December 7, 2021
Colombia and Uruguay sign double tax treaty
The treaty includes reduced withholding tax rates on passive income, permanent establishment rules and rules for taxing capital gain.
On November 19, 2021, the governments of Colombia and Uruguay signed a double tax treaty (DTT). The DTT includes provisions that may reduce taxation on transactions and investments between both countries.
Principal purpose test and anti-abuse rules
In line with the OECD's Base Erosion and Profit Shifting (BEPS) initiative, the preamble of the DTT states that its purpose is to eliminate double taxation on income without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including treaty shopping). In addition, the DTT includes an anti-abuse clause that contains limitation-of-benefits rules, a principal-purpose-test clause, and provisions to prevent abuses through triangular transactions that involve permanent establishments (PEs) / branches, located in jurisdictions other than Colombia and Uruguay.
Under the DTT, a construction PE will exist if the project lasts more than 90 days, which is a lower period than that provided by the OECD Model Tax Convention. A service PE will exist if services are rendered for more than 120 days.
Additionally, the DTT broadens the scope of the agency PE to include situations in which the agent habitually plays the principal role in concluding contracts that are routinely completed without material modifications by the enterprise. The DTT also establishes that all exceptions for specific activities must meet the requirement of being preparatory or auxiliary. Following the BEPS guidelines, the DTT establishes anti-fragmentation rules for preparatory or auxiliary activities. In addition, the DTT includes special provisions that may lead insurance companies to generate a PE in the Contracting State where they collect premiums or where the risks they insure are located.
Taxation on passive income
The DTT includes reduced withholding tax rates for certain items of passive income as follows:
The definition of dividends includes profit allocations made by PEs (including branches) to their home offices that are treated under local regulations as dividends (as in Colombia).
Dividend distributions made out of profits that were not taxed at the corporate/PE level may be taxed in the Contracting State where the distributing company is a resident or the PE is located. This provision applies to dividends distributed out of profits that were not subject to taxation in Colombia (according to Article 49 of the Colombian Tax Code) and are subject to the so-called recapture tax.
Capital gains (transfer of shares or participations)
Capital gains derived from the transfer of shares or participations in an entity or trust will be taxed in the source State as described below:
The DTT states that income derived from the transfer of rights that directly or indirectly grants the owner the right to use real estate located in the other Contracting State (e.g., Colombia) may be taxed without limitation in such Contracting State (Colombia).
Additionally, the DTT provisions cannot prevent a Contracting State from taxing indirect transfers of assets in accordance with its domestic law, when the value of the assets located in the Contracting State represent more than 50% of the total value of the assets held by the transferred entity.
Although the DTT includes wealth tax provisions, those provisions will not be effective unless both countries impose a wealth tax (currently, Colombia does not have a wealth tax). In addition, the benefits included in the DTT for wealth tax purposes are focused on ships and aircraft engaged in international traffic. The DTT also provides for the possibility that the wealth tax paid in a Contracting State may be claimed as a tax credit against the wealth tax levied in the State of Residence.
For the DTT to enter into force, the Colombian Congress must approve it through a law. Subsequently, the Constitutional Court must review the constitutionality of the law. Once the internal approval procedures are fulfilled, the countries will proceed with the exchange-of-letters procedure to confirm they concluded their domestic procedures for ratifying the DTT.