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Tax reforms take hold in Colombia

Carlos Fradique MéndezLucas Moreno
In late December 2012 Colombian Congress passed Law 1607, which introduces significant changes to Colombian tax law, with some provisions particularly relevant to the structuring of inbound and outbound financial transactions. This article, very briefly and generally describes some of the most salient features of the tax reform, with the proviso that the specific details and implementing rules and regulations are to be taken into account in specific cases given the complexity of the subject matters.

Foreign portfolio investments

The tax reform generally reduces the withholding tax rate applicable to gross payments to foreign portfolio investors from 33% to 14%. The 14% rate is generally applicable, unless the foreign investor is located in a tax haven (as indicated in a blacklist to be published by the Colombian Government), in which case the applicable withholding rate would be 25%. While dividends are not typically subject to double taxation, the 14% reduced withholding rate would not apply (and a 25% withholding rate would be applicable instead) to dividend payments subject to taxes in Colombia at the shareholder level.

Deductibility of interest payments

Under the new rules, the total amount of interest payments made under international lending transactions to supranational entities would be deductible for the payor. Under prior rules, the deductibility was subject to an aggregated 15% limit to be calculated on net income.

Substance over form

The tax reform adds a general anti-abuse provision generally following the prevalence of the so-called substance over form doctrine, which allows the tax administration to re-characterise a transaction or pierce the corporate veil, subject to the presence of three out of five issues associated with matters such as the affiliation between the parties, transfer pricing related considerations, the use of tax havens, tax arbitrage and arms-length provisions.

Thin capitalisation rules

While Colombian law has long set forth a general proportionality rule that would be arguably applicable to thin capitalisation analysis, Law 1607 provides for specific rules limiting the deductibility of interest payments made by Colombian taxpayers. These rules generally establish that interest payments exceeding a 3:1 debt-to-equity ratio would not be deductible for income tax purposes, as the borrower would be deemed to be thin-capitalised.

The debt-to-equity ratio applies regardless of whether or not the interest payments are made to related or non-related entities, the domicile of the beneficiary of the payment, and also without prejudice of transfer pricing considerations as may be applicable.

VAT in FX transactions

The tax reform excludes the spot purchase of foreign currency as well as the purchase of FX in the context of exercise or settlement of FX derivatives from VAT.

Carlos Fradique-Mendez and Lucas Moreno

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