08 April 2025 Luxembourg adopts draft legislation approving tax treaty with Colombia
On 2 April 2025, the Luxembourg Parliament approved the text of the draft law to ratify the Double Tax Treaty (Treaty) and the related Protocol between Luxembourg and Colombia, as signed on 19 January 2024. The next Luxembourg legislative step will be the publication in the Official Gazette (Memorial). The Treaty is largely based on the 2017 version of the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention (MTC), while also incorporating elements of the United Nations (UN) MTC. The Treaty was initially signed on 10 February 2022, but was not ratified. The wording of the Treaty remains unchanged compared to the original text. (For background, see EY Global Tax Alert, Colombia and Luxembourg sign double tax treaty, dated 31 March 2022.) In line with the OECD's recommendations from its Report on Action 6 of the Base Erosion and Profit Shifting (BEPS) Project, which aims to prevent the inappropriate granting of treaty benefits, the Preamble of the Treaty clearly states that its purpose is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including treaty-shopping arrangements aimed at obtaining relief provided in the Treaty for the indirect benefit of residents of third States). Furthermore, the principal purpose test included in the Treaty is designed to prevent misuse of the Treaty. It ensures that treaty benefits are not granted if one of the primary aims is to obtain these benefits in a way that contradicts the Treaty's objectives. Article 2 specifies the types of taxes covered by the Treaty. For Luxembourg, the Treaty covers personal income tax, corporate income tax, wealth tax and municipal business tax. For Colombia, it covers income tax and its complementary taxes. Article 4 of the Treaty defines the concept of the term "resident of a Contracting State" as a person that is liable to tax therein by reason of residence or a similar criterion. Recognized pension funds (as defined in article 3 of the Treaty and further clarified in the Protocol) may be considered residents under the Treaty. Article 4 also addresses situations of dual residence, which is crucial for determining the allocation of taxing rights between the two Contracting States. In line with the OECD MTC, if an entity other than an individual is considered a resident in both States, its residence for Treaty purposes is to be decided by mutual agreement between the competent authorities of the two Contracting States. They will consider factors such as the place of effective management, the place where the entity is incorporated or otherwise constituted, and any other relevant factors. If an agreement cannot be reached, the entity will not be eligible for the Treaty's benefits except to the extent and in the manner that the competent authorities of the Contracting States agree. In addition, the Protocol of the Treaty contains an additional clarification regarding Article 4. It specifies that a Collective Investment Vehicle (CIV) established and treated as body corporate (e.g., in Luxembourg as a société anonyme (SA) or société à responsabilité limitée (S.à r.l.)) for tax purposes will be considered as a resident of the Contracting State where it is established and will be regarded as the beneficial owner of the income it receives. Consequently, Luxembourg CIVs that meet these criteria are included within the scope of the Treaty. The provision on taxation of business profits aligns with the 2017 version of the OECD MTC, according to which business profits are taxable in the state of residence unless they are attributable to a permanent establishment (PE) in the other jurisdiction. Where one Contracting State has adjusted the profits that are attributable to a PE, the other Contracting State will have to make appropriate adjustments to the extent necessary to eliminate double taxation. The definition of what constitutes a PE largely follows the OECD MTC but also incorporates elements from the UN MTC. According to that definition, a building site, a construction, assembly, installation or dredging project, including related supervisory activities, constitutes a PE only if these activities exceed 183 days. For services provided by an enterprise, such as consulting services through employees or other personnel engaged by the enterprise for such purpose, these services form a PE only if the activities continue in the territory of a Contracting State for a period or periods totaling more than 120 days within any 12-month period beginning or ending in the fiscal year concerned. Additionally, the Treaty includes a specific rule for the exploration and exploitation of natural resources, including the operation of substantial equipment. Under this rule, a PE is established in the Contracting State where such activities are conducted for a period or periods exceeding 120 days within any 12-month period, unless these activities are limited to preparatory or auxiliary activities that, even if carried on through a fixed place of business, would not be considered as a PE. Furthermore, the Treaty provides an "anti-fragmentation clause" for preparatory or auxiliary activities to prevent an enterprise or group of related enterprises from dividing their activities into several distinct operations to claim that each of them is merely preparatory or auxiliary. When a person acts in a Contracting State on behalf of an enterprise (dependent agent), under certain conditions this will be considered a PE of the enterprise. The Treaty includes insurance enterprises in the definition of a PE, a provision that is also found in the UN MTC and goes beyond the OECD MTC definition for PE. According to this clause, an insurance company from one Contracting State is deemed to have a PE in the other Contracting State if, through a person other than an independent agent, it collects premiums or insures risks located in that other State. This measure does not apply to reinsurance activities. The Treaty does not, however, prevent Colombia from levying income tax on assigned reinsurance premiums. Article 6 of the Treaty deals with the taxation of real estate income (including income from agricultural or forestry operations) and follows the general principle that income from immovable property is taxable in the State in which the immovable property producing the income is situated. Article 8 of the Treaty deals with the taxation of profits from the operation of ships or aircraft in international traffic. It allocates the right to tax such profits to the State of residence of the enterprise in line with the OECD MTC. Article 10 of the Treaty regulates the right to tax dividends between the State of source and the State of residence of the beneficiary. According to the provisions, the tax that may be levied by the State of source may not exceed:
Luxembourg's domestic withholding tax rate on dividends is 15%. However, this rate can be reduced to zero under the domestic withholding tax exemption. For a Colombian-resident beneficiary to qualify for this exemption, several conditions must be met: (1) the Treaty with Colombia must be effective; (2) the beneficiary of the dividend and the distributing company must meet specific legal form requirements; (3) the beneficiary must hold a participation that exceeds a certain threshold in the capital of the distributing company for a specified holding duration; (4) and the beneficiary company must be fully subject to a tax comparable to Luxembourg's corporate income tax. The Treaty permits the State of source to tax interest, but it ensures that the tax does not exceed 10% of the gross interest amount. However, interest arising in one Contracting State and beneficially owned by a resident of the other Contracting State is exempt from withholding tax if any of the following conditions is met:
The definition of "interest" is generally in line with the OECD MTC but has been expanded to include any other element that is treated as income from debt claims under the tax legislation of the resident State of the company paying the interest. According to domestic rules, Luxembourg does not levy withholding tax on most types of arm's-length interest. The Treaty allows both the State of source and the beneficiary's State of residence to tax royalties. This differs from the OECD MTC, which only permits taxation in the beneficiary's State of residence. The tax in the State of source is capped at 10% of the gross amount of the royalties, if the beneficial owner is a resident of the other Contracting State. According to domestic rules, Luxembourg does not levy withholding tax on most types of arm's-length royalty payments. A dedicated article in the Treaty allows the State of source to tax fees for technical services, while stipulating that taxation in the State of source shall not exceed 10 % of the gross amount of these fees. This provision aligns with the principles of the UN MTC. According to domestic rules, Luxembourg does not levy withholding tax on arm's-length fees for technical services. The Treaty includes a "real estate-rich" clause under which capital gains derived by a resident of Contracting State from the alienation of shares or comparable interests, such as those in a partnership or trust, may be taxed in the other Contracting State if, at any time during the 365 days before the sale, these shares or comparable interests derived more than 50% of their value directly or indirectly from immovable property located in that other Contracting State. Luxembourg domestic law does not contain a specific provision with respect to the taxation of the capital gains on shares in real estate-rich companies, so the general rules apply. However, the sale of an interest in a tax-transparent entity from a Luxembourg perspective is assimilated to the sale of the immovable property held by that entity, triggering taxation in Luxembourg unless the immovable property is located in Colombia. The article also addresses gains obtained by a resident of a Contracting State from selling shares of a company, or comparable interests or other rights, such as interest in a partnership or trust. It specifies that these gains are taxable in the other Contracting State if the seller directly or indirectly holds, at any time during the 365 days preceding the sale, shares, comparable interests or other rights representing 20% or more of (1) the capital of the company resident in that other Contracting State or (2) the interests in a partnership or trust located in that other Contracting State. In such cases, the tax is capped at 10% of the gain amount. Certain exceptions apply, particularly for nontaxable reorganizations or recognized pension funds. According to Luxembourg domestic rules, most capital gains realized by nonresidents on shares in Luxembourg companies are not taxable. Gains from the sale of shares, interests in partnerships, or participations in trusts (other than those in real estate-rich companies or those meeting the 20% threshold during 365 days preceding the sale) will only be taxable in the Contracting State where the seller is a resident. Furthermore, the Protocol to the Treaty provides that the Treaty does not limit the right of a Contracting State to apply its domestic legislation regarding the indirect transfer of property located in that Contracting State. Capital represented by shares or comparable interest of a resident of a Contracting State is generally only taxable in that Contracting State. However, the capital of a resident, represented by shares or comparable interests (such as those in a partnership or trust), may be taxed in the other State if these shares or comparable interests derive more than 50% of their value directly or indirectly from immovable property. Furthermore, the Treaty stipulates that a resident's capital, consisting of shares, comparable interests or other rights representing 20% or more of the capital of a company resident in the other Contracting State, or interests in a partnership or trust located in that other Contracting State, may be taxed in that other Contracting State. In accordance with its standard practice, Luxembourg has opted for the exemption with progression method to prevent double taxation. This method exempts from Luxembourg tax income and capital taxable in Colombia, although this income and capital is taken into account when calculating the tax rate for income and capital taxable in Luxembourg. Luxembourg uses the credit method with regard to dividends, interest, royalties, fees for technical services, capital gains from the sale of shares in real estate-rich companies and capital gains from the sale of shares in certain companies or comparable interests, where the right to tax is shared between Colombia and Luxembourg. This method involves including such foreign-source income in the Luxembourg tax base, while deducting from Luxembourg income tax the tax paid on the income in Colombia. However, the deduction cannot exceed the Luxembourg tax attributable to such income. In accordance with the OECD MTC, the exemption method will not apply to income derived or capital owned by a Luxembourg resident if Colombia applies the Treaty to exempt such income or capital from tax or applies the provisions on dividends, interest, royalties or technical service fees. The purpose of this provision is to avoid non-taxation resulting from disagreements between the State of residence and the State of source on the facts of a specific case or on the interpretation of the provisions of the Convention. Under certain circumstances, a mutual agreement procedure can be initiated between the competent authorities of the two States. This procedure applies to situations in which a person believes that the actions of one or both Contracting States will result in taxation that is not in accordance with the provisions of the Treaty, or if there are issues related to the interpretation or application of the Treaty. The Treaty provides for exchange of information between the Contracting States in line with the approach set forth in the 2017 version of the OECD model convention. Assuming that Colombia ratifies the Treaty and both countries notify each other in 2025, the provisions of the Treaty will apply as from 1 January 2026.
Document ID: 2025-0841 | ||||||
