Colombian thin capitalisation rules to limit interest deductibility have been applicable since 2013. The original rules provided a general debt to equity ratio of 3:1. This ratio considered all types of current-year debt, which generated interest, irrespective of whether it was acquired from related or unrelated parties, or from local or foreign creditors. On the other hand, the equity for tax purposes as of December 31 of the prior year were considered for this ratio. Special purpose vehicles (SPVs) engaged in public services' infrastructure projects and financial entities, among others, were not reached by the thin capitalisation rules.
These old rules were subject to several criticisms, such as:
- The broad reach of debts subject to thin capitalisation;
- The fact that the ratio compared current year debts with the prior year's equity could trigger a limitation on the interest in cases in which the company has enough equity in the current year to acquire more debt;
- There was some discussion on whether infrastructure projects related to transportation were subject or not to these rules; and
- The limited interest in one year could not be carried forward for deduction in future years.
In the last tax reform (Law 1943 of 2018), applicable from 2019, the Colombian government did not take the approach of including an interest limitation based on a percentage of the earnings before interest, taxes, depreciation and amortisation (EBITDA) of the company, as recommended by BEPS Action 4, but kept a thin capitalisation rule, with several changes, some addressing the above criticism.
The features of the new thin capitalisation rule include: i) the debt to equity ratio is now 2:1, but only considers related party debt with local or foreign creditors; ii) related party debt includes back-to-back transactions, as well other transactions in which the creditor is, in substance, a related party; iii) a certification of non-related party debt to be issued by the creditor would be required; and iv) it is clarified that the limitations are not applicable to SPVs engaged in infrastructure projects concerning transportation and public services, and for businesses which are in an unproductive stage.
This new rule was recently regulated by Decree 1146 of June 26 2019, providing, among others, the mechanisms for the application and calculation of the thin capitalisation rules, and for the issuance of the non-related party debt certification. In Official Opinion 8159 of April 5 2019, the tax authority mentioned that when the guarantor is not substantially deemed the real creditor the debt should not be considered a related-party debt. Unfortunately, this was not clearly stated in the regulation, and could eventually generate discussion, particularly at the time the certification is issued.
In summary, the new thin capitalisation rule is a development from the prior rule, but still has much room for improvement to make it fairer and economically reasonable. In addition, its application, could mean challenges and potentially the need for further guidance to avoid undesired results. It is important to keep an eye on any developments in the rule. The 2019 tax return (to be filed in 2020) will show its practical benefits and challenges.