and end of year balances must be deducted. If the amount of deduction exceeds 2 percent of the net income of the taxpayer, the excess may be carried forward to the following three fiscal years. To calculate if the reduced amount exceeds 2 percent of net earnings, the reductions carried forward from prior fiscal years must be accounted for first, and then counted toward the present fiscal year.
Taxpayers engaged in hydrocarbon production and related activities that own or lease vessels and use them for coastal or international transportation must compute all expenditures for each voyage as expenditures incurred within Venezuela. If a taxpayer is required to maintain accounting books, the taxpayer must adjust its balances and determine annually the increase in net worth resulting from the readjustment.
The Regulation implementing the Law on Luxury and Wholesale Sales Tax establishes that the service agreements, research studies, execution of mining works, or prospecting, exploration and exploitation of metal-containing minerals, oil, methane gas, quarries and the like, are services subject to the tax. Taxpayers engaged in the exportation of hydrocarbons subject to the zero tax rate shall be subject to the system established in Article 37 of the Law on Luxury and Wholesale Sales Tax.
Tangible and intangible assets located in the country or used in the production of income by persons engaged in hydrocarbon production and related activities are subject to the enterprise assets tax. This tax is equivalent to 1 percent of the average value of the relevant assets.
The Law on Enterprise Assets Tax establishes a tax reduction for exporters, which would benefit taxpayers engaged in the hydrocarbon production and related activities which export all or a part of their production. The asset value against which the assets tax is levied is reduced by the ratio which export earnings bear to total earnings in the fiscal year.
[(Export Earnings x 100) / Total Earnings] = percentage of applicable reduction in the tax base].
Resolution No. 2,923 of the Ministry of Finance, dated 23 October 1995 (Official Gazette No. 35,823 of 25 October 1995), contains regulations for the customs duty reimbursement system or "draw- back." As a whole, the changes were limited to replacing the SENIAT with the General Sectorial Customs Direction. However, the Ministry of Finance also used the opportunity to introduce some in-depth changes, such as the following:
(i) All reference to documents needed for reimbursement has been eliminated. The only governing rules are those contained in the Regulation of the Organic Law of Customs and Special Customs Systems;
(ii) The four-month time limit for submitting requests established in Article 60 of the Organic Law of Administrative Procedure has been eliminated. This time-frame elimination will undoubtedly slow down reimbursements and issuance of the Tax Reimbursement Certificates ("CERT"). However, the elimination of this provision does not exempt SENIAT from its obligation to resolve matters under the Organic Law of Administrative Procedure.
(iii) The reimbursement is calculated by multiplying the percentage corresponding to each industrial activity by the FOB value in Bolivars of the export goods. This amount in Bolivars is calculated at the preferential exchange rate for selling Bolivars, determined by the Central Bank of Venezuela on the date that the export customs declaration is registered. The percentages for reductions and losses are then subtracted from the result.
(iv) A new provision is included, which allows SENIAT to set the percentages for reductions and losses when, in its view, the data submitted by the requesting party are insufficient. This, of course, increases the discretionary powers of the SENIAT and its successor with respect to an element that directly influences the amount to be reimbursed;
(v) Provisions regarding any other matters contained in Resolution No. 2,603 of 10 June 1994 are still in effect, although the resolution itself is expressly repealed.
SENIAT recently introduced an Income Tax Reform Bill before Congress. The most controversial proposals contained in the
Bill are:
(i) the introduction of taxation on a worldwide basis, and
(ii) a provision that would empower SENIAT and its successor to look beyond the form of a transaction to impose tax based
on the commercial substance. The bill also creates tax benefits for the oil, agricultural, cattle, fishing, fish breeding and forest
industries; clarifies the fiscal treatment of consortia; and allows certain companies to maintain accounting books and records in
U.S. dollars.
Taxation on a worldwide basis means that income earned by Venezuelan persons from activities conducted or assets located abroad will be taxed in Venezuela. However, any taxes paid in other countries may be credited against Venezuelan income tax liability, and may be carried forward for three fiscal years. Obviously, a world wide tax system requires a complex and efficient legal and administrative infrastructure, which until now has only been possible in advanced industrialized countries such as the United States. The proposed Venezuelan legislation is highly deficient in this respect and there is substantial doubt as to whether worldwide taxation will be administered wisely and well.
With respect to the expansion of the powers of SENIAT, the proposed rule would, in effect, allow for the piercing of corporate veils and the disregarding of the existence of contracts in order to characterize the true commercial substance of a transaction, provided that there is prima facie evidence of the taxpayer's intent to evade, avoid or reduce tax liability. The proposed rule, however, contemplates no procedure by which the taxpayer may overcome the presumption of intent. An open-ended rule such as this may lead to serious abuses.
Generally, the other amendments to the tax law represent benefits to the taxpayer. Oil industry joint ventures will be granted a credit for new investments of up to 12 percent. The credit may be carried forward for five years. A 20 percent credit for new investments is proposed for the agricultural, cattle, fishing and fish-breeding industries, as well as an additional credit based on increased productivity, calculated on a progressive tariff of ten to 80 percent.
Consortia will be treated in a manner similar to partnerships: the tax will be paid by each consortium participant based on its pro-rata share of net taxable income, and the determination of net taxable income will be made by the consortium. Consortium members will appoint a representative to determine the consortium's net taxable income and to comply with tax obligations.
Associations, partnerships or companies formed under Article 5 of the Organic Law that Reserves Hydrocarbons to the State (the "Hydrocarbon Reservation Law"), must maintain dollar-denominated accounting books and records separate from the Bolivar books and records required by Article 81 of the Income Tax Law. Transactions must be recorded in the books at the rate of exchange determined by the regulations. In addition, these entities are entirely excluded from the inflationary adjustment system.
The legalization of dollar accounting has been heralded as a positive aspect of the Oil Opening. It will clearly give an advantage to the entities formed under Article 5 of the Hydrocarbon Reservation Law. It eliminates the distortions created by the inflationary adjustment system and facilitates reporting to parent companies abroad. However, the dollar accounting method will create some minor distortions for local currency transactions as a result of fluctuations in the exchange rate and, more significantly, may raise some constitutional questions.
Restricting dollar accounting to the entities referred to above may be viewed as a discriminatory rule, particularly by other foreign-owned companies operating in Venezuela. In addition to possibly violating the Constitution, it may also be challenged as contrary to the equality principle contained in the Organic Tax Code.
Congress is discussing a reform of the Organic Tax Code (OTC) to reduce tax evasion by imposing stricter preventive and
punitive measures. The bill includes the following:
(i) imprisonment for tax evasion,
(ii) joint and several liability of the purchasers of shares where the sales price is subject to withholding,
(iii) the power of the Tax Administration to forgive penalties, and
(iv) establishes new pre-judgement types of enforcement.
Under the current OTC, imprisonment for tax evasion is only applied in cases of secret commerce in alcohol. In all other cases, tax evasion is subject to a monetary penalty, as well as confiscation of merchandise and/or closure of the premises. The bill would add a one-to-five-year prison term. It also includes a six-month to five-year prison term for directors, managers and administrators of financial institutions that fail to pay over to the Treasury funds received for taxes and penalties.
Purchasers of shares authorized by the National Securities Commission and sold on a Venezuelan Stock Exchange will be jointly and severally liable for taxes applicable to the sale. Only the Stock Exchange is liable currently.
As a tax payment incentive, the bill empowers the Tax Administration to excuse penalties by general resolution and without the need for a special law or prior consultation with the General Comptroller's Office.
The new pre-judgment enforcement measures include closure of premises for up to ten days and confiscation of merchandise. These measures will be applied in addition to the attachment or sequestration of personal property and the prohibition against alienation or encumbrance of realty. During closure of premises, the employer must continue to pay workers, thereby avoiding an appeal for constitutional protection.
The recent amendment to the Income Tax Law (Extraordinary Official Gazette No. 5,023 of 18 December 1995), exempts income derived from agriculture, cattle, fishing and forestry from income taxation. Taxpayers engaged in these activities are also exempt from inflation adjustment and from paying taxes on the goods used in these activities.
The amendment also modifies the tax regime applied to companies engaged in the production of hydrocarbons and related activities that are taxed at the rate of 67.7 percent, by excluding therefrom companies producing natural bitumens. These companies are now subject to the general corporate tax rate of 34 percent.
Interest on time deposits is also exempt from taxes, as is interest from mortgage bonds and savings certificates. Earnings on investments in mutual funds or listed securities received by individuals are also exempt.
In order to increase tax collections, SENIAT has sent a law to Congress that would enable the Tax Administration, for a term of six months from the effective date of the law, to pardon the penalties, interest and monetary correction on past-due taxes.
The purpose of the law is to encourage taxpayers to pay taxes before they are subject to penalties. Thus, taxpayers who in the past filed returns without paying the respective taxes, omitted income on their returns or failed to file returns may pay the tax immediately without penalties, interest or monetary correction. Income taxes payable to the National Treasury by withholding agents are excluded from the benefits of this law. SENIAT cannot assess deficiencies with respect to fiscal years for which taxes have been paid under the law.
A tax on withdrawals or debits effected with financial institutions governed by the General Law of Banks and Other Financial Institutions has again been proposed. In contrast to the tax on bank debits in effect during part of 1994, only commercial companies would be subject to this tax. The tax rate has not yet been established. The speculation is that it will be between 0.5 percent and 1.75 percent.
The information contained in this article should not form the basis of any decision as to a particular course of action; nor should it be relied on as legal advice or regarded as a substitute for detailed advice in individual cases.
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