October 10, 2002 | By Keith Martin in Washington, DC

Peru threatened to renegotiate tax stability contracts with foreign investors, but then backed away.

A tax stability contract is a promise by the government not to change the tax rules that apply to an investment. Such contracts are often signed to induce foreigners to make long-term investments in the local economy.

The finance minister made the threat in early August after the government lost arbitrations with two electric generating companies over whether each can claim full tax depreciation on assets acquired in a merger with another company that already depreciated them. The arbitrator said the double depreciation benefit was available by law when the government privatized the companies, and tax stability contracts signed with the foreign owners bar the government from changing the rules. A third electricity generator owned by Duke Energy paid an undisclosed amount in December to settle its dispute.

However in September, the finance minister declared that the contracts are “sacred” and will not be amended unilaterally by the government, reports Rafael Rossello, a tax lawyer with the firm Hernandez Rossello in Lima.

The head of the tax agency, Sunat, had said contracts with 570 companies were under review. Peru reopened such contracts with foreign oil companies once before in the 1970’s. The government is facing a budget shortfall after it had to cancel plans this summer to privatize state electricity assets in southeastern Peru in the face of violent public protests.