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Tax treatment of interest relating to foreign indebtedness

Robert Samir KusterDavid BedoyaCarlos Fradique

As a result of a number of recent amendments to Colombian tax law, interests paid in respect of foreign indebtedness are now generally subject to a 14% income tax withholding. During November 2010, the Colombian government made a number of changes to the tax treatment of such payments under Decree 4145 of 2010 issued by the Ministry of Finance and, subsequently, in December 2010, Congress issued Law No. 1430 of 2010 which addressed the same matter.

Former income tax treatment

Prior to the issuance of Decree 4145, most interest payments with respect to foreign indebtedness owed to foreigner creditors were not deemed to be Colombian-source income.

This was a result of a general provision of the tax code which indicated that interest paid in respect of foreign loans and credits obtained by Colombian entities "engaged in activities beneficial for the economic and social development of Colombia according to policies adopted by the Political, Economic and Social National Council (CONPES)", were not deemed to be Colombian-source income and, therefore, were not subject to withholding on account of Colombian income tax.

In general, all activities pertaining to the agricultural, manufacturing and services sectors were considered to benefit the economic and social development of Colombia, and, therefore, the vast majority of such transactions would benefit from such tax treatment.

Modifications introduced during 2010

On November 5 2010, CONPES recommended to modify the tax treatment of such payments and, as a result, Decree 4145, in practice, created a 33% income tax withholding rate on interest payments made in respect of foreign loans entered into and disbursed after the effective date of such decree and in respect of additional principal amount disbursed after the effective date in respect of agreements executed prior to the effective date.

Given the fact that virtually all international credit agreements and debt capital market transactions provide for gross up clauses, such resulted in an increase in the amount payable by the Colombian creditor of close to 50%.

The income tax withholding rate was lowered by means of Law No. 1430 of 2010 to 14% in respect of loans with a term to maturity exceeding one year. Shorter loans (other than trade finance-related financings) may be subject to a 33% income tax withholding rate. A number of exceptions to the income tax withholding remain available; including, in general, financings to financial institutions subject to a number of limitations and restrictions and financing to public entities.

Structuring and tax planning opportunities

As a result of the amendment to the tax rules a number of structuring and tax planning alternatives will likely be considered in respect of project and corporate finance deals. This include, among others, financings by lenders entitled to benefits under double taxation treaties, financings by lenders entitled to immunities under Colombian law, financial structures that minimise, defer or redistribute the tax effect on interest payments by way of bullet structures, variable interest amounts and modified repayment schedules, structures around lease agreements and more structured alternatives including derivatives and other features.

These alternatives would all have a number of restrictions and limitations, but are nonetheless likely to be frequently discussed and evaluated in proposed deals going forward.

Robert Samir Kuster, David Bedoya and Carlos Fradique

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