The proposed US tax reform may incentivize multinational companies that have made investments in Latin America to pursue repatriation alternatives such as dividend distributions and capital reduction.
However, the attractiveness of these alternatives is also subject to the local regulations and corporate steps required for distributing dividends or reducing capital.
This article reviews those regulations in Argentina, Chile, Colombia, Mexico and Peru and looks at steps for multinationals to consider.
In Argentina, a company may distribute dividends abroad as long as the company has retained earnings (or earnings of the same exercise for provisional dividends) that have been duly approved and reserved for dividend distribution during its annual shareholders annual general meeting (AGM). The date of effective payment is flexible and there is no ordering rule (whereby older-year profits would need to be distributed first). Further, while such dividends are generally paid in cash, they can also be paid in specie, subject to a unanimous (except otherwise stated in the bylaws) approval of the shareholders.
Argentina currently does not impose a withholding tax on dividend distributed abroad. If dividends are paid out of profits that were not subject to taxation at a corporate level, a so called equalization tax applies to the tune of 35 percent in respect of such dividend distribution to be paid at the time of payment (rather than the time of declaration).
Capital reductions must be scheduled and approved at any shareholder's annual or extraordinary meeting with sufficient quorum pursuant to the bylaws of the given company. Once approved, the process further requires the filing before the Public Registry of (i) the publications in the official gazette; (ii) a special balance sheet; (iii) a report of the auditor; (iv) certificate of no inhibitions; and (v) a description of the reduction procedure. Once the above-mentioned requirements are met, the payment can be made at any point in time in cash or in kind.
There is no particular payment order under Argentine tax or corporate rules (ie, retained earnings must be paid out before other equity account such as capital balances). Capital account reduction can be paid in cash and/or in kind. Foreign shareholders could incur in taxable income or a capital gain if the value of the received cash or property exceeds the tax basis of the investment. Tax would be due only in respect of the amounts that exceed the tax basis of the investment. The tax rate is 35 percent.
A company may distribute dividends abroad as long as the company has retained earnings (or earnings of the same exercise for provisional dividends) and has the approval of its shareholders during the annual general meeting. It is also possible for the board of directors to agree on provisional dividend distribution, subject to shareholder ratification. Shareholders can also be flexible in the payment date or amount, although the payment follows an ordering rule, whereby older year profits are distributed first. Further, while the dividend is generally paid in cash, they can also be paid in specie, subject to a unanimous approval of the shareholders. Chile imposes a withholding tax of 35 percent on dividend distributed abroad, to be paid at the time of payment (rather than the time of declaration), notwithstanding a tax treaty provision in force.
The process for capital reduction may be more cumbersome. The board's decision to reduce capital is subject to agreement by shareholders in a special meeting (if a sociedad anonima) or unanimous agreement by partners in a public deed modifying the company's bylaws (if a limitada). In addition to the shareholder or partner approval, the decision is also subject to the approval of Servicio de Impuestos Internos (the Chilean tax authority). Once the tax authority approves, the shareholders or partners can agree on the capital reduction period.
The tax on capital reduction depends on the retained earnings. If the company has no retained earnings, the capital reduction is not taxable; if the company has retained earnings, the capital reduction is taxable at a withholding tax of 35 percent. Therefore, for tax purposes, if the company has retained earnings, it may want to distribute the retained earnings before reducing capital. Further, if the capital reduction is paid in species, the shareholders or partners must consider the commercial value of the payment, as the company will be taxed for the increase in equity from the book value to the price allocated for the payment.
In Colombia, a company may distribute dividends abroad as long as it has retained earnings beyond those that are required to be reserved or used to compensate losses from previous years, and has the approval of its shareholders during the annual general meeting. Both the shareholders and a certified independent CPA must approve and audit, respectively, the financial statements. Once approved, the dividends are normally paid within one year, although shareholders may agree to a longer term (via the bylaws, shareholders assembly, or agreement of each individual shareholder). There is no ordering rule with respect to previously taxed earnings, although it is common practice to distribute the previously taxed earnings first.
The dividend can be paid either in cash and/or in specie, but the latter comes with additional restrictions and processes related to the specific assets being transferred (eg real estate requires a notary public deed and registry; productive assets may generally not be distributed; if assets is transferred to a non-resident it requires investment registry procedures with central bank; it will be treated as a sale for tax purposes and accordingly transfer shall be made at fair market value (FMV) with the relevant capital gain implications and VAT at 10 percent if it is movable property).
Colombia imposes a 5 percent withholding tax on dividend distribution to be paid at the time of effective payment, only if the distribution is made out of accounting profits accrued after December 31 of the fiscal year. Distribution of profits that have not been taxed at corporate level is treated as ordinary taxable income for non-resident recipient and is subject to a 35 percent income withholding tax. The withholding tax effects above are subject to review under the applicable tax treaties for the non-resident party that in most cases allow for with reduced withholding tax rates.
At the time of payment, the distributing company must also report foreign exchange transactions related to foreign investment to the Central Bank as part of the wire transfer process. The reporting is normally done through forms provided by the relevant commercial bank undertaking the transaction.
Capital reductions may be addressed at any shareholder's assembly with sufficient quorum and in some cases require an authorization from the Superintendence of Corporations. Once the capital account reduction is approved, the payment can be made at any point in time of the year and no particular ordering rule applies.
Capital account reduction can be paid in cash and/or in kind, however, the same restrictions and processes related to the transfer of specific assets under dividend distribution above apply (ie restriction on distribution of productive assets; transfer is treated as a sale for tax purposes with the applicable capital gain and VAT implications).
US shareholders could incur taxable income or a capital gain if the value of the received cash or property exceeds the tax basis of the investment. The tax rate on capital reduction depends on the asset. Tax would be due only in respect of the amounts that exceed the tax basis of the investment. The tax rates are 10 percent if the investment qualifies as a fixed asset, and has been held two years or more, and 35 percent for other cases.
In addition to tax payments, the foreign exchange registry would have to be updated through a communication sent to the Central Bank incorporating the new amount of shares and investment. The remittance of cash resulting from a capital reduction must be informed to the Central Bank with forms filed with the commercial bank used for the wire transfer. If the reduction is in kind, the company may also need to register the Colombian new investment of the foreign recipient.
For Mexican legal purposes, a Mexican company may only pay out dividends to the extent that it has retained earnings for statutory purposes, as reflected in financial statements approved by the shareholders of the distributing company.
A Mexican company must maintain a previously taxed earnings account (ie, Cuenta de Utilidad Fiscal Neta, CUFIN account) that represents the Mexican company's net taxable income less income taxes, profit sharing contributions and other nondeductible items. The CUFIN account represents previously taxed undistributed earnings of the company. If a dividend distribution is made in excess of the CUFIN balance, then a tax is imposed on the distributing company on the excess amount grossed up by a factor of 42.86 percent. The tax paid from the distribution in excess of CUFIN can be credited against the annual income tax liability in the year of payment or the following two years. Again, the tax is imposed at the Mexican distributing company level.
Under the Mexican Income Tax Law (MITL) in force until 2013, dividends received by an individual or a foreign shareholder from a Mexican company were not subject to withholding tax. However, the 2014 Tax Reform introduced a new withholding tax of 10 percent on dividends when they are distributed to a foreign shareholder or an individual. The new rules also broaden the definition of what should be considered as a dividend, covering other transactions between the distributing company and its shareholders and/or related parties. Further, transitory provisions to the MITL state that dividends coming out of the CUFIN account generated as of December 31, 2013 would not be subject to the 10 percent withholding tax provided by the Tax Reform; for this purpose, companies are required to maintain separate CUFIN accounts for earnings before and after December 31s, 2013. The MITL does not provide ordering rules with respect to how CUFIN balances are considered with respect to dividend distributions; however, it is assumed that older balances should be distributed first.
When dividend distributions are being made to a US shareholder, the provisions of the US-Mexico Income Tax Treaty may allow for a reduced withholding tax rate lower than the one provided under the MITL. To the extent that the US shareholder is able to demonstrate its US tax residency, a reduced 5 percent withholding tax rate would be available on dividends to be distributed by the Mexican company, coming out of the post-2014 CUFIN balance, rather than the 10 percent rate under the MITL.
However, there are further provisions that must meet with the Limitation on Benefits Provisions under the Treaty, and that may allow for a 0 percent withholding tax rate, to the extent that the requirements provided under the Treaty are met.
Furthermore, in cases when the benefits of the Treaty are available, the US shareholders must have a certificate of US tax residency on their files (ie, Form 6166); and the US shareholder must comply with Article 4 of the MITL, which sets out the requirements to apply treaty benefits: "Taxpayers that document their residence in the applicable country and comply with the provisions of the treaty and the additional requirements provided by this law, including filing the informational return of their tax situation in terms of article 32-H of the Mexican Federal Tax Code or file a tax audit report, and to appoint a legal representative."
For Mexican tax purposes, capital reductions are generally treated as a distribution in exchange for shares; therefore, the same provisions would be applicable. The general purpose of these rules is to treat distributions made in a capital redemption as either a tax free return of capital or a deemed dividend or distribution of earnings. In this regard, there are certain tests to be followed in order to determine whether a reduction of capital is considered an earnings distribution, which would then be subject to tax if sufficient CUFIN is not available.
The first test provides that a Mexican company which makes a payment to a shareholder through a reduction of capital stock or equity will be treated as having distributed earnings if, and to the extent that, the amount of the payment made per share exceeds the contributed capital account (ie, Cuenta de Capital de Aportacion, CUCA account), on a per-share basis.
Based on the above, if the amount paid in redemption is equal to or less than the amount of the CUCA account attributable to the redeemed shares or equity quotas, then no dividend will result. In effect, the redemption payment in this instance is treated for Mexican tax purposes as a tax-free return of capital. If, however, the amount paid in the redemption is greater than the adjusted capital of the redeemed shares, then the excess over the adjusted capital of the redeemed shares will be treated as a deemed dividend distribution. In this case, the redemption payment would give rise to Mexican tax at a redeeming company level if the deemed dividend amount exceeds the CUFIN balance related to the shares or equity quotas to be redeemed.
A company may distribute dividends with the approval of the shareholders during any meeting of shareholders during the year. However, dividends may be distributed up to the amount of the retained earnings or the unrestricted reserves, as indicated in the financial statements. The annual financial statements need not be audited by a certified independent CPA, but must be approved by both the board of directors (if such a corporate body exists in the company) and the shareholders during the shareholders meeting. Additionally, there is a possibility to pay interim dividends if some requirements are met, including the favorable opinion of the board of directors or the general management (if the company does not have a board of directors as a corporate body). Once the dividends are declared, the dividends may be paid at any point in time during the year. The payment can be made in the form of cash or in kind, but if they are made in kind, there must be a valuation report supporting the dividend distribution.
The withholding tax payment obligation arises at the time of the shareholders' agreement or at the time of the payment, whichever occurs first. The dividends to be distributed to a US shareholder company will be subject to a 5 percent withholding tax as of 2017. The dividends corresponding to the retained earnings of 2015 and 2016 are subject to a withholding tax of 6.8 percent, while those obtained before 2015 are taxed at a rate of 4.1 percent. The rates are unaffected by existing tax treaties, because none of the existing treaties include provisions on reduced withholding tax rates. In addition to the withholding tax, there may be a tax on financial transactions (ITF) of 0.005 percent on the amount transferred if the funds are transferred from and/or to local bank accounts.
Capital reduction requires shareholder approval through a shareholder meeting. Unlike in the case of dividend distribution, there is no need for the approval of financial statements supporting the capital or equity reduction. However, the shareholder agreement must be published in the Official Gazette (El Peruano) and/or in some other newspaper (depending on the jurisdiction where the company exists) three times, five days apart as a notice to the creditors. If no creditor of the company opposes to such reduction, then 30 days after the publication of the last notice, a public deed must be granted and finally such agreement must be registered before the corresponding Public Registry. Also note that companies that have signed investment agreements in order to be entitled to certain tax benefits (eg, tax stability regimes, anticipated payback of the VAT), particularly common in companies in the mining or oil and gas sectors, would not be able to reduce equity.
Once the capital reduction is approved, the reduction can be made in any point in time and either in the form of cash or in kind. However, for up to 50 percent of the distributable earnings of each year (after deducting the import that corresponds to the legal reserve), the distribution of dividends in cash is mandatory, when such distribution is required by shareholders that represent at least 20 percent of the capital stock. Such requirement may only refer to the earnings obtained in the immediate previous financial year. Further, if the distribution is made in kind, there must be a valuation report supporting the dividend distribution.
Capital reduction to be paid to the US shareholder company may be subject to local taxation, depending on the modality of the capital account reduction. The equity reduction up to the limit of the retained earnings, revaluation surplus, restatement adjustments and/or unrestricted reserves is considered to be a deemed dividend and subject to 5 percent income tax. However, any subsequent distribution of those items would not be taxed. Further, a tax on financial transactions (ITF) would be applicable in the event that funds are transferred from and/or to local bank accounts. The tax rate is equal to 0.005 percent and its tax base would be the amount transferred. The payment of taxes is required at the time of approval or the payment, whichever occurs first.
In addition to the regulations and processes, thin capitalization rules may apply if the ratio between the debt and equity exceeds 3:1.
For further details or information on other Latin American or Caribbean jurisdictions, please feel free to contact John Guarin, Latin American Tax Desk, Project Manager.
Special thanks to Rodrigo Alvarez (BAZ | DLA Piper, Santiago), Felipe Ospina (DLA Piper Martinez Beltran, Bogotá), Francisco Botto (DLA Piper Pizarro Botto Escobar, Lima) and Alex Jorge independent law firm Campos Mello Advogados, São Paulo).
1 Note: The reduced withholding tax rates from a tax treaty is only applicable to interest, capital gains, income from real estate, ships and aircraft, royalties, independent personal services, income from employment, director’s fees, pensions, etc.
2 Countries with existing tax treaties include Canada, Chile, Czech Republic, India, Korea, Mexico, Portugal, Spain and Switzerland. France and the United Kingdom have also signed a tax treaty with Colombia, but the treaties have yet to undergo internal approval procedures.
3 A minimum of 10 percent of the distributable earnings of each financial period, after the corresponding deduction of income tax, must be destined to cover the legal reserve (reserva legal) until such reserve is equal to 1/5 of the capital stock of the company. The losses generated in one fiscal year must be compensated with the corresponding retained earnings or unrestricted reserves, or in lack of such, with the legal reserve. Dividends may be paid by virtue of obtained earnings or unrestricted reserves only if the net equity is not inferior to the paid capital stock.
4 In the case of financial institutions, the anticipated distribution of dividends does not work according to local banking law.
5 For the payback of the equity accounts, an agreement adopted by the shareholders' meeting would be enough.