To avoid the negative effects of this phenomenon, countries established multilateral, bilateral or unilateral reliefs, as the discounts for taxes paid abroad. Usually countries with worldwide income tax systems choose to adopt the model of the tax credit, as Colombia did, instead of allowing for an exemption or tax sparing.
The tax credit is characterised by allowing the deduction of taxes (income and withholding tax) that the Colombian taxpayer has paid abroad in respect of its foreign source income, thereby reducing the tax payable in Colombia. Regarding the amount of the discount, limitations apply to prevent Colombia subsidising higher rates of income imposed in a third country.
Direct credit is given for taxes paid directly by the taxpayer, while the indirect credit is given for taxes paid by controlled companies that distribute dividends to the taxpayer.
Tax credits for taxes paid abroad
The first antecedent to tax credits for taxes paid abroad is found in article 100 of Decree 2053 (1974) which established the direct tax credit, through which, local taxpayers that received foreign income source that was subject to corporate income tax in the country of origin had the right to discount the taxes paid abroad from the Colombian corporate income tax on the same income, as long as the discount did not exceed the amount of the tax that the taxpayer had to pay on that income.
Later, article 168 of Law 223 (1995) introduced the indirect tax credit for taxes paid by affiliates abroad, conditioning its application on the existence of an integration agreement between Colombia and the country of residence of the foreign affiliates. This last requirement was eliminated by Law 1111 (2006), opening the field of application of the tax credit for taxes paid abroad.
Next, article 46 of Law 1430 (2010) introduced important changes to the fiscal credit rule for taxes paid abroad, that meant a change, evolution and adjustment to the international requirements and tendencies for these matters. The first change was to have expanded the range of taxpayers who have the right to this discount, since it did not only apply to nationals, but also to foreigners with more than five years of residence in the country, because of which they are obligated to pay tax on their global income. Other great advances of this law consisted in the possibility of using the tax credit for taxes paid abroad in different and subsequent taxable periods to that in which such taxes were paid (carry-forward). This rule is essential for the fiscal credit system to really be effective in avoiding double taxation. Another modification brought by Law 1430 in these matters was the recognition of the indirect tax credit not only for affiliates, but also for subsidiaries abroad. However, the law established a requirement of minimum share ownership to be able to apply the indirect tax credit. This requirement was later declared unconstitutional by the Constitutional Court because it established a differential and discriminatory treatment in the application of this benefit, and because it is contrary to the principle of tax equity and progressivity.
Finally, the last modification introduced to the tax credit in Colombia for taxes paid in the exterior was provided by article 96 of Law 1607 (2012) which included the following changes: (i) both direct and indirect discounts apply to the income tax for equality (CREE); (ii) direct or indirect share ownership referred to by the law should correspond to investments that are considered fixed assets and have been possessed for a minimum of two years.
The indirect tax discount for subsidiaries in the exterior
As we indicated above, the indirect tax credit for taxes paid by affiliate companies located abroad have been contemplated under the Colombian tax legislation since the year 1995. However, the tax credit for taxes paid by subsidiaries domiciled abroad was only introduced with the tax Bill of 2010.
In accordance with the current article 254 of the tax code, this indirect tax credit is determined according to the following formula:
a) The value of the discount equals the result of multiplying the amount of the dividends or shares by the income tax rate applicable to the profits that they generated; b) When the company that distributes the dividends or shares taxed in Colombia has itself received dividends or shares of other companies located in the same or other jurisdictions, the value of the discount equals the result of multiplying the amount of the dividends or shares earned by the domestic contributor by the rate to which the profits generated have been submitted.
According to the above rule, a Colombian shareholder that invests abroad through a holding company (located in a jurisdiction that has a special regime for these types of companies, or in a country with a network of treaties to avoid double taxation) has the right to take as a tax credit the taxes paid not only in the county of the holding company (affiliate), but also in that of the subsidiary, as shown in Table 1.
|1. Subsidiary jurisdiction||USD ($)|
|Corporate income tax – rate (20%)||-20|
|2. Holding jurisdiction |
|Corporate income tax – rate (10%)||-8|
|3. Shareholder jurisdiction – Colombia|
|Corporate income tax – rate (33%)||23.76|
|Direct tax credit||6.2|
|Indirect tax credit||12.4|
|Taxes applied in Colombia||5.16|
In addition to the previous, the tax credit rule provided in the Colombian tax code expressly provides for the possibility of increasing the value of the indirect discount with the taxes that directly apply to the dividends.
Another point that is important to mention is that the indirect discount also benefits Colombian shareholders that decide to possess investments in Colombian companies through holding companies located abroad. However, as we explain below, this can eventually turn out to be non-beneficial for them.
Notwithstanding the advances in the indirect tax credit law, there still exist various issues that should be clarified or improved, as indicated in the following:
- In first place, it is not clear if the indirect tax credit is only applicable to a second level of investment, or if it is possible to claim the indirect tax credit resulting from taxes paid on higher levels of investment. Nevertheless, we believe that this limitation does not apply, and that the discount applies to any tax that has been paid by the subsidiaries, while obviously respecting the limit provided by law, in the sense that the tax credit cannot in any case exceed the value of the income tax in Colombia applicable to the dividends.
- The law indicates that the tax credit applies when the income from abroad has been "subjected to the income tax in the country of origin". This reference to the income tax can cause issues, given that this could lead to the understanding that the tax credit only applies to income tax effectively declared and paid abroad, and not to retentions at the source.
- The limit provided by article 259 of the tax code is maintained, in which it is stated that in no case can the income tax after discount be less than 75% of the income tax determined by the presumptive income system (corporate taxpayers are required to pay a minimum amount of income tax, which is determined based on the presumptive income method, under which presumptive taxable income is measured as 3% of net assets (or tax equity) as of December 31 of the preceding tax year as reported by the taxpayer on the corresponding CIT return. The CIT rate is then applied to the greater of the regular taxable income (revenue less allowable costs and expenses) or the presumptive taxable income (exempting certain business activities)). Keeping in mind that the carry-forward is now accepted, permitting use of the tax discount not only in the taxable period in which the taxes were generated and paid abroad, but also in different and later tax periods, it is convenient to evaluate whether this limit should be maintained.
- Because the law refers to tax paid abroad based on the same income, it is not clear if the calculation of the fiscal credit should be made in a scheduled manner, meaning for each of the incomes obtained abroad separately, or if all the incomes originating outside of the country must be grouped together, in the sense that in Colombia, scheduler incomes are not applicable.
- The formula for the tax credit is objective, which means that it is the result of multiplying the amount of the dividends by the income tax rate to which the profits that were generated were submitted. This generates distortions in the sense that the result normally does not correspond to the tax effectively paid abroad. Therefore, the discount should be based on the tax effectively paid, and not the rate applicable, as provided in our laws, as this can result in a situation where the tax credit is not sufficient to avoid double taxation.
- As we indicated above, the indirect tax discount applies even in cases in which the shareholders are Colombian-resident companies. However, as we will explain in the following, this situation can be inconvenient for Colombian investors. Consider the example in Table 2.
|1. Subsidiary A (Colombia)||USD ($)||• As can be observed in the example, shareholders C and D cannot apply the indirect tax credit for the dividends distributed by the Subsidiary A (which is located in Colombia), and as established in article 254 of the Colombian tax code, this discount only applies to cases of income from a foreign source, which clearly is not the case of the dividends paid by Subsidiary A.|
• On the other hand, in relation to the indirect credit of the taxes paid in the jurisdiction of Subsidiary B, the drafting of the law generates a deviation by demanding that the calculation of the indirect discount is made by taking the dividend effectively paid by the income tax rate to which the profits which generated the dividends had been submitted, and not on the value of the tax effectively paid, which results in a larger tax credit.In that regard, observing the application of the indirect tax credit in other countries, we find that to calculate the discount, a value equal to the discount that can be taken for indirect taxes paid abroad is added to the dividend received by the local company (gross-up). As such, for our example, the tax credit would be calculated on the dividend effectively distributed by Subsidiary B in addition to the tax effectively applied.
• Therefore, the law that we are analysing is not clear in defining whether the third level shareholders (in our example, C and D) would have the right to calculate their tax discount by applying the total of the tax demanded abroad, or only the part that corresponds to their participation. This difference is observed in sections 4.5 and 5.5 of our example, as in this case we have adopted a conservative position that considers that they would only have the right to take the tax discount corresponding to the share ownership of each one of them in the subsidiary (in our case, 50% for each one). However, adopting the contrary position, each one of the shareholders would be able to take the total discount, which would result in a lower received dividend tax.
|1.1 Taxable income||100|
|1.2. Corporate income tax - rate (33%)||-33|
|1.3 Distributed dividends [1.1 × 1.2 (33%)]||67|
|2. Subsidiary B (Abroad)|
|2.1 Taxable income||100|
|2.2 Corporate income tax - rate (20%)||-20|
|2.3 Distributed dividends [2.1 × 2.2 (20%)]||80|
|3. Holding company (Abroad)|
|3.1 Taxable income [1.3 + 2.3]||147|
|3.2 Corporate income tax - rate (0%)||0|
|3.3 Distributed dividends [3.1 × 3.2 (0%)]||147|
|4. Shareholder C - Colombia 50%|
|4.1 Taxable income [3.3/2]||73.5|
|4.2 Corporate income tax - rate (33%) [4.1 × 4.2 (33%)]||48.51|
|4.3 Direct tax credit||0|
|4.4 Indirect tax credit subsidiary A||0|
|4.5 Indirect tax credit subsidiary B [(4.1 × 2.2)/2]||7.35|
|4.6 Payable tax in Colombia [4.2 - 4.5]||41.16|
|4.7 Dividend received after taxes (4.1 - 4.6)||32.34|
|5. Shareholder D - Colombia 50%|
|5.1 Taxable income||73.5|
|5.2 Corporate income tax - rate (33%)||48.51|
|5.3 Direct tax credit||0|
|5.4 Indirect tax credit subsidiary A||0|
|5.5 Indirect tax credit subsidiary B||7.35|
|5.6 Payable tax in Colombia||41.16|
|5.7 Dividend received after taxes||32.34|