Colombia

Ximena Zuluaga and Ricardo Ruiz
Ernst & Young
Colombia

Ximena Zuluaga and Ricardo Ruiz of Ernst & Young comment on the recent tax reform bill submitted to Congress, its impact on foreign investment and its interaction with existing investment incentives and protection measures.

A new tax reform bill (the proposed reform) was submitted to the Colombian Congress in an effort to prevent a decrease in future revenues.

Government policy

As of 2002, positive economic indicators have been observed in Colombia as a consequence of the measures adopted by the government and supported by Congress. Among others, President Uribe's Democratic Security Policy and the regulatory benefits provided to attract foreign investment, resulted in continuous growth , reaching its peak in 2007, when GDP grew by 7.5%.

As a consequence of the world economic downturn, a decrease in growth will affect the State's revenues for 2010. In fact, the government expects a decrease from 16.1% to 14.5% in Colombian GDP. In addition, from 2011 Colombia's fiscal revenues shall suffer a strong impact from the expiration of the national equity tax (Net) . To the extent it is a priority for the Colombian government to obtain new revenue sources; three major fiscal adjustments are introduced in this proposed reform:

A new Net applicable for fiscal years 2011, 2012, 2013 and 2014. A collection of COP$1.3 billion ($637 million). Although this tax would be new from the legal standpoint, in general, the rationale behind the government proposal is to exten of the Net with some adjustments:
A reduction of 10% on the capital allowance granted for acquiring real and productive fixed assets (RPFA). This special deduction is 40%. $700 million ($343 million) of tax savings have been forecasted.
This tax benefit was created to promote economic growth and increase employment through investments in RPFA, by providing a 40% deduction to individuals and legal entities over the amount of actual investments in RFPA, in the year that the investment is made, in addition to the normal 100% depreciation, which effectively provides for a 140% deduction on the asset's cost. This means that government's contribution for the acquisition of RPFA would be of $9.90 for each $100 being invested. This benefit is extended to the shareholders at the time of distribution of the corresponding dividends (real savings – it does not create taxable profits for the shareholders).
This special deduction is lost if the RPFA is no longer used in the income producing activity, or if it is sold before the expiration of its useful life. In this case, the taxpayer must reverse the tax benefit received pro rata of the asset's remaining useful life at the time the transfer, or change in use, is verified (the taxpayer must recognise the amount as taxable income).
Eliminate the capital allowance granted for acquiring RPFA to taxpayers qualified for an industrial free trade zone. The corporate tax rate applicable to such taxpayers is 15% (vs general 33% rate). This limitation was already being promoted through a separate bill proposed to Congress.

Diagram 1: Colombia’s GPD growth (Variation)

Interaction with other measures

Legal stability agreements

The objective of legal stability agreements (LSA) is to guarantee investors that their investments will not be adversely affected by changes made to laws, regulations or rulings listed by the taxpayer relevant for the investment in Colombia for up to 20 years. Therefore, if the stabilised provision is subject to an unfavourable modification, the investor is allowed to continue applying it as enacted at the date of the LSA throughout the term of the contract period. However if the change in the law is favourable to the investor, he may apply the new favourable law.

The legal stability regime is based on a negotiation with the government, consisting of an agreement on the contract terms and scope. The applicable law (963 of 2005) does not anticipate negative consequences for the petitioner such as penalties, if the latter finally decides not to execute the agreement that the government has submitted to him. In other words, as in any negotiation, a risk exists that agreement is not reached and, accordingly, that the LSA is not entered into.

Once the LSA is executed with the Colombian government, investors shall have to pay a premium of 1% over the value of the investment (0.5 % if the investment is in an unproductive period) which in our interpretation, is deductible for income tax calculation purposes.

Rules stabilised by foreign investors

Although an LSA provides stability for most of the Colombian provisions, provided that the investor demonstrates that these were relevant to the investment decision, usually foreign investors who apply for LSAs are more interested in obtaining protection against changes in the tax provisions. In our experience, these are the most requested provisions included in the LSA application, whose stabilisation has been granted:

Article 147 of the Colombian Tax Statute (CTS). The possibility of NOLs carry forward without time or amount limitations (in the past, the carry forward has been limited in time and percentage of the amount to be used in each individual tax period).
Article 158-3 of the CTS (capital allowance). Probably is the most important general benefit, taking into account its direct impact on income tax results.
Article 245 of the CTS. Distribution of profits to foreign shareholders without paying a dividend tax (formerly 7%), taking into account its reduction to zero rate in 2006.
Article 319 of the CTS. No remittance tax (formerly 7%) on branch's profits, taking into account the elimination of this tax in 2006.
Article 25 of the CTS. Foreign debt obtained by domestic, foreign and mixed enterprises or domestic trusts with foreign creditors are not sourced in Colombia for tax purposes (no withholding on interest payments), to the extent the activities undertaken by the them are considered of interest for economic and social development of Colombia. In general, the latter activities cover sectors such as primary, manufacturer and some services. Restrictions exist to commercial activities and certain types of services, pursuant to recent judicial precedents.
The temporary nature of Net up to 2010.

Interaction with the proposed reform

It is important to note that, up to August, 2008, 45 LSAs have been executed by the government; and more than 120 applications have been submitted to enter into an LSA. Hence, from the tax standpoint, this shall imply that the Proposed Reform will not have an impact on the latter 45 taxpayers to the extent they have stabilised:

The temporality of the NET; however, a final conclusion may only be reached depending on the legislative technique to be adopted by the Congress when issuing the law; in other words, the Congress may (a) amend the equity tax statute/provision in the CTS; or, may(b) insert a new statute/provision, causing a debate regarding its effects over LSA; and
The 40% capital allowance, including those qualified as industrial free trade zone users.

In particular cases, an LSA executed before the issuance of the NET (Law 1111 of 2006) has even prevented some taxpayers to be liable for that tax.

Double tax treaties

Spain

The only double tax treaty (DTT) in force in Colombia is the one between Colombia and Spain. The 2003 version of the OECD model convention was used as reference.

In principle, under article 21 only (i) immovable property in Colombia, (ii) movable property of a permanent establishment in Colombia, and (iii) ships, aircraft operated in international traffic, and movable property pertaining to the operation of the latter, if the place of effective management of the enterprise is situated in Colombia, should be taxed under the new Net that is being adopted by the Congress. However, since the Net law was issued before the DTT with Spain, no precedent exists with regard to the interpretation to be assumed by the tax authorities and the courts on this topic.

In case of shares or other rights in a company whose assets consist mainly of immovable property located in Colombia, no specific provision has been included in article 21. However, since Spain has made a reservation to protect its right to tax this kind of property in case of any immovable property located in Spain, Colombia may enter into a mutual agreement procedure to include these shares within the new Net basis.

No information has been released by the government on any future protocol to the DTT with Spain, taking into account that no Net existed at the moment the treaty was negotiated. However, it is important to note that a DTT is considered a law for internal purposes, so if Colombia decides to override the treaty law with the new tax law, it is not possible to anticipate the result since no judicial precedent exists. In any case, the mutual agreement procedure exists for any dispute.

Therefore, it is more likely that Colombia respects the convention executed with Spain to limit its taxing powers with regard to those Spanish taxpayers covered by the treaty. It means the impact of the proposed reform on Spanish taxpayers shall be reduced.

Andean community

Under the rare Andean Community (CAN) double tax treaty, article 17 provides that only the equity located within the territory of Colombia should be subject to the new Net.

To the extent there is no specific reference to immovable or movable property (as happened with the OECD type model), the new Net basis shall be narrower to include only immovable and movable property (including shares and intangibles) within Colombian territory. In addition, an official interpretation issued by the National Tax Authority (DIAN) provides that Colombian residents' shares of held on a CAN country are exempted for equity tax purposes in Colombia.

It is important to note that this treaty is applicable to residents of Colombia, Perú, Ecuador and Bolivia.

Bearing in mind that the Andean Community tax treaty is considered as a supranational provision, if the proposed reform is approved by Congress, no disputes or treaty override issues should arise.

Relations with other countries

Colombia has entered into several DTTs recently, but they must be ratified before they enter into force. The ratification process requires (i) the issuance of a domestic law by the Congress, (ii) Constitutional approval by the Constitutional Court, and (iii) an exchange of notes between governments involved in the DTT. Tax treaties that have already become domestic law are those with Chile (1261 of 2008) and Switzerland (1344 of 2009). The treaty with Canada is on the way to becoming domestic law. In addition, negotiations with Mexico are finalised.

Table 1
	Current equity tax	New equity tax
Description	It levies taxpayer’s tax net equity (asset minus liabilities) if greater than COP$ 3 billion at January 1 2007. However, this tax shall have to be paid in 2008, 2009 and 2010	It levies taxpayer’s tax net equity (asset minus liabilities) if greater than COP$3 billion at January 1 2011, 2012, 2013 and 2014
Basis	Net equity at January 1 of 2007. For years 2008, 2009 and 2010 a reference to the latter basis is required (fixed basis). Some restrictions apply to liabilities with related parties. Among others, shares and interests on companies domiciled in Colombia are excluded	Net equity at January 1 of 2011, 2012, 2013 and 2014 (dynamic basis). Liabilities with related parties would be disregarded. Among others, shares and interests on companies domiciled in Colombia are excluded
Rate	1.2% for years 2007, 2008, 2009 and 2010	0.6%
Covered by legal stability agreements (LSA)	Yes. However, since the proposed reform was submitted to the Congress, the government has limited its acceptance	No
Deductibility from income tax purposes	Non deductible. However, an accounting procedure may be used to prevent affecting the E&P