Colombia and Brazil sign double tax treaty

The treaty includes reduced withholding tax rates for certain passive income and permanent establishment provisions. Taxpayers in the technology/software industry should be aware of the technical services/technical assistance and royalty provisions as they might benefit from a reduced withholding tax rate of 10%. Both Colombia and Brazil must complete their internal ratification processes for the treaty to enter into force.

Executive summary

On 5 August 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 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.

Detailed discussion

Taxes covered

The DTT covers the federal income taxes of both Contracting States, including Brazil’s social contribution tax (CSLL), and Colombian complementary income taxes.

Residence

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 6 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.

Passive income

The DTT includes reduced withholding tax rates for certain items of passive income as follows:

1. Distributions of profits from the PE/branch to its head office will be treated as dividends for purposes of the DTT.
2. This DTT does not prevent Colombia from imposing tax on dividends paid by a company resident in Colombia or a PE in Colombia out of profits that have not been subject to taxation at the company or PE level (this is the so-called recapture tax, which is currently 35%).
3. The term “interest” includes "interest on equity" (juros sobre o capital próprio) applicable in Brazil. Interest on loans in default is not covered by the interest article; therefore, it will generally be taxed under domestic rules (under the "other income" rule of the DTT).
4. The definition of technical services under this article excludes payments made (i) to employees of the person making the payment; (ii) for teaching in or by an educational institution; or (iii) by an individual for services of personal use.

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.

Anti-abuse rules

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.

Approval process

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.

For additional information with respect to this Alert, please contact the following:

Ernst & Young S.A.S. Bogota

• Luis Orlando Sánchez
• Juan Torres Richoux
• Andrés Millán Pineda
• Zulay Andrea Arevalo
• Amalia Borja Gonzalez
• Isabel Rodriguez Daniels

Ernst & Young LLP (United States), Latin American Business Center, New York

• Ana Mingramm
• Lucas Moreno
• Enrique Perez Grovas
• Pablo Wejcman
• Pablo Angel

EY Assessoria Empresarial Ltda, São Paulo

• Aline Milla 
• Gustavo Carmona

Ernst & Young LLP (United Kingdom), Latin America Business Center, London

• Lourdes Libreros
• Claudia V León Campos

Ernst & Young Tax Co., Latin America Business Center, Japan & Asia Pacific

• Raul Moreno, Tokyo
• Luis Coronado, Singapore

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.