Originally Published January 2008

Colombia had two double taxation treaties, the first one with Spain, already approved by Congress through Act 1082 dated July 31, 2006, but pending favorable decision by the Constitutional Court about its constitutionality, and a second one with Chile, signed on April 19, 2007 and already presented to the Congress for its approval. Following the trend of constructing a treaty network, Colombia and Switzerland signed a double taxation treaty ("the Treaty") on October 26, 2007.

Although there are already three double taxation treaties signed, none of them is already applicable, considering that in order to be applicable in Colombia, any treaty (i) has to be approved by the Congress; (ii) the Act issued by the Congress containing the Treaty has to be sent to the Constitutional Court in order to decide about its constitutionality; (iii) both governments have to notify the other about the internal approval of the treaty.

It is expected that the proceedings with regard to the treaty with Spain will end in 2008, and thus the treaty would apply as from taxable year 2009. In the case of the other two treaties it is expected that Congress approve both during 2008, the Constitutional Court will probably decide about their constitutionality during 2009 for the treaties to be applicable in 2010. In any case, the applicability also depends on the proceedings in the other contracting countries.

With respect to its content, the following aspects of the treaty with Switzerland may be highlighted:

  1. Treaty model. As in the case of the treaties with Spain and Chile, the treaty with Switzerland is based on the OCDE model. Nevertheless such treaties apply UNO model variations (i.e. taxation on royalties), being the treaty with Chile the one with more elements from the UNO model (i.e. permanent establishment rules, transfer of stock, maintenance of article 14, etc.) while the other two follow OCDE guidelines more strictly.
  2. Taxes covered (Art. 2). The Treaty applies to residents in both signing states and covers income tax and net worth tax. From the Colombian perspective, income tax includes complementary taxes (i.e., capital gain tax). From the Swiss perspective, the Treaty covers all federal, communal and cantonal taxes on income and net worth.
  3. Permanent establishment (Art. 5). The Treaty includes the concept of permanent establishment (PE), which is alien to the Colombian tax regulations, except for the double taxation treaties with Spain and Chile and some similar regulations included in Andean Community Commission Decision 578 which contains rules to avoid double taxation among member countries (Bolivia, Colombia, Ecuador and Peru). For purposes of the Treaty, PE is understood as "a fixed business place through which a company carries out all or part of its activities". PE's definition will be applicable only for purposes of the Treaty and may not be applied to situations subject to other Colombian regulations.
  4. Income from immovable property (Art. 6).This type of income as well as any capital gain derived form the sale of immovable property will be taxed by the source country (i.e., where the property is located), which means that source country is allowed to tax income received by a resident of the other state.
  5. Business income (Art 7).Taxation on income of a company will be only taxed in the state in which the company has its residence, unless it performs activities in the other state (i.e. source country) through a PE but only with respect to income received by the PE.
  6. Dividends (Art. 10). The Treaty's general rule is that dividends paid to shareholders or partners of the other state should be subject to a maximum 15% withholding tax rate, and 0% if the shareholder or partner owns more than 20% of the shares or quotas of the company. Considering that in Colombia dividends paid out from profits taxed at corporate level to foreign shareholders or partners are not subject to taxation, the general rule does not have a practical application for such dividends paid by a Colombian company.
  7. Interest (Art. 11). According to the Treaty, interests paid abroad may be subject to an income tax withholding up to 10% by the source country, unless (i) beneficiary is the other contracting state; (ii) interests correspond to credit sales; or (iii) interests correspond to credits granted by a bank or any other financial entity. In any of such cases interests will be only taxable in the residence state. Per general Colombian rules, interests paid abroad are not subject to income tax withholding, and thus this rule has just a limited practical effect for interest payments from Colombia. This rule is similar to article 11 of the Treaty with Spain, but differs from article 11 of the treaty with Chile which sets forth that interests paid abroad may be subject to an income tax withholding up to 15% by the source country, unless paid to a bank or insurance company in which case the maximum withholding tax rate will be reduced to 5%.
  8. Royalties (Art. 12). The Treaty sets forth that royalties may be subject to taxation in the source country at a withholding tax rate up to 10%. Considering that in Colombia royalty payments abroad are subject to an income tax withholding of 33%, this rule has a very important practical application. This rule also applies to technical services, technical assistance services and consultancy services.
  9. Gains from the transfer of stock (Art 13). Any capital gain obtained in the transfer of stock may be taxed in the source country (i.e. where the company that issued the stock is located), only if the capital gain is originated in stock which value is related with immovable property in an amount equal or higher than 50%. This rule is similar to the one contained in the treaty with Spain but differs from the one in the treaty with Chile, which also allows to tax the gain in the source country if the tax payer has possessed at any moment in the previous twelve months shares or other rights representing more than 20% of the company's capital. The treaty with Chile also allows the source country to tax any gain from the sale of stock with a rate not higher than 17%.
  10. Anti abuse clause (Art 21).The Treaty sets forth that if a person resident in a contracting state receives an income from the other contracting state and transfers directly or indirectly at any moment at least half of such income to one or more persons not residents of such other contracting state, the Treaty does not apply to such income, unless (i) transferred to an unrelated party or; (ii) by transmitting it the income will have an equivalent or more favorable treatment. The treaty with Spain did not adopt any specific anti abuse clause, while the treaty with Chile adopted LOB clauses (i.e. Limitation of Benefit clauses), which have the same purposes, but with a different approach.
  11. Methods to avoid double taxation (Art 22). The Treaty adopted a tax credit method for the elimination of double taxation when a person resident in Colombia is subject to taxation in the other state. In the case of a person resident in Switzerland the treaty adopted the exemption method as a general rule, but it has special rules for dividends, interests and royalties allowing both the tax credit and the exemption method according to special Swiss regulations.

Value added tax; export of services.

The Council of State denied the VAT exemption for sales promotion services rendered by a Colombian company to foreign entities, supported on the following arguments:

  1. To consider that a service has been exported and thus is VAT exempted under literal e), article 481 of the Tax Code, the key factor is its "total and exclusive use outside from Colombia".
  2. When analyzing the agreements executed by the taxpayer with foreign entities, it was concluded that the rendering of the service agreed in some of the clauses and its use were exhausted in the Colombian territory, since the person who benefits from such service is the Colombian party (right to be granted a discount in products purchased to the foreign company; resale of products refunded by customers; possibility to purchase goods at a favorable price for the application of agreed discounts), which prevents to understand that the service is totally and exclusively used outside Colombia.
  3. Agreements do not have a clause establishing that services rendered would be totally and exclusively used abroad as set forth in article 23 Decree 380 of 1996 (applicable for the taxable period under discussion), aspect that excludes VAT exemption for the exportation, as consequence of the noncompliance with a legal requirement. (Council of State, Fourth Section, Decision of October 10, 2007, file 15839).

From the foregoing the following practical conclusions arise:

  1. Taxpayers have to be careful to fulfill formal requirements necessary to be granted the right to the exemption, considering that the lack of compliance leaves not only a problem of evidence but it may lead to the rejection of the benefit.
  2. The agreement, as key evidence, has to be clear regarding the exclusive use of the services abroad, excluding any mention that could leave any doubts in that regard, but in any case, reflecting the reality of the legal relation between the parties. Bear in mind that the sole use of the principal obligation abroad is not enough since all obligations derived from the contract have to be used abroad.

Legal stability contracts

Act 963 of 2005 contains the so-called Legal Stability Contracts, which are available for new investments or the expansion of the existing one in an amount higher than 150.000 UVTs ($3.308.100.000 for the year 2008; approx. US$1.650.000). Investors identify regulations and rulings considered as fundamental for the economic success of their investment with the purpose to include them in a Legal Stability Contract.

Regulations included in such a Contract will apply for the term of the agreement even in case that they are modified or even eliminated. Stability is granted to protect investors form adverse modifications only.

Stability is granted up to 20 years and investors have to pay a premium of 1% of the amount of the new investments.

At Lewin & Wills we are convinced about benefits that a Legal Stability Contract may bring to national and foreign investors and thus recommend seeking to execute such a Contract as part of the legal requirements of any new investment planned.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.