August 17, 2022
Colombia and Brazil signed double tax treaty
On August 5, 2022, the governments of Colombia and Brazil signed a Double Tax Treaty (DTT), aimed at avoiding double taxation on transactions and investments between both jurisdictions, as well as preventing tax evasion and avoidance. The DTT must complete the internal ratification process in both countries before it can enter into force.
The DTT's provisions are generally aligned with the standards of the United Nations (UN) and the Organisation for Economic Co-operation and Development (OECD), as well as the OECD's Base Erosion and Profit Shifting (BEPS) action plans.
The DTT is a welcome addition to both Brazil's and Colombia's DTT networks. Once the DTT enters into force, Brazil will have 38 DTTs in force while Colombia will have more than 14 DTTs in force.
The DTT covers the federal income taxes of both Contracting States, including Brazil's social contribution tax (CSLL), and Colombian complementary income taxes.
If a taxpayer has dual residence, taxation will be determined through a few factors, including the place of incorporation or headquarters and place of effective management, among other things.
Permanent establishment (PE)
Under the DTT, a construction PE will exist if the construction projects or activities last more than six months. A service PE will exist if the services are rendered for more than six months in a 12-month period.
Additionally, the DTT includes an anti-fragmentation clause for preparatory or auxiliary activities. Under that clause, the overall activity resulting from the combination of preparatory and auxiliary activities will not have an auxiliary or preparatory character if the activities constitute complementary functions that are part of a cohesive business operation.
The DTT broadens the agency PE concept to include scenarios in which the agent habitually plays a leading role in the conclusion of contracts, without significant modifications by the foreign enterprise.
The DTT also includes PE provisions for insurance enterprises. Under those provisions, if an insurance enterprise in one State collects premiums in the other State (source State), or insures risks located therein through a person other than an independent agent, the enterprise will have a PE in the source State. This provision does not cover the assignment of reinsurance premiums, which, according to the DTT, may be subject to withholding tax.
In addition, Brazilian domestic PE rules are not as broad, as they are focused mainly on agents, representatives or similar institutions carrying on business in Brazil, with powers to bind the foreign entity.
The DTT includes reduced withholding tax rates for certain items of passive income as follows:
Regarding dividends, although the DTT does not provide a 0% rate, amounts paid by a Brazilian entity after 1996 are not subject to withholding tax under current Brazilian tax legislation, regardless of the location of the beneficiary.
Several tax reform proposals are under discussion in Brazil, which could establish a 15% withholding tax on dividends paid to individuals and nonresident shareholders. In the case of Colombia, the recent tax reform proposal would increase the dividend tax rate from 10% to 20%.
Under the DTT, technical services/technical assistance and royalties are addressed in separate articles. Historically, DTTs signed between Brazil and other jurisdictions have treated technical services/technical assistance as analogous to royalties and applied, therefore, the same tax treatment. With the split into two separate provisions, more accuracy is expected in the application of the DTT. Considering that both articles provide for a reduced withholding tax rate of 10%, taxpayers in the technology/software industry should be aware of these provisions.
Capital gains (sale of shares or participations)
The DTT does not provide benefits on the direct or indirect disposal of shares or participations. Therefore, domestic rules will apply for these transactions.
The preamble of the DTT states that its purpose is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax avoidance or evasion, including treaty shopping.
In addition, the DTT includes an anti-abuse clause that contains a limitation of benefits (LOB) rule with which taxpayers must comply (in any of the scenarios provided by the LOB clause) for DTT benefits to apply. Even if taxpayers do not comply with the LOB rule, the competent authority of the Contracting State may grant the DTT benefits if the resident can prove that the principal purpose of its establishment, acquisition, maintenance or performance of its operations was not to obtain DTT benefits.
The DTT also contains a special rule for triangulations through a PE in a third jurisdiction (i.e., an enterprise of the resident State derives income from the source State and the Resident State attributes such item of income to a PE in a third jurisdiction).
The provisions of the DTT will not prevent States from applying their domestic rules against tax evasion and avoidance.
For the DTT to enter into force, Colombia's Congress must approve it as a law and Colombia's Constitutional Court must review the constitutionality of the law. Brazil's Congress (both Senate and Lower House) also must approve it as a law. Subsequently, Brazil's president must approve it, and then the treaty must be published to become officially enforceable. Once these procedures are completed, the countries will proceed to exchange the corresponding diplomatic notes, reporting that they have completed the required internal procedures.