The International Tax Treaty Policy of Colombia
This article examines Colombia’ s policy with regard to the negotiation of tax treaties since 2005 when Colombia first started entering into tax treaties.
1. Introduction
Until recently (2005), Colombia was reluctant to conclude or negotiate tax treaties.1 Various reasons can be advanced
for this position, including the application of the source-based approach, the lack of certainty with regard to the cost versus benefit of concluding tax treaties and the impor-tance of collecting revenue, for example, by way of various previous tax reforms.2
The first tax treaty concluded by Colombia was the Colom-bia-Spain Income and Capital Tax Treaty (2005),3 which
entered into force 23 October 2008. One of the main reasons for the change of approach towards the negotia-tion of tax treaties was the need for Colombia to create more mechanisms to improve its competitiveness in order to attract foreign investment.4
The Colombian government has decided to negotiate tax treaties along with bilateral investment treaties (BITs). It has stated that the primary objective of these BITs is to promote and attract foreign investment, especially from countries that channel investment into Colombia, such as Canada, Chile, Spain, the United Kingdom and the United States.5 It was in this context that the first BIT between
* Tax Consultant at Hamelink & Van den Tooren in The Hague and Lecturer at The Hague University. The author can be contacted at irma@hamelinktooren.com.
The author would like to acknowledge Hans Mooij and Jan van den Tooren for their comments on the article. The views expressed herein are, however, solely those of the author.
1. The only tax treaties signed by Colombia prior to 2005, were, for example, the international tax agreements with regard to air and maritime transportation. Bilateral agreements were signed with Argentina (CO: Law 15 of 1970), Brazil (CO: Law 71 of 1993), Chile (CO: Law 21 of 1972), France (CO: Law 16 of 1988), Germany (CO: Law 16 of 1970), Italy (CO: Law 14 of 1981), the United States (CO: Law 24 of 1961 and Law 4 of 1988), and Venezuela (CO: Law 16 of 1976) in respect of air and/or maritime transport.
2. I.J. Mosquera Valderrama, What the Colombian Tax Reform Means, Intl. Tax Rev. (Sept. 2003).
3. Convention Between the Kingdom of Spain and the Republic of Colombia for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital [unofficial translation] (31 Mar. 2005), Treaties IBFD [hereinafter: Colom.-Spain Income and Capital Tax Treaty].
4. Included in the last three National Plans in respect of Development for Colombia (2003-06, 2006-10 and 2010-14).
5. In this regard, the Colombian government document with respect to the Convenio Entre la Republica de Chile y la Republica de Colombia para Evitar la Doble Imposicion y para Prevenir la Evasion Fiscal en Relacion al Impuesto a la Renta y al Patrimonio (19 Apr. 2007), Treaties IBFD [hereinafter: Chile-Colom. Income and Capital Tax Treaty], provides more insight. See Legislative Proposal 198 of 2007 and the Senate discussion of 5 December 2007, Senate Gazette No. 631 of 2007.
Colombia and Spain for the promotion and protection of investments of 31 March 2005 was concluded.6
At the time of the writing of this article, Colombia had con-cluded, or was negotiating, the following treaties:7
– ten free trade agreements (FTAs): in force with Canada, Mexico and the United States; with the North-ern Triangle (El Salvador, Guatemala and Honduras); with the European Free Trade Association (Iceland, Liechtenstein, Norway and Switzerland); and within the framework of the MERCOSUR8-CAN (Andean
Community).9 An FTA with the European Union has
been signed, but is not yet in force. Currently, Colom-bia is negotiating FTAs with Israel, Korea (Rep.) and Turkey.10
– Seventeen investment agreements (including BITs and FTAs): in force with Canada, China (People’ s Rep.), India, Mexico, Peru, Spain and the United Kingdom, Northern Triangle, and the EFTA and MERCOSUR countries. Investment agreements have been signed but are not yet in force with Japan, Korea (Rep.), the United States and the European Union.11 Investment
agreements are being negotiated with Kuwait, Panama and Turkey.
– Fifteen tax treaties in force, signed or under negotia-tion, in line with the OECD Model. At the time of the writing of this article, the tax treaties in force were those with Canada, Chile, Spain and Switzerland. The tax treaties with India, Korea (Rep.) and Mexico had been signed, but were not yet in force and tax treaties were being negotiated with Belgium, Czech Repub-lic, France, Germany, Japan, the Netherlands, Portugal and the United States.
– One multilateral tax treaty within the framework of the Andean Community, being Decision 40 of 1971,
6. CO: Law 1069 of 2006 of 31 July 2006, Official Gazette 46346 of 31 July 2006.
7. Source: Proexport Colombia.
8. The member countries are Argentina, Brazil, Paraguay and Uruguay and the associate member countries are Bolivia, Chile, Mexico and Peru. 9. This is intended to create a free-trade area through the reduction of trade
tariffs and non-trade tariffs insofar as they affect trade. With regard to double taxation, the agreement refers to the possibility to conclude new tax treaties in article 31.
10. Source: SICE Foreign Trade Information Systems. Organization of American States, available at www.sice.oas.org/ctyindex/COL/ COLagreements_e.asp.
as amended by Decision 578 of 2004.12 Colombia has
never followed the Andean Community model in its negotiation of tax treaties.
– One (bilateral) tax information exchange agreement (TIEA)13 with the United States.14
As a result of the changes to Colombia’ s international tax treaty policy Colombia is now regarded as an important emerging market for international investors. In the recent World Bank “Doing Business” ranking, Colombia was ranked as the third most friendly country for investment in Latin America after Chile and Peru and before countries such as Mexico and Panama. Colombia is ranked 42nd in the World Ranking of Doing Business (in 2011, 47th) and, in terms of the strength of investor protection, Colom-bia is currently ranked 5th, the highest ranking for a Latin American country.
At the domestic level, Colombia has recently approved a comprehensive tax reform, i.e. Law 1607 of 26 December 2012 (“Law 1607”), which is substantially aligned with in-ternational tax standards.15 Law 1607 entered into force on
1 January 2013 and consists of 198 articles that amend or introduce new provisions to the Colombian Tax Code.16
The changes include the introduction of the definition of a permanent establishment (PE), changes to the criteria of residence for individuals and corporations, and the intro-duction of rules regarding abuse. Law 1607 will, however, still need to be subject to a constitutional review by the Constitutional Court. This article, where necessary, refers to the changes introduced by means of Law 1607 to the Tax Code.
At the international level, the Colombian government has expressed its interest in seeking membership in the OECD.17 One of the steps towards such membership has
already been taken by Colombia, i.e. joining the OECD Development Centre.18 Colombia has also signed the
12. Decision 40 (and Decision 578) provide for two Annexes that contain a model tax treaty for Andean Community member countries and a model tax treaty for tax treaties concluded with third parties. Both models differ from the OECD Model and the UN Model in that they grant the taxation right almost exclusively to the source country.
13. This TIEA contains both a multilateral and a bilateral model. The multilateral agreement does not entail a multilateral agreement in the traditional sense, i.e. one agreement for all parties, but, instead, makes it possible for a party to be bound in relation to the parties it chooses. 14. Signed on 30 March 2001 and not yet in force. See I. J. Mosquera
Valderrama, EU and OECD proposals for international tax cooperation: A new road?, 59 Tax Notes Intl. 8, pp. 609-622 (August 2010).
15. CO: Law 1607 of 26 December 2012. See I. J. Mosquera Valderrama,
Sweeping Tax Reforms Take Effect, 69 Tax Notes Intl. 5, pp. 429-434 (February 2013).
16. CO: Tax Code (Estatuto Tributario) enacted by Decree 624 of 1989, National Legislation IBFD. Also available at http://www.secretariasenado. gov.co/senado/basedoc/codigo/estatuto_tributario_pr011.html. 17. Approved by CO: Law 1479 of 2011 of 28 September 2011 and approved
by the Constitutional Court by CO: CC, 6 June 2012, Decision C 417/92. 18. According to the OECD, the OECD Development Centre is “a forum where countries come to share their experience of economic and social development policies. The Centre contributes expert analysis to the development policy debate. The objective is to help decision makers find policy solutions to stimulate growth and improve living conditions in developing and emerging economies”. Up to October 2012, 41 countries had become members of the OECD Development Centre (24 OECD member countries, and 17 developing and emerging economies (see www. oecd.org/dev/)).
OECD Declaration on International Investment and Mul-tinational Enterprises,19 which, according to the OECD
2012 Investment Review, demonstrates “recognition of the country’ s progress in fostering investment liberalisa-tion, deepening its international integration and promot-ing responsible business conduct”.20
Despite this, the author argues that Colombia needs to address issues regarding the timeframe for review of its tax treaties by the Constitutional Court, the use of the most-favoured-nation (MFN) clause in tax treaties, the use of provisions in the OECD Model with regard to tax trea-ties that, to some extent, do not reflect the tax system of Colombia, and the lack of a consistent and clear interna-tional tax policy.
The objective of this article is to analyse the international tax treaty policy of Colombia. In order to make this review comprehensive, the article is structured as follows. Section 2. sets out the unilateral domestic tax rules to prevent double taxation. Section 3. then considers the constitu-tional review of tax treaties. Section 4. examines the main provisions in the tax treaties concluded by Colombia taking into account whether or not these provisions follow the OECD Model or the UN Model. The relevant provi-sions relate to: residence, PE, dividends, interest, royalties, MFN treatment, treaty anti-abuse clauses and arbitration. Finally, section 5. provides recommendations with regard to the international tax treaty policy of Colombia.
2. Unilateral Domestic Measures with Regard to Taxation
Before the first tax treaties were concluded, the only way to avoid double taxation in Colombia was through the granting of an ordinary tax credit (descuento tributario) in respect of the amount of income tax paid abroad, under article 254 of the Tax Code.21 This tax credit is still
avail-able and has the following features.
The tax credit is first subject to certain requirements. It is necessary that: (1) the taxpayer be an individual or legal person resident for tax purposes in Colombia;22 and (2)
the income tax paid abroad cannot exceed the Colombian tax attributable to the same income, i.e. an ordinary tax credit.23
In addition, article 254 governs dividends received from foreign companies by the Colombian resident taxpayer in
19. The Declaration contains two Annexes, one representing the OECD Guidelines for Multinational Enterprises and the other dealing with general considerations and practical approaches concerning conflicting requirements imposed on multinational enterprises (see www.oecd.org/ daf/internationalinvestment/investmentpolicy/oecddeclarationoninter-nationalinvestmentandmultinationalenterprises.htm).
20. OECD, Investment Policy Reviews: Colombia (OECD 2012).
21. In Colombia, all types of taxes are consolidated into a single code, i.e. the Tax Code.
22. Previously, the tax credit could only be claimed by a national (an individual or legal person) or resident (individual) of Colombia for a period (consecutive or not) of at least five years. This modification was effected by way of art. 96 Law 1607 of 2012.
respect of which the Colombian resident taxpayer has an indirect or direct participation.24 With regard to a direct
participation, Colombian resident taxpayers can credit their Colombian tax against the foreign withholding tax paid on the dividends insofar as it does not exceed the Colombian tax attributable to the same income.
Dividends received from other companies domiciled abroad, i.e. from an indirect participation, are taken into account if received by the underlying foreign company distributing the dividends. Accordingly, the amount of the underlying foreign income tax paid by companies domiciled abroad on the profits is also taken into account in determining the portion of the tax credit available in Colombia. For this purpose, the taxpayer must present evi-dence that the tax has actually been paid abroad.25
The final feature of the tax credit is that it can be claimed in the year that the foreign taxes were paid. Alternatively, it can be carried forward for a maximum of four years.
3. Constitutional Review of Tax Treaties
One feature of the Colombian legal system that influences international treaty policy is that the legislature and the Constitutional Court must approve a tax treaty. Accord-ingly, tax treaties concluded by Colombia must be rati-fied by the legislature, i.e. the Senate and the Chamber of Representatives, before they can enter into force.26 Once
the legislature has ratified a tax treaty, the Constitutional Court27 reviews the tax treaty and the law containing the
tax treaty to ensure they are compatible with the Consti-tution.28
The constitutional review should take place within six days of enactment by the legislature of the executive pro-vision.29 It should address not only the contents of the Law
(substantive provisions), but also the (formal) legislative procedure for adopting the law. Therefore, in addition to the one-to-two-year ratification process, investors also have to await the constitutional review.
For illustrative purposes, the Colombia-Spain Income and Capital Tax Treaty (2005) was ratified by way of Law
24. Law 1607 of 2012 instituted two additional requirements in respect of the ordinary tax credit for direct and indirect participations being: (1) the taxpayers must be Colombian residents with a direct or indirect participation in respect of fixed assets; and (2) the fixed assets must be held for more than two years.
25. Changes introduced by way of CO: Law 1111 of 2006, art. 15. 26. CO: Constitution of 1991, art. 150(16).
27. The Constitutional Court was created by the Constitution of 1991. Constitutional reviews are not an exclusive power of the Constitutional Court. The Council of State may also perform the task of a constitu-tional review with regard to administrative decrees where such review has not been assigned to the Constitutional Court. See D. Younes-Moreno,
Derecho Constitucional Colombiano p. 343 (Legis. 1997).
28. In Colombia, the following taxation principles were introduced by article 363 of the Constitution: equity; efficiency; progressivity; and non-retroactivity. The following principles also apply to taxation by means of intervention of the judiciary, specifically the Constitutional Court, by way of constitutional reviews: legality (article 338); equality (article 13); non-seizure (article 34) and good faith (article 83). See I.J. Mosquera Valderrama. Leasing and Legal Culture - Towards consistent behaviour in tax treatment in civil law and common law jurisdictions, dissertation (2007).
29. Art. 241(10) Constitution.
1082 of 31 July 2006. The Constitutional review took place on 13 June 2007.30 As a result of a mistake in the
proce-dure approving Law 1082, the Law was returned to the legislature, which corrected it. Law 1082 with corrections was then published in the Official Gazette of 29 October 2007.31
In the end, it took approximately three and a half years to complete the procedure, i.e. between 31 March 2005 (the date on which the Colombia-Spain Income and Capital Tax Treaty (2005) was concluded) and 23 October 2008 (the date on which the tax treaty entered into force). Section 4. now analyses the main provisions of the tax trea-ties concluded by Colombia that may be of relevance with regard to third countries. In this respect, primary attention is given to the tax treaties that are in force, i.e. those con-cluded by Colombia with Canada, Chile, Spain and Swit-zerland, and the subsequent constitutional review of these tax treaties by the Constitutional Court.32
4. International Tax Treaty Policy in Colombia
4.1. Residence
In general, Colombia follows the OECD Model with regard to the definition of a company in tax treaties, this being “any body corporate or any entity that is treated as a body corporate for tax purposes”. For tax purposes, in Colombia, resident companies are taxed on their worldwide income. Conversely, foreign companies with branches and PEs in Colombia are taxed on income sourced in Colombia. By means of Law 1607, the income tax rate for resident companies and foreign companies with branches or PEs has been reduced from 33% to 25% (as of 1 January 2013). Despite this change in the tax rate, the overall effective tax rate is not 25% but 34% for 2013, 2014 and 2015 and 33% for 2015 onwards. This is because resident corpora-tions and foreign corporacorpora-tions with branches and PEs in Colombia are also subject to a new fairness income tax (impuesto sobre la renta para la equidad CREE).33
Furthermore, in Colombia, by way of article 19 of the Tax Code, a special tax regime for foundations and other non-profit entities applies provided that the entities are engaged in specific activities that are considered to be of general interest, i.e. health, education, technology, environmental
30. CO: CC, 13 June 2007, Decision C-383/2008.
31. CO: Law 1082 of 2006 (31 July 2006), Official Gazette No. 46796 of 29 October of 2007.
32. CO: CC, 13 June 2007, Decision C-383/2008, in regard to the Colom.-Spain Income and Capital Tax Treaty; CO: CC, 26 Aug. 2009, Decision C-577/09, in regard to the Chile-Colom. Income and Capital Tax Treaty; CO: CC, 16 June 2010, Decision C-460/2010, in regard to the Convenio Entre la República de Colombia y la Confederación Suiza para Evitar la Doble Imposición en Materia de Impuestos sobre la Renta y el Patrimonio (26 Oct. 2007), Treaties IBFD [hereinafter: Colom.-Switz. Income and Capital Tax Treaty]; and CO: CC, 18 Apr. 2012, Decision C-295/12, in regard to the Convention Between Canada and the Republic of Colombia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital (21 Nov. 2008), Treaties IBFD [hereinafter: Can.-Colom. Income and Capital Tax Treaty].
protection, etc. Such entities are subject to a reduced tax rate of 20%.34
Until recently (December 2012), Colombia applied the cri-teria of domicile or incorporation to determine the resi-dence of companies. Law 1607 added the criterion of place of effective management. Place of effective management is further defined in paragraph 1 of article 84 of Law 1607. These criteria follow, to a significant extent, the criteria in the Commentary on Article 4(3) of the OECD Model. Such criteria include the place where (1) the key manage-ment and commercial decisions are made, (2) the meet-ings of its board of directors or equivalent body are usually held, and (3) the senior day-to-day management of the company is carried on.
Furthermore, paragraph 2 of article 84 of Law 1607 intro-duced additional criteria to clarify the residence of corpo-rations in Colombia. Paragraph 2 states that a corporation is not a resident of Columbia for tax purposes solely on the basis that the management board meets in Colombia or on the basis that individuals or companies resident for tax purposes in Colombia are shareholders.
As a consequence, in order to determine the tax residence of corporations, the domicile, incorporation or place of effective management of the corporation will be taken into account. By introducing the place of effective management criterion, Colombia is essentially updating the residence criteria in accordance with the tax treaties that have been concluded to date.
For illustrative purposes, the Colombia-Spain Income and Capital Tax Treaty (2005) and the Colombia-Switzerland Income and Capital Tax Treaty (2007)35 follow article 4
of the OECD Model, which provides for the use of the place of effective management as a tie-breaker rule where a company is a resident of both countries (dual residence). In the Chile-Colombia Income and Capital Tax Treaty (2007),36 in case of dual residence, the parties determine
residence by mutual agreement. In the Canada-Colombia Income and Capital Tax Treaty (2008),37 in case of dual
residence, the place of incorporation prevails. This tax treaty also states in article 4(4) that, if it is not possible to determine residence, the states may determine residence by mutual agreement and, if agreement cannot be reached, no treaty benefits are given to the company.
Prior to Law 1607, individuals were resident for tax pur-poses if they had been in Colombia for a period exceeding six months in the relevant tax year. Colombian nationals were also resident if there had been a close connection, i.e. family ties or place of business in Colombia.
With Law 1607, the criterion of residence for individuals has been substantially amended. Individuals will be resi-dent for tax purposes if they have been in Colombia more than 183 days (consecutive or not) in a period of 365 days. Members of the diplomatic service will also be
consid-34. Art. 356 Tax Code.
35. Colom.-Switz. Income and Capital Tax Treaty. 36. Chile-Colom. Income and Capital Tax Treaty. 37. Can.-Colom. Income and Capital Tax Treaty.
ered to be Colombian residents. In addition, Colombian nationals will be residents if one of the following condi-tions are met: (1) a spouse or child(ren) are resident for tax purposes in Colombia; (2) 50% of the income, including assets and/or wealth, are sourced in Colombia; (3) the indi-viduals are resident in a tax haven; or (4) upon request by the Colombian tax administration, no proof of residence in another country is provided by the taxpayer.
Residence in regard to individuals in the tax treaties con-cluded by Colombia with Canada, Chile, Spain and Swit-zerland is based on article 4 of the OECD Model, including the tie-breaker rules. However, the changes to the criteria of residence in Law 1607 can potentially raise issues of dual residency that will need to be taken into account by Colombia when negotiating future tax treaties. For illustra-tive purposes, Law 1607 states that a Colombian national can be deemed to be resident for tax purposes in Colombia even if the national is a resident of another country. This may result in an additional burden for the taxpayer, i.e. dual residence, simply because the person is a Colombian national. Furthermore, the tax administration will need to further clarify how these criteria in respect of nationals will apply, and what to do in the event of dual nationality, for instance, in regard to a national of the United States and Colombia in respect of which there is no tax treaty.
4.2. PEs
When the Colombia-Spain Income and Capital Tax Treaty (2005) was negotiated, Colombia did not have a PE concept. At that time, the Colombian government, however, stated that, even though Colombia does not employ a PE concept, it is important to follow the definition of a PE in the OECD Model, except for construction activities and independent personal services, and that this definition assists Colombia in determining what does not constitute a PE.38
The Constitutional Court, in its constitutional review of the Canada-Colombia Income and Capital Tax Treaty (2008) stated that the lack of a PE definition in the Tax Code does not imply that article 5 is unconstitutional, as the same article provides for the elements of the defini-tion. However, the Constitutional Court stressed that it was important for the government to introduce a PE def-inition in the Tax Code taking into account compliance issues that would have to be addressed in collecting tax from PEs.39
Law 1607 introduced a PE definition. This definition is, to a significant extent, in accordance with the OECD Model. The definition does not include activities of a preparatory and auxiliary character, which is in accordance with the Commentary on Article 5 of the OECD Model (2010).40
However, in contrast to the current tax treaties concluded by Colombia, no specific reference is made in Law 1607
38. See Legislative Proposal 198 of 2007, supra n. 5.
39. Decision C-295/12 (18 Apr. 2012), at para. 9.5.4. This was also emphasized in CO: CC, 16 June 2010, Decision C-360/10. Seealso art. 5(4) Colom.-Switz. Income and Capital Tax Treaty.
to a PE including a building site or construction activities or to a six-month period in regard to these activities. In accordance with the tax treaties concluded by Colombia, independent personal services are specifically excluded from this definition.
Colombia has been following the UN Model (2001) with regard to a building site, a construction assembly or instal-lation project or connected supervisory activities carried out in the source state. Where these activities have been performed for more than six months, a PE is considered to exist in the source state. In article 5(3) of the OECD Model, the term set with regard to these activities is a period of more than 12 months. The Canada-Colombia (2008) and Chile-Colombia (2007) Income and Capital Tax Treaties also introduced consultancy services into the definition of a PE if carried out by employees or dependent agents for more than 183 days in a 12-month period.
In addition, Colombia has included in its tax treaties article 14 of the UN Model in respect of independent per-sonal services. With regard to the OECD Model, article 5 includes independent personal services in the PE def-inition. The objective of the Colombian government in including article 14 of the UN Model in its tax treaties was to remove the limitation imposed on the source state to only tax income from independent personal services if the income is derived from a fixed base.41
4.3. Dividends
Article 245 of the Tax Code provides for a 0% withhold-ing tax on dividends paid to foreign individuals or com-panies that are not resident in Colombia insofar as the profits from which the dividends are paid have been taxed at the corporate level. Otherwise, the dividends are subject to income tax at an overall tax rate of 34% for 2013, 2014 and 2015 and 33% for 2015 onwards). This tax rate includes a 25% income tax and a 9% (8% as of 2015) fairness income tax (CREE).
At the international level, Colombia follows the source principle. Accordingly, in respect of dividends, interest and royalties, for example, withholding tax at source applies. With regard to dividends, certain exemptions apply such that a 0% withholding tax applies at source to a substantial shareholding of more than 25% (in respect of the Chile-Colombia Income and Capital Tax Treaty (2007)) and 20% (in respect of the Spain (2005) and Colombia-Switzerland (2007) Income and Capital Tax Treaties). However, in the Canada-Colombia Income and Capital Tax Treaty (2008), the percentage for a substantial share-holding is 10% and the withshare-holding tax rate 5%.
Portfolio dividends are subject to a 15% (the Colombia-Switzerland (2007) and Canada-Colombia (2008) Income and Capital Tax Treaties), 5% (the Colombia-Spain Income and Capital Tax Treaty (2005)) or 7% withholding tax rate (the Chile-Colombia Income and Capital Tax Treaty
41. See Legislative Proposal 198 of 2007, supra n. 5. Article 14 of the UN Model applies two alternative tests: (1) regular fixed base, and (2) the 183-day rule.
(2007)). The concept of “beneficial owner” is also included in the dividend provisions of all of these tax treaties. In the Chile-Colombia (2007) and the Colombia-Switzer-land (2007) Income and Capital Tax Treaties, article 10, which deals with the lower tax rate for substantial share-holdings, applies if the payment is received by a company holding directly the capital of the company making the payments. Conversely, in the Canada-Colombia (2008) and the Colombia-Spain (2005) Income and Capital Tax Treaties, such ownership may be direct or indirect. The dif-ferences in these percentages and direct and/or indirect shareholdings arise from the treaty negotiations and, for the Constitutional Court, the percentages are not contrary to the Constitution, as the rates are the result of the applic-ation of the principle of reciprocity.42
A 0% withholding tax rate on dividends also applies to di-vidends that are exempt in Colombia (see article 10 of the Protocol to article 10 of the Chile-Colombia (2007) and the Colombia-Spain (2005) Income and Capital Tax Trea-ties). Accordingly, dividends paid to foreign companies or entities not domiciled in Colombia are subject to a 0% withholding tax rate when the dividends are exempt from Colombian income tax, provided that the dividends are reinvested in Colombia for a minimum period of three years.43 A further different approach can be found in the
Protocol to article 10 of the Canada-Colombia Income and Capital Tax Treaty (2008), where a 15% withholding tax rate applies if the dividends are exempt in Colombia from income tax and insofar as the effective beneficiary of these dividends is a Canadian resident shareholder.44
The Colombia-Switzerland Income and Capital Tax Treaty (2007) contains none of these provisions.
The Constitutional Court has not lodged any objections to the addendums to these tax treaties. However, in its constitutional review of the Canada-Colombia Income and Capital Tax Treaty (2008), the Constitutional Court provided further explanation regarding the use of this approach by Colombia. Specifically, the Constitutional Court stated that, in order to encourage foreign invest-ment, dividends received by Colombian residents are exempt from tax in Colombia.45 However, the foreign
resident shareholder must pay tax in Canada and, if there is no taxation at source, the foreign resident shareholder (taxpayer) in Canada cannot claim a credit in respect of the dividends.46
The Constitutional Court also acknowledged that this affects the principle of reciprocity between states, as the only beneficiaries of reduced withholding tax on these di-vidends are the foreign resident taxpayers in Canada and not Colombian residents. However, for the Constitutional Court, by introducing this addendum to the Protocol, the taxpayer (investor) is protected given that the decision to exempt dividends is part of the domestic tax policy of
42. Decision C-577/09 (26 Aug. 2009), at para. 6.2.3.
43. Protocol ad Art. 10 Colom.-Spain Income and Capital Tax Treaty. 44. Protocol ad. Art. 10 Can.-Colom. Income and Capital Tax Treaty.
45. Arts. 48 and 49 Tax Code.
Colombia and is independent of the subject and the source of these dividends.47
4.4. Interest, royalties and the MFN clause in tax treaties
4.4.1. Initial comments
Colombia follows the UN Model by including a with-holding tax in articles 11 and 12 on interest and royal-ties, respectively. The tax treaties concluded by Colombia (including those that are in force) also require the recipient to be the beneficial owner so as to counter treaty shopping.
4.4.2. Interest
As of 1 January 2013, interest paid to a foreign resident that cannot be attributed to a PE or branch in Colombia is subject to a withholding tax rate of 33%.
In the Canada-Colombia (2008), Colombia-Spain (2005) and Colombia-Switzerland (2007) Income and Capital Tax Treaties, the withholding tax rate for interest is reduced to 10%. In the Chile-Colombia Income and Capital Tax Treaty (2007), a distinction is made between 5% for inter-est, where the recipient (the beneficial owner) is a bank or an insurance company and 15% in other cases. According to the Constitutional Court, the approach in this provision is in accordance with the Constitution.48
The Colombia-Spain (2005) and Colombia-Switzer-land (2007) Income and Capital Tax Treaties provide for an additional article 11(3), which states that the interest can only be taxed in the residence state if one of the fol-lowing conditions is met: (1) the beneficial owner is the contracting state or one of its political subdivisions or local authorities; (2) the interest paid relates to an instal-ment sale (venta a crédito) of merchandise or equipinstal-ment in respect of a company of a contracting state; or (3) the interest paid relates to loans provided by a bank or any other credit institution resident in the contracting state. The Constitutional Court did not refer to this provision, but, in principle, it can safely be argued that the provision is also the result of treaty negotiations between contract-ing states and, therefore, is in accordance with the prin-ciple of reciprocity.
4.4.3. Royalties
As of 1 January 2013, royalties paid to a foreign resident that cannot be attributed to a PE or branch in Colombia are subject to a withholding tax rate of 33%. No definition of royalties is provided for in the Tax Code.
In general terms, the provisions of Colombia’ s tax trea-ties regarding royaltrea-ties follow the UN Model (2001) in that withholding tax is applied at source. In the Canada-Colombia (2008), Chile-Canada-Colombia (2007), Canada- Colombia-Spain (2005) and Colombia-Switzerland (2007) Income and Capital Tax Treaties, the withholding tax rate is 10%. If the royalties arise via a PE situated in, or that undertakes
47. Id.
48. Decision C-577/09 (26 Aug. 2009), at para. 6.2.3.
independent personal services in, the other state from a fixed base, the royalties article does not apply and, instead, article 7 regarding business profits or article 14 regarding independent personal services (UN Model) is applicable (see section 4.2.).
Payments made to foreign residents for technical services, management fees, commissions and rental payments are also subject to withholding tax at a rate to be determined by the government, but that cannot exceed 20%. At the time of the writing of this article, this percentage was 10%. Article 12 of the Canada-Colombia (2008), Chile-Colom-bia (2007), ColomChile-Colom-bia-Spain (2005) and ColomChile-Colom-bia-Swit- Colombia-Swit-zerland (2007) Income and Capital Tax Treaties includes payments made for technical services, technical assistance, and consultancy services in the royalties’ definition. Such payments are not included in the relevant definitions of the OECD Model or the UN Model.
4.4.4. MFN clause
Another specific feature of the tax treaties concluded by Colombia is MFN clauses. An MFN-type provision states that, if Colombia concludes a tax treaty with another (third) state in respect of which Colombia grants a reduced percentage or an exemption, this percentage or exemp-tion automatically applies to the tax treaty concluded by Colombia with the other (second) state.49 It is submitted
that Colombia does not explicitly use the term “MFN” in the text of tax treaties or in related protocols, but the con-sequences are the same.50 At the time of the writing of
this article, such an MFN-type provision had been intro-duced in the Protocols to the interest and royalties art-icles in the Canada-Colombia (2008), Chile-Colombia (2007), Colombia-Spain (2005) and Colombia-Switzer-land (2007) Income and Capital Tax Treaties.
The Constitutional Court, in its review of the constitu-tionality of the Canada-Colombia (2008)51 and
Colom-bia-Switzerland (2007)52 Income and Capital Tax
Trea-ties, considered the use of such an MFN-type provision in light of the principle of reciprocity. The Court stated that, even though the application of this clause is contrary to the principle of reciprocity, as the only country that ben-efits from this clause is the other contracting state and not Colombia, based on an analysis of the treaty provisions and the Protocol as a whole this does not run counter to the principle of reciprocity. Nevertheless, the Constitu-tional Court called for the government and the legislature to evaluate the use of such MFN clauses in international treaties and specifically in tax treaties.53
49. Protocol ad art. 12 Chile-Colom. Income and Capital Tax Treaty. 50. Tax treaties may include an MFN clause. In this way, the application of the
provisions of a favourable tax treaty can be extended to other tax treaties signed by the country of the taxpayer.
4.5. Treaty anti-abuse clauses
4.5.1. Anti-abuse clauses: limitation of benefits and main purpose test
Until recently (December 2012), at the domestic level, Colombia did not have specific rules regarding abuse and, therefore, the doctrine that holds that private law should be followed for tax law purposes in such circum-stances applied. By means of this doctrine, the intention of the parties is followed if that intention deviates from the arrangement that the parties have purported to enter into.54
Law 1607 introduced two abuse rules for tax purposes. The first rule relates to abuse in general and the second to fraus legis (fraude a la ley). There will be a presumption of abuse or fraus legis where an operation takes place in accordance with two or more of the following criteria: (1) the opera-tion is between related parties; (2) the operaopera-tion makes use of tax havens;55 (3) the operation includes a special entities
regime or an exempt tax entity; (4) the price agreed differs by more than 25% from the arm’ s length price; and (5) the conditions agreed by the parties would not have been agreed by third parties in similar circumstances. In these circumstances, the burden of proof lies with the taxpayer. In cases of abuse, the tax administration may recharac-terize a transaction as if the abusive behaviour had not taken place. Law 1607 also states that the tax administra-tion may guarantee the applicaadministra-tion of the constituadministra-tional principle of substance-over-form in cases that are of sig-nificant economic and legal importance to Colombia. No further specifications are given in regard to defining or clarifying this last provision.
At the tax treaty level, Colombia has introduced the term beneficial owner for dividends, interest and royalties in the tax treaties with Canada, Chile, Spain and Switzerland. In addition, following the OECD Model, Colombia has made use of other anti-abuse clauses in some tax treaties. Accordingly, article 26 of the Canada-Colombia (2008) and article 27 of the Chile-Colombia (2007) Income and Capital Tax Treaties provide for the following anti-abuse clauses: (1) a limitation on benefits (LoB) clause,56
except where the transaction is undertaken for commer-cial reasons; and (2) a main purpose test. These provi-sions have been partially followed in other tax treaties, for
54. J. Paniagua-Lozano, Jorge & H. Mayorga-Arango, Colombia, Form and substance in tax law, IFA Cahiers de Droit Fiscal International vol. 87a, sec. 2. (SDU Uitgevers 2002), Online Books IBFD.
55. Law 1607 introduces new rules that aim to tackle the abuse of tax havens (art. 117 amending art. 260-7 Tax Code). Law 1607 allows the government to identify tax havens based on one of the following criteria: (1) low or no tax; (2) lack of effective exchange of information; (3) lack of transpar-ency; and (4) lack of real activity or economic substance. The government may also use international standards as a reference to determine what is a tax haven. However, there is no further definition of international standards or reference to the OECD. The reason may be the position of the Constitutional Court with regard to the list of tax havens as defined by the OECD. See CO: CC, 12 Aug. 2003, Decision C-690.
56. LoB clauses “generally provide a ‘ safe haven’ test based on share ownership by treaty country residents coupled with restrictions to insure that the corporation has not reduced its tax base in the residence country through deductible payments”. P. McDaniel, H.J. Ault & J. Repetti, Introduction to United States International Taxation 5th ed., p. 183 (Kluwer L. Intl. 2005).
example, article 21 of the Colombia-Switzerland Income and Capital Tax Treaty (2007) includes an LoB clause that allows for the taxpayer to prove that the transaction was carried out for commercial reasons. The Colombian gov-ernment has not (to date) provided an explanation for why these provisions have been included in these tax treaties. However, it is arguable that this may be the result of treaty negotiations. Until now, the Constitutional Court has held that such treaty anti-abuse clauses are in accordance with the Constitution.57
4.5.2. Anti-abuse clause to counter the improper use of tax treaties
The Canada-Colombia (2008) and the Chile-Colombia (2007) Income and Capital Tax Treaties contain an anti-abuse clause to counter the improper use of the tax treaty. In the event of abuse, the relevant treaty provisions may be subject to renegotiation by the parties. Article 27(4) of the Chile-Colombia Income and Capital Tax Treaty (2007) provides for a more comprehensive provision. It states that, if abuse is present, the competent authorities may, by means of mutual agreement, recommend specific changes to the tax treaty and, if necessary, modify it. Article 26(4) of the Canada-Colombia Income and Capital Tax Treaty (2008) adopts this approach, but, in case of abuse, provides for a toned down provision pursuant to which the com-petent authorities may discuss possible modifications to the tax treaty. The Constitutional Court has not raised any objections to such anti-abuse clauses.58
4.6. Capital gains
Until recently (December 2012), capital gains resulting from the sale of (fixed) assets held by corporations (foreign or domestic) and non-resident individuals for a period longer than two years were subject to a tax rate of 35% (articles 313 and 316 of the Tax Code). Law 1607 reduces the capital gains tax rate to a single flat rate of 10% for all companies and individuals whether or not resident for tax purposes in Colombia.
In principle, the Canada-Colombia (2008), Chile-Colom-bia (2007), ColomChile-Colom-bia-Spain (2005) and ColomChile-Colom-bia-Swit- Colombia-Swit-zerland (2007) Income and Capital Tax Treaties contain a capital gains provision that follows the OECD Model. However, the Canada–Colombia (2008) and Chile– Colombia (2007) Income and Capital Tax Treaties intro-duced additional provisions to article 13(4) that deviate from the OECD Model. Article 13(4) of the OECD Model gives the taxing right to the source state in respect of gains derived by a resident of a contracting state from the alien-ation of shares deriving more than 50 per cent of their
57. See, for example, Decision C 295/12 (18 Apr. 2012), regarding the
Can.-Colom. Income and Capital Tax Treaty, at para. 9.5.18 and Decision C 577/09 (26 Aug. 2009), regarding the Chile-Colom. Income and Capital Tax Treaty, at para. 6.2.3.
58. See, for example, Decision C 295/12 (18 Apr. 2012), regarding the
value directly or indirectly from immovable property situ-ated in the other state.
The Canada-Colombia Income and Capital Tax Treaty (2008) adds to article 13(4) two additional provisions. The following gains derived by a resident of one state may be taxed in the source state:
(1) an interest in a partnership, trust or other entity, deriv-ing more than 50 per cent of its value directly or indi-rectly from immovable property situated in the source state; or
(2) shares or other rights in the capital of a company that is a resident of the source state, where the resident of the first-mentioned state (residence state) owned, at any time within the 12-month period preceding the alienation, directly or indirectly 25 per cent or more of the capital of that company.
The Chile-Colombia Income and Capital Tax Treaty (2007) introduces to article 13(4) a similar provision as that of the Canada-Colombia Income and Capital Tax Treaty (2008) for capital gains on shares or other rights in the capital of a company (provision (2) above). However, in this case, the percentage of direct or indirect participation in the capital of the company is 20% (instead of 25%). The provision was not included in the Chile-Colombia Tax Treaty.
Furthermore, the Chile-Colombia Income and Capital Tax Treaty (2007) states that the percentage of taxation at source for the capital gains on shares (provision (2)) should not exceed 17% of the total amount of the gain. Until now, the Constitutional Court has held that such additional provisions in article 13(4) are in accordance with the Constitution.59
4.7. Arbitration and the dynamic interpretation of treaty provisions
The Constitutional Court, in reviewing the Colombia-Switzerland Income and Capital Tax Treaty (2007), stated that reference to the Commentaries on the OECD Model is not mandatory either for the purpose of interpretation of a tax treaty in regard to international tax disputes or in regard to interpretation by the tax authorities or taxpayers in domestic tax disputes. At that time, the Court stated that to make the OECD Commentaries mandatory would go against the principle of legality, as the OECD Commentar-ies do not have the force of law. This has been reinforced by the fact that the OECD Commentaries are derived from an organization, i.e. the OECD, of which Colombia is not a member.60
However, it may be argued that this approach could change in the future, as Colombia is seeking to become an OECD member country.61 If membership is granted
59. See, for example, Decision C 295/12 (18 Apr. 2012), regarding the
Can.-Colom. Income and Capital Tax Treaty, at para. 9.5.11 and Decision C 577/09 (26 Aug. 2009), regarding the Chile-Colom. Income and Capital Tax Treaty, at para. 6.2.3.
60. Decision C-360/10 (16 June 2010), regarding the Colom.-Switz. Income and Capital Tax Treaty, at para. 5.3.2.
61. Law 1479 of 2011 of 28 September 2011, approved by Decision C 417/12 (6 June 2012).
and is approved by the Constitutional Court, the OECD Commentaries could be used in interpreting tax treaties. If so, the question would be whether or not Colombia would adopt a static or a dynamic approach to the use of the OECD Commentaries for the purpose of interpreting tax treaties.62
It is submitted that the approach would most likely be static based on the traditional approach (see section 3.) of the Constitutional Court regarding the interpretation of OECD Model provisions and for the following two reasons. First, the Constitutional Court has accepted, in respect of the Canada-Colombia (2008) and the Chile-Colombia (2007) Income and Capital Tax Treaties, that in regard to abuse of treaty provisions, the parties may agree on changes to the tax treaty, but has not said anything regarding the use of the latest version of the OECD Com-mentaries to introduce those changes. Second, the Consti-tutional Court attaches great importance to the principle of reciprocity in its constitutional review of tax treaties and, therefore, the outcome of such a consideration would run counter to the principle of reciprocity. The argument is that it would be against the principle of reciprocity to make use of a dynamic interpretation that could bring about results that had not been agreed by the parties. The tax treaties concluded by Colombia with Canada, Chile, Spain and Switzerland refer to a mutual agreement procedure (MAP) between competent authorities. The Constitutional Court has agreed with such an approach, stating that the MAP is part of the settlement of disputes between parties given the bilateral nature of a tax treaty.63
Colombia has not, however, included the use of binding arbitration with regard to a taxpayer in accordance with article 25(5) of the OECD Model in its tax treaties. Article 25(5) provides for a MAP and, if it is not possible to reach agreement within two years, there is a possibility for (binding) arbitration at the request of the taxpayer.64
62. The dynamic approach results in the application of the OECD Model: Commentaries existing at the time that a tax treaty is applied, whereas the static approach results in the application of the OECD Model: Commentar-ies at the time that a tax treaty is concluded.
63. See, for example, Decision C 295/12 (18 Apr. 2012), regarding the
Can.-Colom. Income and Capital Tax Treaty, at para. 9.5.16 and Decision C-577/09 (26 Aug. 2009), regarding the Chile-Colom. Income and Capital Tax Treaty, at para. 6.2.3.
64. Article 25(5) of the OECD Model Tax Convention on Income and on Capital (22 July 2010), Models IBFD reads as follows: “Where, a) under paragraph 1, a person has presented a case to the competent
authority of a Contracting State on the basis that the actions of one or both of the Contracting States have resulted for that person in taxation not in accordance with the provisions of this Convention, and
b) the competent authorities are unable to reach an agreement to resolve that case pursuant to paragraph 2 within two years from the presentation of the case to the competent authority of the other Contracting State,
5. Recommendations Regarding International Treaty Policy
Colombia has, to a great extent, made use of the OECD Model in concluding tax treaties with countries like Canada, Chile, Spain and Switzerland. These tax treaties have been the subject of constitutional review by the Con-stitutional Court, which occurs after the tax treaty has been signed. Sometimes, as result of the constitutional review, it may take one or two years for a tax treaty to enter into force. The Constitutional Court approves tax treaties primarily on the basis of the principles of legality and reciprocity. The approach of the Constitutional Court has changed in the last 10 years. In analysing Law 788 of 2002, the Consti-tutional Court declared that a provision regulating low-tax or tax haven jurisdictions introduced by means of Law 788 of 2002 was incompatible with the Constitution.65 In order
to define these jurisdictions reference was made by the leg-islature in Law 788 to the areas considered to be such by the OECD. The Constitutional Court held, at that time,66 that
this provision was incompatible with the Constitution, as Colombia was not an OECD member country and, there-fore, the provisions did not have any effect in Colombia. This approach changed in 2005 when Colombia started negotiating tax treaties. The Constitutional Court now favours the OECD Model even though Colombia is not yet an OECD member country. Colombia is currently seeking OECD membership and, therefore, the government has made use of the OECD Model and definitions in its tax treaties and domestic law, for example, the PE concept in accordance with OECD standards and the place of effec-tive management rule to determine the residence of cor-porations.
It is arguable that the main source for analysing the in-ternational tax policy of Colombia is the decisions of the Constitutional Court and the constitutional reviews of tax treaties. However, these decisions have evolved since the constitutional review of the Colombia-Spain Income and Capital Tax Treaty (2005). This article, therefore, has pro-vided a short overview of the tax treaties concluded by Colombia and approved by the Constitutional Court. It should also be pointed out that the negotiation of tax treaties is a recent development in the international tax policy of Colombia.
The introduction of transfer pricing rules in 2003, in force as of 1 January 2004, resulted in an increase in the inter-est of the government in introducing further rules in ac-cordance with international tax law developments, such as rules amending the free trade zone regime, the repeal of the remittance tax and the deduction of expenses incurred abroad in obtaining Colombian-sourced income.
65. This Law introduced transfer pricing rues into Colombian tax law. Accordingly, entities carrying out transactions affecting transfer pricing in low-tax or tax haven jurisdictions are deemed not to have carried out their transaction in accordance with the arm’ s length principles. For an explanation of the transfer pricing provisions see Mosquera Valderrama,
supra n. 2.
66. CO: CC, 12 Aug. 2003, Decision C-690.
However, it is the author’ s opinion that these rules are rare and do not reflect a consistent international tax policy. Until recently (December 2012), international tax law pro-visions were rare in the Tax Code, for example, the lack of a PE definition. The Tax Code did not contain anti-abuse provisions that may be applied in domestic and cross-bor-der situations.
Law 1607 introduced substantial changes to the Tax Code effective 1 January 2013. These changes include the intro-duction of a PE definition and new criteria in respect of the residence of individuals and companies that, to a great extent, accord with the OECD Model. These changes rep-resent a significant step forward towards aligning Colom-bian tax rules with international tax standards. Colombia has also decided to take steps to counter abuse by means of anti-abuse rules for tax purposes, which include thin capitalization rules, a general anti-abuse clause and a spe-cific fraus legis clause, and by making it possible for the gov-ernment to define tax havens and to effectively exchange information.
It is submitted that all of these changes are positive and that they should be introduced. However, Law 1607 still requires constitutional review. Further, regulations from the tax administration to implement the provisions of Law 1607 are expected. In the meantime, Colombia continues to negotiate and conclude tax treaties. The questions will then be whether the changes will have an effect on the tax treaties that are currently at an advanced stage of negotia-tion, for example, the Colombia-Netherlands Income Tax Treaty and whether Colombia will be willing to recom-mence negotiations in respect of the tax treaties that have not yet been signed or simply to make use of the amend-ments in future negotiations.
Third, it may be argued that the economic starting point is not determined by Colombia, but, rather, is imposed by the countries with which Colombia has concluded tax treaties, i.e. Canada, Chile, Spain and Switzerland. The two issues in respect of which Colombia may have a strong position relate to (1) the construction PE clause, which, in contrast to the 12-month period in the OECD Model, is six months, as in the UN Model, and (2) the introduction of article 14 of the UN Model in respect of independent personal ser-vices. Examples of the strong position of other countries are treaty provisions that provide for a 0% withholding tax on dividends on substantial shareholdings (20% or 25%), an MFN-type provision in respect of interest and royalties, and the introduction of treaty anti-abuse clauses, such as LoB clauses and a main purpose test clause.
deter-mined by the other contracting states, i.e. Canada, Chile, Spain and Switzerland. These countries have more experi-ence in concluding tax treaties than Colombia, which only started concluding tax treaties in 2005. The concern is that, once a tax treaty has been concluded, it will be difficult to amend it and, therefore, the conditions agreed by
Colom-bia will apply in the future. Accordingly, further research is recommended in respect of the domestic tax policy of Colombia and, more specifically, regarding the tax pro-visions that must be addressed in tax treaties and on the effect of tax treaties on investment in Colombia.
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