Foreign Relations of the United States, 1958–1960, Volume V, Microfiche Supplement, American Republics

VE–19. Instruction from the Secretary of State to Certain Diplomatic Missions¹

CA–6027.

Washington, January 19, 1959

SUBJECT

• Recent Change in Venezuelan Income Tax Law

On December 19, 1958, effective December 20, 1958, and retroactive to 1958 income, the Government Junta of Venezuela decreed an amendment to the Venezuelan income tax law providing for increased surtax rates. The decree has the effect of breaking the 50–50 principle which had its origin in Venezuela as pertains to the petroleum and mining industries.

1. Venezuelan Concession System

The Venezuelan concession system, during its entire history, including under the 1943 Petroleum Law, has fixed and defined the terms and conditions of the respective concessions in the Petroleum Laws themselves. Until enactment of the 1943 Petroleum Law, such terms and conditions referred not only to technical and operating matters but, moreover, froze the tax regime for the full life of the concessions in that the concessionaire was guaranteed against taxes directly burdening his enterprise or in amounts larger than those in existence at the time of concession issuance. The foregoing rights were considered to be acquired and inherent in the concession.

During the discussion of the 1943 Petroleum Law, the principle of equal sharing of profits between the Venezuelan Government and the petroleum concessionaire was developed. Although the petroleum industry full well realized that by converting petroleum concessions issued under prior laws to the Petroleum Law of 1943, it was exposing itself to the legal possibility of unlimited income taxes, industry had, from the outset, the moral assurance from the government that the purpose of the new arrangement was only to share equally with the concessionaire the profits arising from his Venezuelan operations. While, as stated above, the Venezuelan Government has always had the power since 1943 to raise income taxes so as to impair the 50–50 principle, it never did so. On the contrary, until December 19, 1958, the Government repeatedly reaffirmed the 50–50 principle. Relying on such assurances, the petroleum industry has invested in Venezuela vast sums of money.

Therefore, under the “equal sharing principle”, government and industry have shared profits from the industry on the basis that royalties plus income and other incidental taxes would give the Venezuelan Government 50 percent of the concessionaire’s profits. In other words, if a petroleum concessionaire, after paying royalty and taxes, as aforesaid, had a profit which exceeded government “take”, the excess profit was to be divided on a 50–50 basis between government and the respective concessionaires.

2. Pre-December 1958 Tax System

In Venezuela the oil industry has been subject to three different taxes on income. The first two are general provisions applicable to all personal and corporate incomes, and the third is a special provision covering the extractive industries. Until the December 20, 1958, tax decree, the oil companies tax bills were made up in the following manner.

(a) The Basic or Normal Tax

This is a 2½ percent assessment on net income derived from normal industry operations such as production, transportation or refining. Net taxable income is calculated by deducting from gross income the usual charges of doing business, similar to those in the U.S. Depreciation and depletion are allowed, but depletion is limited to a return of cost rather than as a percentage of total production income as in the U.S. Losses are deductible much on the same basis as in the U.S. and a carry-forward of losses for the purpose of this tax is permitted for two years.

(b) The Supplementary Tax (Surtax)

This was levied at progressive rates commencing with 1.5 percent on net taxable income up to Bolivars 10,000 ($3,236) reaching a maximum of 26.0 percent on amounts in excess of Bs. 28,000,000 ($9.06 million). In some cases a reduction in the supplementary tax rate was granted for new investment in increased production facilities.

(c) The Additional Tax (50–50 Provision)

Under this provision of law, a levy of 50 percent was assessed on the amount by which a company’s net income after deduction of taxes (royalties - a minimum 16-2/3 percent under the Petroleum Law - are included as taxes paid) exceeds total taxes paid. This classical example of the 50–50 principle applied only to companies whose net income for the tax year was 15 percent or more of the capital invested in the production of that income. For companies whose net income was more than 10 percent but less than 15 percent of capital invested, the additional tax applied to only ½ of the excess income over the aggregate of the taxes. Companies whose net income after the normal and surtax did not exceed 10 percent of the capital invested were exempt from the additional tax.

In practice the 50–50 principle has resulted in a somewhat greater share of revenues for the government than profits for the companies. It has been characteristic of the Venezuelan petroleum industry that a high volume of operations has been required before a profit could be realized. Therefore, until a level of production and profits has been reached allowing the 50–50 profit sharing tax to become effective, the division has resulted in favor of the government by reason of a relatively high royalty and heavy exploration and development costs. An unofficial, although reliable comparison of the direct income of the Venezuelan Government from petroleum companies (other than from bonuses for new concessions) with the net profits of those companies over a period of ten years (through 1957) shows a ratio of 53–47 favorable to the government.

3. Decree Law of December 20, 1958

The decree law of December 20, 1958, increases the supplementary tax (No. 2 (b) above) to provide for a minimum of 2 percent on taxable income up to Bs. 10,000 and a maximum of 45 percent on net taxable income in excess of Bs. 28,000,000. As under the prior law, certain reductions may be granted for new investment in increased production facilities. Neither the “basic tax” (No. 2 (a) above) nor the “additional tax” (No. 2 (c) above) is altered. Although the additional tax remains unchanged in the new law, it is rendered ineffective so far as the oil companies are concerned since the operation of the new surtax schedule in combination with the basic tax and royalty payments will, in all cases that can be envisioned, result in total revenue to the Government of considerably more than 50 percent.

In view of public statements made by the Venezuelan government that the level of the Venezuelan income tax is still favorable when compared to other countries such as the U.S.A. where the corporate rate is 52 percent, it must be pointed out that this is not accurate in the case of a U.S. corporation producing oil in the United States. With the application of the 27.5 percent depletion allowance, the level of U.S. income taxation is substantially below that of the Venezuelan law, i.e., about 38 percent in the United States versus 47.5 percent in Venezuela.

While much study is needed to make a precise calculation as to the effect of the December 20 decree, preliminary estimates indicate that most oil companies will find their payments to government for 1958, and succeeding years, increased from a 50 percent to a 60 percent basis.

The action of the Government Junta was not preceded by public discussion of the measure and it came as a complete surprise. In February 1958, Admiral Larrazábal, then President of the Government Junta, had given explicit assurances to the oil industry that the provisional government intended to maintain, without modification, the then prevailing laws affecting the petroleum Industry. On various occasions since the provisional government gave the foregoing assurances, government spokesmen, both publicly and privately, have acknowledged the moral undertaking of the Venezuelan Government to respect the 50–50 principle and reaffirmed the intention, in any event, to leave fundamental decisions for the elected government which was to take office early in 1959.

4. Action Taken to Date

The U.S. has expressed no opinion on the substantive provisions of the tax law amendment. However, our Embassy in Caracas, on first learning of the measure, expressed to the Venezuelan Ministry of Foreign Affairs surprise that action on an issue as sensitive as this, which not only directly affected U.S. investments in Venezuela, but which could have an adverse effect on U.S. interests in other parts of the world had been taken without consultation. Further, the Embassy pointed out that failure to consult was inconsistent with Venezuela’s insistence on consultation before U.S. action on matters affecting Venezuela’s interests. Similar representations were made to the Venezuelan Ambassador by the Department. The Venezuelan Government has taken the position that the decree was a general tax reform affecting all Venezuelan tax-payers, including oil companies, and, therefore, within its sovereign power. In reply, we have said that we do not question Venezuela’s sovereign right to take the action, but are seriously concerned over the failure to consult in advance and the manner in which the decree was promulgated.

On January 5, Assistant Secretary Mann met with representatives of U.S. oil companies having operations in Venezuela in order to exchange views on the effect of the recent tax decree on the Venezuelan oil industry and on world trade. The consensus of the meeting was that, although the tax amendment would obviously result in immediate and short term fiscal benefits for Venezuela, the long term effect would be adverse in view of the harmful effect it would have on Venezuela’s competitive position in the world oil market, and the lessened attractiveness of Venezuela in the future to investors. It was considered unlikely that the elected government, which is to take office early in 1959, would find it politically possible to undo the decree itself, even if the new government were so inclined. It was agreed that the main objective of the companies, and of the Department, should be to reduce the possibility of further harmful action by the new government, and to modify or to ameliorate the effect of the decree itself. It was recognized that Venezuela’s government would be sensitive to any action which could be interpreted as retaliation by the companies against the tax decree. It was agreed that the companies should attempt to inform influential Venezuelans of the probable economic consequences of the tax decree and should avoid public statements that might further exacerbate the issue. It was agreed that the Department would undertake to induce the Venezuelan Government to educate the Venezuelan public on the economic issues involved so as to remove the matter as far as possible from a political and emotional plane. The Department suggested that each company evaluate the effect of the decree on its own operation and on Venezuela’s competitive position in the world oil market both in the short term and as far in the future years as can be projected. Although industry is still assessing the financial impact of the new tax regime, there is little doubt of the detrimental effects of this action on investment climate, on Venezuelan oil in world markets, on Industry operations in Venezuela, and, in general, the impairment of confidence which, up to now, has caused foreign capital to invest vast sums of money in Venezuela.

In summary, although the petroleum industry realized from the beginning that by converting their concessions to the Petroleum Law of 1943 the legal possibility existed that unlimited income taxes could be imposed, industry had the assurance from the outset that the Venezuelan Government’s intent was to share equally with the concessionaires the profits arising from their operations.

While the Venezuelan Government has had the legal right since 1943 to rupture the 50–50 principle, it never did so. On the contrary, until December 19, 1958, the 50–50 principle was repeatedly reaffirmed by the government. The sovereign right of the Venezuelan Government to do this is not challenged; however, the wisdom of handling the matter as it did is questioned, particularly due to the adverse effect on investment climate and the ultimate detriment to the economic well-being of the country.

Neither the Department nor American petroleum companies regard the situation created by the Venezuelan tax decree as having that finality which would preclude discussion between Venezuela and industry of the issues involving mutual interests. Protests have been registered with the Venezuelan Government stressing the lack of prior notice and opportunity to be heard both on the part of the U.S. Government and the oil industry. It is hoped that as a result, the Venezuelan Government will grant the opportunity for friendly consultation aimed at reducing the adverse impact of the decree.

When considering the possible Impact of Venezuela’s action on Middle Eastern arrangements, it is the Department’s firm view that the concession relationships in the Middle Eastern countries are contracts which may be modified only by mutual agreement of the interested parties. The United States attaches utmost importance in international relations to the maintenance of confidence that contractual obligations will be honored, and would be deeply concerned if contracts with its citizens should be breached. This is in contrast to the situation in Venezuela where the concessionaire was not legally assured of any limitation on the government’s power to tax, but relied on the moral assurance of the government’s stated intention to adhere to the 50–50 principle.

5. Recommended Action

The foregoing is forwarded to provide U.S. representatives with an accurate picture of the Venezuelan situation as it stands today and to enable U.S. Missions to answer questions which may be put to them on the subject by host governments. It may also be used, at the discretion of the Missions, as the basis for discussions with senior representatives of American oil companies. In the Department’s judgment, it would be unwise for U.S. representatives to initiate conversations with the respective governments. However, if approached, U.S. representatives should indicate that the U.S. disapproves of the failure of Venezuela to consult with interested parties prior to the promulgation of the decree law, and is deeply concerned over the probable economic consequences to Venezuela. The total effect of this law on Venezuela’s revenue and investments remain to be seen. If appropriate in the circumstances, representatives should emphasize the difference between the Middle East arrangements and those in Venezuela, stressing the requirement, in the case of the former, for prior consultation in any effort to change contractual relations, since commitments in the Middle East are subject to international contracts which may only be modified by mutual agreement between the interested parties.

In the event the government indicates intention to revise existing arrangements, the Department should be promptly notified.

The Department would appreciate receiving information on press comments and other views being expressed in Middle Eastern countries on Venezuela’s tax decree.

Dulles

1. Source: Department of State, Central Files, 831.112/1–1959. Secret. Drafted by M. Hollis Kannenberg of the Fuels Division, Bureau of Economic Affairs, and John Shaw of the Office of Near Eastern Affairs; approved by William M. Rountree, Assistant Secretary of State for Near Eastern and South Asian Affairs. This despatch was also sent to the Embassies in Baghdad, Beirut, Cairo, Damascus, Dhahran, Jidda, Kuwait, and Tehran.