Global Tax Alert. Colombia issues regulations on taxation of permanent establishments. Permanent establishment definition. Fixed place of business

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1 8 January 2014 Global Tax Alert News from Americas Tax Center EY Americas Tax Center The EY Americas Tax Center brings together the experience and perspectives of over 10,000 tax professionals across the region to help clients address administrative, legislative and regulatory opportunities and challenges in the 33 countries that comprise the Americas region of the global EY organization. Copy into your web browser: Services/Tax/Americas-Tax- Center---borderless-clientservice Colombia issues regulations on taxation of permanent establishments Colombia s Ministry of Finance and Public Credit issued Decree 3026 (27 December 2013), regulating the taxation of permanent establishments and branches of foreign entities in Colombia. This Alert discusses the most relevant aspects of the new regulation. Permanent establishment definition For purposes of the permanent establishment definition, foreign company includes not only companies and foreign entities, but foreign individuals who develop any business or activity in Colombia. Under the decree, in the case of individuals, a business or activity includes the exercise of professional services, the performance of personal services and the performance of independent activities. Fixed place of business To verify a fixed place of business, the decree provides that a taxpayer must satisfy the following requirements: A place of business must exist in Colombia. However, the taxpayer only has to show that it has a space in Colombia. It does not have to show exclusivity to occupy the space or a formal title to occupy the space. The space has to be located in a certain place and have a certain degree of permanence. The taxpayer performs all or a part of its activities at that space. The decree does not establish any time for determining the degree of permanence at the fixed place of business, as opposed to the international context, which uses a period for a fixed place of business. For example, in agreements to avoid double taxation signed by Colombia, six months is the parameter used for certain service activities.

2 The decree also establishes exceptions for when a permanent establishment is not verified because of preparatory or auxiliary activities. Those activities include storage, advertising and marketing. Under the decree, activities that are essential, significant or primary to the business will not be considered auxiliary. Representative offices of companies or foreign entities must be able to engage in business contracts. The permanent establishments will be taxed on their income, assets and capital gains that are attributable to a Colombian source, as accepted by international parameters. The decree indicates that income and capital gains will include those directly derived from the permanent establishment. The decree requires each permanent establishment or branch to declare income. However, nonresident individuals, companies or foreign entities deriving income or capital gains that are not attributable to a permanent establishment or branch, but must be reported on a tax return, must include that income or capital gains on the permanent establishment s or branch s tax return. The decree does not clarify whether this provision includes cases of substitution or cancellation of foreign investment in Colombia. Permanent establishment obligations Withholding obligation The decree requires permanent establishments to determine their tax residence. For income attributable to permanent establishments, withholding at source must be conducted at the rates and under the conditions provided at the domestic or local level. If the foreign entity demonstrates that it qualifies as a permanent establishment through the presentation of its tax identification registration (RUT), the withholding agent may withhold at the rates and under the conditions applicable to local transaction. The withholding agent may request verification of permanent establishment status from the tax authorities (DIAN). Additionally, the decree provides that, if income or capital gains are not directly attributable to a permanent establishment, withholding will apply to payments abroad. Unless provided otherwise, a payment or accrual made to a permanent establishment is a payment made directly in favor of the permanent establishment. For payments or accruals between a permanent establishment and nonresident individual, or company or foreign entity of which the permanent establishment is a part (i.e., an internal transaction), the decree establishes that withholding for payments abroad will be done by the permanent establishment. To determine the applicable withholding at source and to comply with the requirement on the RUT, the decree requires the permanent establishment to put EP at the end of its name or EP 2 if there is more than one permanent establishment. The decree also requires a document or statement, sworn under oath, attesting to the circumstances leading to the existence of a permanent establishment in Colombia. To determine the assets, income and capital gains attributable to the permanent establishment, the assets, income and capital gains that could have been received under the arm s length principle must be considered, as if the permanent establishment would be separate and independent of the company of which it is a part of. Importantly, the decree recognizes the possibility of internal transactions with other parts of the same company that is a permanent establishment or branch. Documentation obligation The decree requires a study of the functions, assets, risks and staff to be conducted. The study should consider: The attribution of rights and obligations between the company that is a part of the permanent establishment and independent companies Identification of the significant functions performed by the staff that are relevant to the allocation of the economic ownership of the assets and risks Attribution of the economic ownership of the assets and risks Identification of other functions The consideration and determination of the nature of the internal operations with other parts of the company that is a part of the permanent establishment Attribution of capital to the permanent establishment or branch 2 Global Tax Alert Americas Tax Center

3 With the study and supporting documents, the decree requires records to be kept for each permanent establishment or branch, for tax purposes only. In each separate account, the rules for the realization of income, costs and deduction contained in the Tax Statute should be considered. In addition, the decree requires a functional and factual analysis that allows for the identification of the allocation of income and capital gains realized by companies as independent affiliates. The analysis must also include the internal operations of the company of which the permanent establishment is a part, including capital, liabilities, rights, obligations and the attribution of economic ownership of assets. The decree requires a registered auxiliary to allocate attributable operations and, in the final tax period, create a document with the results of all operations. The provisions in the Tax Statute should be used to determine the tax liability, including the transfer pricing regime and internal transactions with the company of which the permanent establishment is a part. The decree does not require the formal delivery of the study to the DIAN, but allows the study to be voluntarily incorporated with the transfer pricing documentation when the taxpayer is obligated to comply with the transfer pricing rules. In all cases, the study and supporting documentation must be kept for five years beginning on 1 January of the year following the tax year. Permanent establishment profits The decree requires the taxpayer to comply with the rules contained in Articles 48 and 49 of the Tax Statute and the applicable tax rate for dividends will be 33%. As a general rule, dividends will be realized when transferring profits abroad. For branches subject to a special exchange law regime, the transfer of profits will be subject to the following rules: When the supplementary investment to assigned capital account results in a debit balance (negative of equity), the decree states that the value of the dividend will be the same as the debit balance at the end of the year. When the debit balance at the beginning of the year increases during the year, the dividend value will correspond to the increase in the debit balance during the year. The supplementary investment to assigned capital will include the capital account balance and the account balance of the retained profits and reserves, and the revaluation of assets that existed on 31 December 2006, and have not been capitalized or subsequently transferred to the additional capital investment account. CREE tax The decree states that permanent establishments will be subject to the income tax for equity (CREE). Global Tax Alert Americas Tax Center 3

4 For additional information with respect to this Alert, please contact the following: Ernst & Young Ltda., Bogotá, Colombia Ricardo Ruiz ricardo.ruiz@co.ey.com Clara Ines Inés Ramírez clara.ramirez@co.ey.com Andrés Amaya andres.amaya@co.ey.com Co-Directors of EY Americas Tax Center Global Tax, Eric Solomon, Washington, DC Global Tax, Michael Mundaca, Washington, DC EY Americas Tax Center America s Tax Center Chief Operating Officer Declan Gavin, Washington, DC ATC - Customs William Methenitis, Dallas ATC - Global Compliance and Reporting (GCR) Ken Brown, Dallas ATC - Global Tax Desks Gerrit Groen, New York ATC - Tax Controversy Rob Hanson (interim), Washington, DC ATC - Tax Effective Supply Chain Management (TESCM) Lisa Lim, New York ATC - Tax Performance Advisory (TPA) Gary Paice, Chicago ATC - Tax Policy Michael Mundaca (interim), Washington, DC ATC - Value Added Tax (VAT) Jean-Hugues Chabot, Montreal, Canada ATC - Insurance Terry Jacobs, Washington, DC 4 Global Tax Alert Americas Tax Center

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