Even though startups structure themselves as a C Corp, Cayman or UK company, if they have local subsidiaries, they will likely have to pay an indirect tax on the sale when the holding company is acquired.
These indirect taxes can be a surprise for many non-Latin American investors, and if handled correctly, generally don’t increase tax liability, but distribute the payments it across multiple jurisdictions. If done incorrectly, they can cause issues for founders and investors alike.
Indirect Sales Tax
As of 2020, both Colombia and Chile have implemented indirect sales tax to stop companies from selling their offshore holding company for a big profit and not paying any local taxes where the company had operations. In the past, businesses would put an offshore holding company on top of their Latin American entity, and when it was time to sell, only sell the off shore entity, allowing them to not pay any taxes on the transaction.
Some Latin American countries didn’t think this was fair, and implemented indirect taxes. Other Latin American countries may have or add similar taxes in the future. Here’s a very simplified version of how it works:
A startup has a holding company in US, Cayman, UK or really anywhere. It has subsidiaries with operations in Chile, Colombia and Mexico. The buyer of the holding company is required to report the transaction to the local tax authorities in Chile, provided certain requirements are met, and Colombia and allocate a percentage of the purchase price to each country. For example, 10% of the purchase price would be allocated to Chile, 25% Colombia, 65% Mexico, and sellers would owe local taxes on their gains.
|Corporate Tax Rate||21%||0%|
|Corporate Tax Paid||$21||$0|
|Chile Profits Allocation 10%||$10||$10.0|
|Chile Tax Rate||35%||35%|
|Colombia Profits Allocation 25%||$19.8||$25.0|
|Colombia Long Term Tax Rate |
(30% if short term)
|Colombia Long Term Tax||$2.0||$2.5|
|Indirect Sales Tax Paid||$5.5||$6.5|
|Entrepreneur + Investor Tax Rate||21%||21%|
|Total Net Proceeds||$58||$74|
Colombian Capital Gains: 10% vs. 30% and why SAFEs and Convertible Notes can bring surprises
Like the US, Colombia calculates its long term vs. short term capital gains based on the date you first held the equity. It’s not when you have a SAFE or a convertible note. In Colombia, the holding period is 2 years, not 1 like in the US, to qualify for long term treatment. And the tax rates are 10% for 2+ years and 30% for under two years.
We generally try to have direct equity instead of SAFEs if we can as early as possible in companies that are operating in Colombia.
Company A raises a pre-seed from investors on a SAFE. They continue to raise SAFEs for 2 more years at progressively higher valuations. Finally, they do a priced round and convert the SAFEs to equity. The clock starts for long term capital gains, and becomes a total of 4 years, not 2. The company sells in 3.5 years. Investors pay 30% tax on the portion of the exit allocated to Colombia.
We are willing to do SAFEs at early stage in Latin America, but if we are investing in your LLC or Cayman when you are creating it from scratch, we will generally ask to price the round at the valuation cap we agreed to so we can start our long term capital gains clock.
To be clear, this is not legal or tax advice. You should always work with a lawyer and accountant when thinking about corporate structures. The money you’ll spend getting good advice will save hundreds of thousands or even hundreds of millions of dollars down the road. I can’t stress this enough. Don’t just follow these guidelines. Your situation is unique. Talk to an experienced lawyer and accountant.
If you want to read more about Latin America startup legal structures, check out the original post.