Under the Colombian tax rules the deductibility of an expense requires that it should be deemed as related to the profit producing activity of the taxpayer, as well as necessary and proportional according to the business.
In the case of interest paid to related parties, the thin capitalisation rules should be observed, and if the lender is a foreign related party the transfer pricing rules apply. There are no specific rules that denies the deduction of interest paid on loans that are used for the acquisition of shares; hence, the general rules should be followed.
In tax ruling No. 048168 of June 7 2006, the tax authority considered that the interests paid on loans for the acquisition of shares could have nexus with the income producing activity. However, it highlighted that in situations where the dividends received from the target acquired are non-taxable, the interest related to the acquisition are non-deductible.
In tax ruling No. 83813 of September 28 2006, the tax authority specified that if in a given year the non-taxable dividends were not received (for example, because no dividend distribution was made), in such year the interest deductibility was allowed.
It is important to mention that under Colombian rules, dividends paid by Colombian entities are non-taxable to the extent they are distributed out of profits that were subject to Colombian corporate income tax (CIT) at the level of the distributing company.
It is possible that some dividends are taxable, as they are not taxed at the Colombian distributing entity level due to the application of some tax benefit or some book to tax difference, among other reasons. Generally, dividends distributed by Colombian companies tend to be non-taxable.
On the other hand, dividends received by non-resident companies usually are taxable, with some exceptions like dividends received under the Andean community tax treaty (decision 578), or in application of the Colombian holding company regime. Therefore, it is common that when a Colombian entity obtain funds via debt to acquire a Colombian target, after such acquisition a merger follows with the Colombian target, so non-taxable dividends which may prevent the deductibility of the interest, are not received in the future by the Colombian acquiror.
However, on March 7 2019, the Colombian tax authority issued tax ruling No. 005739, that considered interests paid on loans to fund the acquisition of shares were not deductible for CIT purposes. The non-deductibility was considered to apply even if the acquiror company merges downstream with the acquired company (eliminating the non-taxable dividends).
The tax ruling supported its conclusion to the brief argument that these expenses do not meet the general deductibility requirements provided in the Colombian rules, since the payments, in view of the tax authority, are not necessary and do not have nexus with the income-producing activity of the debtor. No further arguments or explanations were provided in the tax ruling.
This tax ruling generated a lot of uncertainties in relation to several acquisitions that included debt and raised questions on its proper alignment to the Colombian tax rules. Therefore, legal procedures were initiated before the courts. As part of these procedures, the Council of State (CoS), Colombia’s highest tax court, in the decision of February 2 2021, ordered as a preliminary measure, to suspend the application of this ruling.
In view of the CoS, there is no express provision that prevents the deductibility of interest on loans for the acquisition of shares. Thus, the deductibility of interest cannot be denied as a general rule, but it should be analysed on each specific case. It is important to bear in mind that suspension of tax ruling application is an interim measure, but a final decision would be required to nullify the 2019 tax ruling, and this may still take some time.
In any case, in recent tax rulings issued by the tax authority (i.e. No. 08221 of March 26 2021), the approach has been to reintroduce references to the tax rulings of 2006, allowing the deductibility of interest to the extent they are not linked with non-taxable dividends.
Furthermore, it has brought to the discussion a final decision of the CoS on November 26 2020, which generally recognises the deductibility of expenses (including interests) to the extent they are related to the economic activity of the taxpayer, even though they are not directly related to the income generation.
It is important to carefully analyse the facts and circumstances in each case to determine whether or not the deduction of interest is appropriate or if it is possible to take certain measure that may help to claim deductibility. Following up on the final decision that the CoS will issue in respect to the 2019 tax ruling is also recommended.
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