Colombia: TP audits, APAs and increasing investor confidence

Colombia, like most countries in Latin America, is living in a time of instability. The country lost its decade-old investment grade status for issuing long-term sovereign debt because of the deterioration of public finances, a rising government debt level and the government’s capacity to credibly place debt on a downward path in the coming years. In addition, there is uncertainty regarding the approval of the health, pension and labour reforms proposed by the elected left-wing government, as well as the significant levels of inflation faced by the local economy, and the eminent social discontent this represents. Therefore, the national government inevitably faces pressure to balance its finances by intensifying its audit activities, particularly in connection with TP activity.

Colombia has had formal TP regulations in place since 2003, but over the last decade many multinational and national enterprises have experienced TP controversy, such as enquiries or audits by the National Tax and Customs Directorate (Dirección de Impuestos y Aduanas Nacionales, or DIAN).

In the past, most of the TP audits were led by the DIAN under a centrally driven approach. Typically, they focused on formal aspects (errors or omissions, filing date, etc.) and on specific inter-company transactions carried out with foreign related parties. These included services and purchases and/or sales of finished products under traditional distribution and manufacturing business models.

Nevertheless, over the last few years, a decentralised model has been applied, in which the Cali, Medellin and Barranquilla local TP bureaus have led different audits based on their knowledge in specific industry segments within their geographic inspection area. These audits have an emphasis on transactions carried out with related parties located in zonas francas (free trade zones) within Colombia due to their taxation rate.

Additionally, the tax authority is learning from the experience of other tax authorities in the region by adopting best practices and using them in its inspection activities. Finally, the DIAN has started an investing plan in the use of data analytics to identify risk cases (transactions with foreign related parties, with related parties located in a free trade zone, or even with persons, corporations, entities or companies located, resident or domiciled in non-cooperating jurisdictions with low or no taxation or preferential tax regimes). This may improve its levels of effectiveness in the selection of entities to be audited, and to eliminate its former masse audit model.

As the audits are advancing from the application of TP methodology and the selection of comparable companies to more complex transactions, such as those related with intangible assets (royalties, know-how, technical assistance), inter-company loans, derivatives, etc., it has become necessary to promote the use of advance pricing agreements (APAs).

APAs constitute effective negotiation and controversy resolution tools that may reduce the exposure to TP litigation. In addition, APAs may also serve to increase the foreign direct investment in Colombia to ensure that a specific TP policy would not be subject to challenge during the APA five-year term (it will also avoid potential penalties or assessments that may affect the cash flow of the entity).

For multinational enterprises with activities in Colombia and for those groups (multinational or national) with activities in a free trade zone within Colombia, APAs will allow the application of their standardised inter-company policies in a certain business and tax environment. It will also improve cooperation and communication with the local tax authority, and avoid long and expensive TP audit processes that may result in an adjustment in its policies for one or more years.

From the above, the tax authority should actively promote the negotiation of APAs (unilateral or bilateral) to increase the certainty of the local and foreign investors in the country in the medium to long term.