Colombian tax rules on non-cooperative or low tax jurisdictions (tax havens), as well as preferential tax regimes (PTRs), provide some tax implications on payments made from Colombia to persons or entities located, residents, domiciled or carrying out activities in tax havens or PTRs, mainly that:
- These transactions trigger transfer pricing (TP) obligations and reporting (even if the transaction is with an unrelated third party). In the case of transactions concluded with related parties, it should also be required to prepare a functional profile of the entity in the tax haven or PTR; and
- Colombian source payments, considered as taxable income for the recipient, would be subject to withholding tax at the general corporate income tax rate (31% for 2021, 35% as from 2022).
The current list of tax havens was issued in 2014 and includes 37 jurisdictions. On the other hand, no list of PTRs has been issued yet, as in the law such issuance is optative, but this does not prevent the fact that the tax authority could determine the existence of PTRs on a case-by-case basis.
According to the law, in order to determine the existence of a PTRs at least two of the following criteria should be met in an specific situation: (i) Non-existence of tax rates or existence of low nominal rates on income; (ii) Lack of an effective exchange of information or the existence of legal regulations or administrative practices that limit such exchange of information; (iii) Lack of transparency at the legal, regulatory, or administrative level; (iv) Non-existence of a substantial local presence or the development of a business activity with economic substance; and (v) Regimes available only for nonresidents (ring fencing regimes).
Until now, we are not aware of discussions around PTRs in Colombia, as the criteria above was rather vague and hard to apply. However, on October 28 2021, the Colombian government issued Decree 1357, providing guidance on how the criteria should be determined. With this new regulation, the identification of PTRs is likely to become a hot topic on tax audits in Colombia.
The new regulation
Decree 1357 includes guidance on multiple aspects of the PTRs, some of them are relevant clarifications. For example, that if the PTR entity is resident in a tax treaty jurisdiction (and qualifies for the benefits of the treaty), such tax treaty should prevail over the withholding tax applicable on payments to PTRs. However, certain aspects that generate doubts regarding the application of PTRs (and tax havens) regime were not addressed. It is the case of whether dividends paid to PTRs should be subject to the increased withholding tax, considering that they are not deductible for the payor.
Moreover, many provisions of the decree may be controversial, in particular if the expectation is that tax officers, on their tax audits, determine in each case the existence or not of PTRs, just based on the new regulations.
A few examples of items that may be problematic could be:
- Scope of the PTRs: In principle, it could be expected that PTRs would refer to a specific regime within a given jurisdiction, which deviates from the general taxation established in such jurisdiction. Indeed, it seems reasonable that if a whole jurisdiction is not considered appropriate, it should be rather listed as a tax haven. However, the drafting of Decree 1357 is not clear on this aspect, and sometimes mentions that the criteria should be tested at the ‘jurisdiction’ level. Therefore, some discussions may arise on whether certain jurisdictions as a whole are considered PTRs, such as those that do not have corporate taxes in general or establish a territorial system;
- Interaction with OECD’s harmful tax practices: Decree 1357 refers to the list of harmful practices issued by the OECD, but providing that harmful practices should be also tested under the criteria provided in the Colombian law and the regulations. Therefore, it seems that a regime that has been found as not harmful by the OECD, may still be considered as a PTR for Colombian purposes. This may not be consistent and could be inappropriate for Colombia as an OECD member; and
- Low tax rate as criterion for PTRs: Pursuant to Decree 1357 the criterion of low taxes will exist when the tax applicable for the PTR is below 60% of the Colombian tax that would have been applied over the same taxable income. The decree accepts that income tax, as well as taxes of ‘identical nature or analogous to the income tax’ can be considered to determine the tax applied for the PTR, but it is not provided guidance on what taxes could be deemed as such. Moreover, considering the high corporate tax applicable in Colombia, this below 60% could still be high in many instances (considering the 35% rate for 2022, below 60% would be anything under 21%). In particular, taking into account that according to the OECD for 2021 the average nominal corporate income tax rate (considering 111 jurisdictions) is 20%.
What to expect?
The introduction of the new regulation to identify PTRs could initiate multiple disputes with the Colombian Tax Authority, in particular if tax officers can apply such rules on its tax audits on a case-by-case basis, as this may derive in inconsistent outcomes in similar situations.
It is highly desirable that a list of PTRs and/or additional guidance on this respect is issued to reduce potential uncertainty and controversy. However, further action on the regulatory side is not clear at this point.
In the meantime, it is recommended that Colombian taxpayers review the payments made to non-residents to either document that the recipients are not PTRs (and have it readily available in case of a tax audit), or taking the corrective measures, to manage the application of penalties, interests, the request of additional withholding tax, and the potential denial of the costs or expenses.
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