Mergers and acquisitions provide a popular mechanism for investors to start or restructure operations in Venezuela, either through merger procedures per se, or through acquisitions of assets (sale of going concerns) or shares of Venezuelan entities. The tax and legal implications resulting from each of these transactions need to be considered and analyzed in order to choose the most convenient for the purposes of the investors.
This article is intended to provide investors with a brief description of the legal and tax implications that would derive in each type of transaction.
In the first place the article will analyze merger procedures, and then the acquisition of going concerns and the acquisition of assets of Venezuelan entities. Each of these transactions are regulated separately by the Venezuelan Commercial Code.
MERGER TRANSACTIONS
The Venezuelan Commercial Code does not contain a definition of mergers, however it regulates it after classifying the transaction as a cause of dissolution of legal entities (article 340 number 7, Venezuelan Commercial Code).
Mergers can occur in Venezuela in two ways, the first as a result of the merging of one or more legal entities into an existing entity, called merger by absorption (fusión por absorción). This merging process implies the transfer of all the assets and liabilities from the absorbed entity or entities into the absorbing company, and hence the dissolution of the absorbed entities and the unification of all the shareholders. The second type of merger, called merger per se or merger by integration (fusión propiamente dicha o por integración), occurs as a result of the incorporation of a new entity and the dissolution of the merging entities, where previously existing entities contribute their whole patrimony to the new entity.
The legal effects resulting from both kinds of merger are the same, namely, the absorbing entity or the new entity will be the legal successor of all rights and liabilities of the absorbed entities (article 346 Venezuelan Commercial Code).
Merger procedure
In accordance with Venezuelan legislation, the steps that must be undertaken to complete a merger under Venezuelan Corporate legislation are as follows.
After the merger agreement is drafted, the shareholders of the merging companies must call a shareholders' meeting in order to resolve and approve the merger, which must be attended by a number of shareholders representing three-quarters of the capital stock of the relevant entities (article 280 number 3, Venezuelan Commercial Code). The votes in favour of the merger must represent at least half of those representing the minimum required capital stock.
The administrators must register and publish the minutes of the shareholders' meetings. This formality must be completed 15 days following the date of the meeting before the corresponding Mercantile Registry Offices, together with the respective balance sheets (article 344 Venezuelan Commercial Code).
The merger will take effect at least three months after the registration and publication of the minutes of the shareholders' meeting (article 345 Venezuelan Commercial Code).
Once the merger has taken place a shareholders' meeting must be called. In this meeting the administrators of the surviving company must present the new capital makeup of the company. The minutes and the respective balance sheet must then be registered before the Mercantile Registry Office.
Once the previous steps have been completed and as a result the merger has taken place (after the three-month period has elapsed) the entities that disappear or that have been absorbed must notify the merger into the surviving entity to the national and municipal tax administrations, as well as the institutes and governmental entities to which payroll contributions are made, namely, the Venezuelan Institute of Social Security (IVSS), National Training Institute (INCE), and Ministry of Labor. If the absorbed companies are proprietors of trade marks or patents, it will also be necessary to notify the change in the title of such rights to the Autonomous Intellectual Property Service (SAPI). Notice must also be given to the Superintendence of Foreign Investment (SIEX), if the transaction involves the participation of foreign investors.
Within three months of the merger, the absorbed companies must file an income tax return reporting net income or net losses as well as a business asset tax (alternative minimum tax) return for the corresponding fiscal period.
The surviving company must then continue to follow its regular tax period, unless its bylaws are amended in this respect.
The merger will not need to be approved by any Venezuelan governmental authority, unless the parties to the transaction are publicly-traded companies or are regulated by a special law that makes this requirement.
Income tax
Because the surviving company is the legal successor of the dissolved entities in merger processes, the surviving company assumes all tax rights and responsibilities, both assets and liabilities, from the absorbed companies. All tax credits resulting from pre-tax (withholdings), new investment tax credits, as well as non-expired tax loss carryforwards will also be passed on. The surviving company will also be responsible for all tax liabilities, whether already assessed or not, that are still open to the review of the tax administration and that derive from the absorbed company or companies activities (article 16, fifth paragraph, Venezuelan Income Tax Law, National Gazzette no°5.566 Extraordinary, December 28 2001).
It is relevant to point out that tax losses from the absorbed entity or entities can only be carried forward by the surviving entity after the three month waiting period for the merger has been satisfied, as mentioned above. Before this period, the merger is not considered effective. It becomes effective after the three month period has elapsed.
Value-added tax
As far as indirect taxes are concerned, the Venezuelan value-added tax (VAT) law considers the onerous transfer of movable assets as a tax event. Notwithstanding the fact that the merger may involve a transfer of movable assets, a transfer is considered onerous when all the following elements are present:
a transferor;
a transferee; and
consideration.
The absorbed entity does not receive a consideration in exchange for the merger transaction; rather, the absorbed entity is dissolved and disappears. Furthermore, the partners of the absorbed entity as a result of the merger will have a participating percentage in the surviving company. Therefore, this transfer does not qualify as "onerous transfer", and consequently it is not subject to VAT. However, there is the risk that the Venezuelan tax administration may deem the merger as an "onerous transfer" and consider the merger as a taxable event for VAT purposes.
Municipal tax
In regards to municipal taxes, which are levied on taxpayers' gross receipts derived from the performance of commercial or industrial activities from or within a given municipality, based on the same argument explained above, that is, that the merger does not qualify as an onerous transfer, mergers do not constitute a taxable event for municipal taxes, or for the absorbed entity, which disappears, or for the absorbing entity, which does not pay a price in consideration for the equity that it receives.
Labour law implications
The absorbing entity would become jointly and severally liable for employees' claims. In most cases, a merger process would result in an employer substitution (sustitución de patrono), which according to the Venezuelan Organic Labor Law, occurs when there is a transfer of ownership, title or operations of a company from one legal entity to another, irrespective of the cause, with the purpose of continuing the company's business activities. The former employer will be held jointly and severally liable with the new employer for any obligations derived from the law and employment contracts that arose before the substitution for the term of the statute of limitations, which is of one year. After one year, only the new employer can be held liable unless prior labour suits exist.
ACQUISITION OF GOING-CONCERNS
A going-concern is an enterprise which is carried on as a whole and that joins not only material assets because of their nature, but also intangible assets, known in business as goodwill. The Venezuelan Commercial Code regulates the sale of going-concerns. It is worth looking here at the legal requirements that need to be completed in order for the transfer of a going-concern to take place.
The company that intends to sell a going-concern should call a meeting of shareholders or its board of directors (or of any other governing body as stipulated in the company bylaws) to resolve to sell the going-concern. Before the final transfer of the going-concern (even if the sale document has not been issued or registered with the pertinent Mercantile Registry Office), the transferor needs to comply with the publication requirements established in the Commercial Code. These are as follows.
The intended sale should be published in a newspaper of the area where the going-concern operates as well as a widely-circulated newspaper within Venezuelan territory. It needs to be published three times at 10 calendar day intervals.
Generally, the transferor publishes the intended sale in order to notify its civil and mercantile creditors of its intention, in such a way that the creditors may demand payment or the related guarantee of all credits before the transfer of the going-concern. In any event, the acquirer may assume the expense.
The above-mentioned publications are required by law and may not be replaced by any other means of notice. The content of the notice generally specifies: the publication number, a brief description of the going concern to be sold and identification of both transferor and acquirer.
Income tax
Once the sale of the going-concern takes place, the acquired entity must file a final income tax return until the close of its fiscal year, which is marked with the date that it ceases its business activities. The tax return must be filed within the three months following the closing of operations.
The acquired entity would pay income tax on income received until the date of the sale of the going-concern.
The sale of going-concerns is subject to income tax withholding at a rate of 5% on the sale price. This income tax withholding can be offset against final income tax due in the seller's final tax return. Income tax so withheld would represent a financial cost for approximately three months, which is the period between the date on which the relevant income tax was withheld and the date on which the final income tax return is filed. Notwithstanding the above, it is relevant to mention that income tax withholding only applies if payment is made in cash.
Value-added tax
The sale of a going-concern is subject to VAT, only in respect to the moveable assets involved in the operation, at a 16% rate. This rate could be set from a minimum of 8% and a maximum of 16.5%. The Budget Law would set the applicable rate annually (article 27 of the Value Added Tax Law dated August 30 2002). It is important to note that if the going-concern is sold for a global amount, then it would be necessary to compute the value of the assets according to their market value.
Municipal tax
The purchaser must register in the municipalities where the acquired entity used to perform its activities, provided it continues in the same course of business of the acquired entity.
The acquired entity must file its municipal tax return for the months up until it ceases its business operations and must notify the municipalities where it used to do business that it is ceasing its activities.
Stamp tax
The sale of the going concern is subject to stamp tax of 5 tax units. The value of each tax is adjusted annually according to the consumer price index of the city of Caracas. Each tax unit is equivalent to VEB14,800 ($11.30). Plus 0.02 tax units per each tax unit or fraction of tax unit of the agreed price of the operation (article 6.8 , Stamp Tax Law, National Gazzette no 5.416 dated December 22 1999).
ACQUIRING SHARES
Another procedure that may be used by investors to start or restructure operations in Venezuela is through the purchase of shares of a Venezuelan entity. A description of the tax and legal implications that would derive in the event this alternative is implemented, is provided below.
Sale procedure
The sale of the shares must be recorded in the shareholders' book of the company whose shares are being sold. The seller, the purchaser and representative of the entity must sign the entry in the shareholders' book. The entry will represent proof of ownership of the shares.
The sale of the shares must be notified to the Superintendency of Foreign Investment (SIEX) if the entities involved are foreign investors, in order to notify or update the information of ownership of the shares of the Venezuelan entity whose shares are been transferred, as well as to request or update the Venezuelan entity's qualification as a national, foreign or mixed entity, according to the foreign investment participation in entity. The notification to SIEX must be made within 60 days of the sale of the shares.
Income tax
Capital gains, if any, derived from the sale of stock, in principle would be subject to tax in Venezuela on the grounds of being considered Venezuelan source income. The rate at which the income will be taxed will range between 15% and 34%, if the seller is a legal entity, and between 6% and 34% if the seller is an individual.
According to Venezuelan Income Tax Withholding Regulations the sale of shares of a Venezuelan company is subject to income tax withholding at a rate of 5% calculated on the transaction price, if payment is made in cash. The tax withheld may be used to offset the final income tax liability of the seller, because the income tax withholding constitutes an advance payment of the final income tax.
If the seller of the shares is a qualified tax resident of a treaty country, the tax treatment could vary. Most conventions for the avoidance of double taxation signed by Venezuela grant the country of residence of the seller the power to tax capital gains derived from the sale of movable goods, as is the case with shares. If this were the case, the capital gain would not be taxed in Venezuela. Under specific tax treaties, if the assets of the relevant company are mainly composed of immovable property located in Venezuela, the sale of the shares will also be taxed in Venezuela.
Value-added tax and municipal tax
The sale of intangible goods, such as shares, is expressly excluded from the taxable events for VAT purposes (article 16 number 2 of the Venezuelan Value Added Tax Law, National Gazzette N° 5.061 Extraordinary, August 30 2002).
As mentioned above, municipal tax is imposed on gross receipts derived from commercial and industrial activities performed by taxpayers. Therefore, the sale of shares will not constitute a taxable event for municipal tax, unless this transaction constitutes the seller's main business activity.
Treaty network
A key aspect to be taken into account when considering establishing in Venezuela, by way of creating a new entity, merging, purchasing a going concern or assets of a Venezuelan entity is the Venezuelan tax treaty network which is comprised of 17 conventions for the avoidance of double taxation. Venezuela has executed double taxation treaties with the member countries of the Andean Community of Nations (Colombia, Perú, Bolivia and Ecuador), Italy, France, the United Kingdom, Germany, Norway, Belgium, Switzerland, Sweden, Portugal, the Czech Republic, Trinidad & Tobago, Barbados, Indonesia, the Netherlands, the United States of America, and Denmark. Treaties with Canada, China and Mexico, have been subscribed and are pending final governmental approval and exchange of diplomatic notes in order to enter into force. Treaties with Spain and Austria have been initialed. Most of them following the OECD model. This fact may help to maximize the tax efficiency of the structure implemented.
Economic substance
Having said all of the above, it is fundamentally important to base any transactions on the substantial foundations on which the Venezuelan tax system is built (article 16 of the Venezuelan Tax Code, National Gazzette N°37305 dated October 17 2001), otherwise the Venezuelan Tax Administration may disregard the incorporation of companies, the execution of contracts and in general the execution of legal forms or procedures, when the fundamental intention has been to evade, elude or reduce the effect of the application of the tax.
Therefore, it is recommended that the involved entities are able to support the economic and business reasons for restructuring their operations in Venezuela. It is a good idea to have all the process supported and documented (economic study and estimated gains/losses, shareholder's meeting minutes of entities involved, expressly mentioning the business reasons to merge, and so on).
Excess tax credits
The Income Tax Withholding Regulations usually establish the applicable income tax withholding rate on gross payment, namely the total transaction amount (that is, sales price in the case of transfer of going-concerns and sale of shares of Venezuelan entities when not traded on the stock exchange). This situation may result at the end of the fiscal period in an excess income tax withheld on the taxable income, which could derive from the fact that the transaction resulted in a tax loss, or neither capital gain nor loss, for example.
If this was the case, and based on the Venezuelan Tax Code, it is possible for the relevant taxpayer to sell the excess credits - usually at a discount - to third parties (article 49 through 51 of the Venezuelan Tax Code, National Gazzette N°37305 dated October 17 2001), whether related or not, that are in a tax-paying position. These tax credits may only be used to pay income tax. The sale of tax credits must be notified to the Venezuelan tax administration, within the legal terms established in the Tax Code.
Deducting losses from share transfers, liquidation or capital reduction
The Venezuelan Income Tax Law expressly regulates the situation in which the losses resulting from the transfer of shares, liquidation or capital stock reduction of stock companies and taxpayers assimilated to stock companies are allowed (article 33, Venezuelan Income Tax Law, National Gazette N° 5566 Extraordinary dated December 28 2001). The use of the losses is only permitted under the following circumstances:
the acquisition cost of the shares or participation quotas has not been higher than the quotation price on the stock exchange or than an amount that is reasonable when compared to the book value, if no quotation price exists;
the seller of the shares or stock quotas has owned the goods for at least two consecutive years from the date of the sale; and
the seller proves to the tax administration that the companies whose shares or participation quotas have been sold, performed an economic activity with a reasonable capacity during the last two tax years immediately before the year in which the sale that originated the loss was made.
The limitations on the deductibility of losses only apply to tax losses arising from the following transactions: transfer of shares, liquidation or capital reduction. This legal provision does not apply to mergers, since the Venezuelan Commercial Code deems these as dissolution of legal entities.
Deloitte & Touche (Romero-Muci & Asociados)
Avenida Blandin. Torre CorpBanca, Piso 18, La Castellana, Postal Code 1060, Venezuela
Tel: +58 212 206 87 30
Fax: +58 212 206 87 40
E-mail: hromero-muci@dttve.com
