Tax residence for companies
After the 2012 tax reform a company is considered domestic (national company) and subject to worldwide taxation if it (i) is incorporated according to Colombian law, (ii) has its principal domicile in Colombia, or (iii) has its effective place of management in Colombia (M&M).
The conclusion of whether M&M is located in Colombia should be based on a facts and circumstances test. However, law gives precedence to the location in which senior day-to-day management is carried out, departing from the OECD approach where this is just one of the indicators for determining the existence of M&M. A company should also not be deemed national solely based on the fact that its board of directors meets in the Colombian territory, or because Colombian residents are the shareholders of the entity.
Informally the Colombian tax authority has expressed that this is more an anti-avoidance rule intended to capture those cases where shell entities abroad are used by Colombian companies or individuals to avoid taxes, but that the rule should not be construed to consider that foreign operative entities with real activities and substance abroad are effectively managed in Colombia. Unfortunately, this position has not been expressly included in the regulations.
In case of an audit, a special committee of the tax authority should make the determination of whether a company is effectively managed in Colombia. This committee, its members, rules and procedures are still waiting for regulation.
Regulations allow the self-recognition and registration of a foreign entity as a national company, based on the fact that the company is effectively managed in Colombia. The affirmative use of this rule in some cases could give place to tax planning opportunities, such as in the case of foreign tax credit use.
After many years of waiting, the government issued a list of tax havens in 2013, which included 44 jurisdictions. Payments to entities domiciled, localised or carrying out activities in a tax haven should be subject to an increased withholding tax of 33% to deduct such payments for income tax and income tax for equality (CREE) purposes. Some exceptions are applicable to payments related to financial transactions registered before the Colombian Central Bank; in which the general withholding tax rules apply (for example, payment of interests are subject to a 14% withholding tax if the term of the loan is greater than one year, otherwise a 33% rate applies).
Some controversy has been created around payments to tax havens that should not be subject to withholding tax when they are related to foreign source income (for example, payments for the purchase of merchandise abroad). The tax authority initially considered that these payments were not deductible (nor did they create a tax basis), even if a withholding tax was applied. However, recent opinions issued by the tax authority provided that payments could be deductible, without the need to apply withholding tax, to the extent that payments are supported under transfer pricing principles. Colombian tax law requires that payments to tax havens are subject to a transfer pricing study, irrespective of whether they are made to third parties. The required study should include special information regarding assets used, risk assumed, functions carried out, as well as cost and expenses incurred in the tax haven. In practice, preparing a transfer pricing study when a payment is made to a third party could be difficult, jeopardising the deductibility.
Special attention should be given to the fact that some jurisdictions (including Panama) may be automatically included in the list from October, unless a tax information exchange agreement is executed by that date.
Colombian definition of permanent establishment (PE) follows article 5 of the OECD model convention; with some exceptions (numerals 3 – construction PE; and 7 – regarding the possibility that the company is the PE of its holding or subsidiary – of article 5 of the OECD model are not included in the definition). Under local definition, a PE can be created by: i) a fixed place of business located in the country, through which a foreign entity carries on its business wholly or partially (fixed place of business PE), except if it is used to develop auxiliary or preparatory activities (there is no definition but a non-exhaustive list of cases); or ii) a dependent agent in Colombia that habitually concludes contracts on behalf of the foreign entity (agent PE).
PEs are only taxed with income and CREE tax on the Colombian source income attributed to them. The attribution should be based on the employees, assets, functions and risks of the PE, generally following the guidance adopted in the OECD's Report on Attribution of Profits to Permanent Establishments. The PE is required to prepare accounting records exclusively for tax purposes, and an analysis to support the recording of the attributed income and expenses.
Recent tax regulations have required PEs to file VAT returns. This is highly controversial as, in principle, the existence of a PE does not necessarily entail that the PE is VAT responsible. Moreover, in practice the Colombian VAT rules do not seem to allow that a PE may become a VAT responsible entity without having a legal presence in Colombia (for example, a branch).
It is important to consider that even if no PE is found in Colombia, it does not mean that the foreign entity is not subject to taxation in this country, as foreign entities are subject to tax on their Colombian source income. For example, if tangible assets are located in Colombia at the time of their sale, the foreign seller should be subject to a 14% withholding tax and, in addition, will be required to file a return and pay tax at a rate of 33%. This taxation may not be triggered in case of an entity resident in a treaty partner jurisdiction. In such case, a PE should be required to subject the business profits to taxation in Colombia.
Finally, depending on the "permanent nature" of the activity of the PE, it may be required to register a branch, according to the Colombian commercial law. Interestingly, the grounds for the PE rules were the deficiency of the commercial laws to require foreigners to register branches. Branches of foreign companies are considered a kind of PE regardless of the level of activity developed and are subject to similar rules as the other PEs.
Thin capitalisation rules in Colombia require a 3:1 debt to equity ratio. Interests paid related to loans exceeding such ratio will not be deductible, for which a special formula applies. The rules in Colombia have a broader scope than in other jurisdictions, as they cover loans with related and unrelated parties, in Colombia or abroad.
For calculation purposes it is considered the tax equity of the previous year (as of December 31) with the current year loans accruing interests. This methodology could raise difficulties when the company has increased its equity in the current year (for example, due to a contribution or a merger), because such increases should be disregarded when determining compliance with the 3:1 ratio.
Financial entities and loans obtained by special purpose vehicles (SPVs) engaged in infrastructure projects for the provision of public services are excluded from the application of the rule. In addition, a 4:1 ratio is applicable to loans for certain housing projects.
Re-characterisation of loans
Financing transactions with foreign related parties must consider market terms and conditions (not only interest rate, but also term, guarantees, and so on) otherwise loans will be deemed to be capital contributions, and interest payments will be re-characterised as dividends and therefore become non-deductible for income tax purposes.
The 2012 tax reform package included a set of rules regarding reorganisations (mergers and spin-off/demergers). Previously, the rules were very ambiguous and vague, giving rise to multiple interpretations.
Requirements based on continuity of business enterprise (COBE) and continuity of interest (COI) were established. The COBE relates to the requirement that in demergers a business unit (and not just isolated assets) should be transferred. The COI requirement would vary depending on the parties engaged in the reorganisation (related or third parties). In addition, a holding period on the shares of the entities participating in the reorganisation was established, for the year of the transaction plus two more taxable years; otherwise, an increased tax will be applied to the disposal of the shares.
A cross-border reorganisation that involves a Colombian entity will be tax-free to the extent that the company resulting from the transaction is a Colombian (national) company and all the general requirements are met. On the other hand, in the case of transactions between foreign entities that result in the direct transfer of assets held in Colombia (including shares of Colombian entities), the transaction will be taxable if the Colombian assets represent 20% or more of the value of the assets of the group to which the companies participating in the transaction belong, measured based on the consolidated financial statements of the controlling entity of the participating companies.
Finally, in-kind contributions of intangibles to foreign companies are subject to transfer pricing rules, irrespective of whether the beneficiary is a related or third party.
Foreign tax credit
Opinion issued by the Colombian Tax Authority, as well as the forms issued to file returns, have limited the possibility to take a foreign tax credit (FTC) against the CREE tax (9% over tax base similar to the income tax). This has resulted in the creditability of taxes paid abroad only against the income tax (25%), creating a carry-forward of the excess of FTC for a period of up to four years.
Cost sharing agreements and business restructuring
New transfer pricing rules have introduced some concepts that are brand new for the domestic legislation. One of these relates to cost sharing agreements (CSAs), which are defined as agreements to share the costs and risks to develop, produce and obtain assets, services and rights. This rule is relevant as in other Latin American jurisdictions the implementation of CSA has raised some opposition. Also, the concept of business restructuring, defined as the redistribution of functions, assets and risks to foreign related companies, has been regulated in the law.
The rules regarding CSA and business restructuring are scarce and mainly focused on the documentation that should be prepared to demonstrate compliance with the arm's-length principle. Therefore, it is likely that in practice the Colombian tax authority will try to follow the OECD guidance to properly address issues that may arise regarding these concepts.
Tax treaties update
During 2014, the tax treaty with Mexico, the OECD Convention on Mutual Administrative Assistance in Tax Matters, and a Tax Information Exchange Agreement with the US, entered into force. The latter agreement is relevant to establish the frame for the application of the US Foreign Account Tax Compliance Act (FATCA) in Colombia.
Tax treaties with India and South Korea were approved by the Constitutional Court and the expectation is that they will be in force in 2015. The Constitutional Court should soon be making decisions regarding the constitutionality of the treaties with Portugal and Czech Republic.
2014 tax reform
The government will submit a tax Bill to Congress imminently. Pursuant to the government's public announcements, it is likely that the equity tax will be restated (the last applicable rate was 6%), the 0.4% debit tax will be stable until 2018, and some type of temporary amnesty rules will be put in place.
The introduction of a dividend tax – at around 5% – and an increase in the VAT rate to 18% have been proposed by private entities, but there are no public comments on these possible measures.