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The Council of State's interpretation of the general requirements for interest deductibility may allow taxpayers to claim deductions for interest expense on loans used to acquire shares. These deductions were previously denied under the Colombian Tax Authority's interpretation of the requirements. To claim those deductions, however, taxpayers will need to demonstrate compliance with the general deductibility requirements based on the specific facts and circumstances of their case.

On July 29, 2021, Colombia's Council of State (the highest tax court)¹ annulled an opinion by the Colombian Tax Authority (Official Opinion No. 005739 of 2019) that denied income tax deductions for interest on loans used to acquire shares in a company. In the opinion, the Colombian Tax Authority also concluded that the same treatment would apply if the target company subsequently merged into the acquirer (which held the debt for the loan).

Background

Colombian corporations may generally deduct, for corporate tax purposes, expenses that are incurred during the tax year and: (i) are necessary expenses, (ii) have a cause-effect relationship with the corporations' income-producing activity, and (iii) are proportionate or reasonable.

In Official Opinion No. 005739 of 2019, the Colombian Tax Authority concluded that interest expense on a loan used to acquire shares in a company did not meet the general requirements for deductibility. In reaching this conclusion, the Tax Authority noted that interest expense could not qualify as necessary to a share acquisition. Additionally, it noted that the interest could not have a cause-effect relationship with the taxpayer's income-producing activity but did not specify the specific scenario in which the cause-effect relationship requirement was not met.

The opinion was challenged before the Council of State on the grounds that the Tax Authority's interpretation violated Colombian law by denying interest deductions for loans used to acquire shares without analyzing in detail whether the general deductibility requirements were met.

Analysis

The Council of State noted that Colombian law does not generally restrict or limit deductions for interest on loans used to acquire shares; as long as the general deductibility requirements are met, the interest expense is deductible for income tax purposes.

Disagreeing with tax authorities, the Council concluded that a cause-and-effect relationship could exist between a taxpayer's interest expense and its income-producing activity even though none of the income from its business is related to the interest expense.

To make that determination, however, the Council of State concluded that it is necessary to consider the facts and circumstances of the taxpayer's situation, particularly the reasons for the share acquisition and how that acquisition relates to the taxpayer's business. In support of this conclusion, the Council of State cited a case in which a taxpayer's interest expense met the deductibility requirements based on the taxpayer's specific facts and circumstances (the acquisition of the shares involved an expansion of the taxpayer's income-producing activity).²

Finally, the Council of State stated that the same facts-and-circumstances analysis would apply if the target company subsequently merges into the acquirer (which held the loan).

Implications

The Council's decision rejects a narrow interpretation of the deductibility rules for taxpayers that purchase shares using loans. By introducing a facts-and-circumstances-based approach, the Council allows for a broader interpretation of the requirements. This interpretation may make it easier for taxpayers to claim interest expense deductions, provided they can demonstrate compliance with the general deductibility requirements. In developing their arguments, taxpayers may want to consider other rules affecting interest deductibility, such as thin capitalization, transfer pricing, nexus with non-taxable dividends and anti-abuse rules, as well as the general deductibility requirements.

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ENDNOTES

¹ Council of State, Decision No. 25346 of July 29, 2021 (Case No. 11001-03-27-000-2020-0017-00).

² Council of State, Decision No. 21329 of November 26, 2020 (case No. 25000-23-37-000-2013-00443-01).