International figures in project financing

The financing bill proposes that permanent establishments (PEs) be taxed both for their local income and for their foreign source income, in order to avoid what was being developed by some foreign companies that, under the protection of the law, carried out operations that were not considered Colombian source income through PEs located in the country and therefore were not taxed in Colombia on such income.

The above is somewhat in line with the form of taxation of PEs in other countries that simply mention that the income taxed in the PEs are those attributed to their patrimonial elements through the functional analysis, regardless of the place where the income originates (the PE is in an intermediate place between source taxation and residence taxation).

What is striking is that Article 51 of the bill proposing this change is not being incorporated to the Tax Statute, nor does it modify Article 20-2 ibidem, which establishes the rule of taxing only local source income.

On the other hand, it is proposed to amend Article 885 of the ET in the sense of presuming by right the generation of 100% active income by a Foreign Controlled Entity (ECE) when less than 20% of the income received by the ECE is passive, eliminating the existing distortion in the current regime that requires the incorporation of certain passive income even when the ECE is a fully operational company.

Regarding withholding at source for payments abroad, it is proposed to increase to 20% the rates for labor and capital income, including as such, income from the exploitation of software whose rate was 33% (general income tax rate) on a base equivalent to 80% of the payment or credit on account, which resulted in a rate of 26.4% (article 411 of the ET is repealed). 

Likewise, the withholding tax rate for payments abroad applicable to income from consulting, services and technical assistance is increased to 20%, which will increase the effective tax rate if it is taken into account that such withholding is assumed by the payer in most cases.

This is without prejudice to the applicable rate in accordance with the agreements to avoid double taxation subscribed by Colombia (CDI), in which case such rate is 10% when the beneficiary of the payment is a resident of countries such as Canada, Chile, Czech Republic, India, South Korea, Mexico, Spain, Portugal and Switzerland; and that may be 0% for residents located in France and United Kingdom when these agreements enter into force (treatment that may be extended to several treaties by the most favored nation principle).

In addition, the proposed modification to the thin capitalization rule is highlighted, which reduces the burden associated with indebtedness, establishing the limitation to interest from debts contracted with national or foreign related parties (directly or indirectly). Therefore, if the indebtedness is with a NON related party for the deduction, the general rules must be observed. If, on the other hand, the indebtedness is with a related party, the deduction will be applicable provided that the debts that generate the interest subject to deduction do not exceed twice the net worth of the previous year.

Consequently, and when applying the restriction to local related parties, the non-discrimination rule provided in the DTTs signed by Colombia may not be invoked to lift the limitation when the financing operation is between economic related parties resident in any of the contracting states.

Finally, Article 254 of the ET (Discount for taxes paid abroad) is amended to specify that the rate on which the indirect discount is calculated, in the case of dividends received from abroad, is the effective rate of the country of origin of the dividends and the formula is updated due to the repeal of the CREE.