Controlled Foreign Corporations – What are the Changes Due to Law 1819?
It is worth clarifying that Controlled Foreign Corporations (CFCs) are those whose fiscal residence is outside of Colombia or that are controlled by one or more Colombian fiscal residences.
Are you part of this program? On December 29, 2016, Law 1819 introduced some regulations to the National Tax Laws (Estatuto Tributario Nacional) regarding Controlled Foreign Corporations (Entidades Controladas del Exterior or ECE). What follows are some of the principal changes that you should know about.
ECE Laws at the International Level
Law 1819 from 2016 set up the Entidades Controladas del Exterior or ECE as an anti-tax avoidance and international anti-tax evasion measure. This has implications in tax planning when foreign entities are involved.
Rules for Controlled Foreign Corporations are not new. However, in 2015, they began to take on greater importance with BEPS’ action plan published by the Organization for Economic Co-operation and Development (OECD). In fact, the new national laws are aligned with the government’s interest in being admitted to the international organization for best practices.
The third act in BEPS’ final report recommends that countries that who are OECD members incorporate measures to strengthen laws regarding international fiscal transparency. The aim is to counteract the risk that taxpayers transfer their income and tax benefits to jurisdictions with lower tax rates than their foreign subsidiaries.
It is important to keep in mind that the CFC rules seek to prevent taxpayers with foreign subsidiaries in countries with a lower tax rate from transferring income in order to lower their taxable base in the country in which the headquarters and stockholders are located.
The ECE Regimen and Colombian Tax Law
As the Libro Septimo Titulo I (Seventh Book, Title 1) of Colombian Tax Law takes effect, the ECE rules are being adopted. Some of the most salient points:
•ECE are defined as those entities or foreign vehicles not residing in Colombian that are managed by Colombian residents and fulfill certain criterion. These are defined by numbers i, ii, iv, and 5 from paragraph b, numbers 1 and 5 from Article 260-1 of the Colombian Tax Law. That said, these entities are only required to comply with the ECE rules if the Colombian resident has a direct or indirect share of 10% or more in capital.
•It is understood that the ECE rules automatically apply in situations in which a company has taken up residence, is incorporated, or is operating in a jurisdiction that does not enforce these rules, is of minimal or no enforcement, or is subject to a special tax code.
•Passive income, as well as expenses and deductions associated with them, are expected to be dealt with by the controlling taxpayer according to their proportion of participation in the capital or in the results of the ECE. Because of this, the controlling taxpayer should include these passive incomes (passive income realized by the ECE less associated expenses and deductions) in their income statement and supplements.
•The following are considered to be passive income: (i) dividends, (ii) interest, (iii) income derived from intangible profits, (iv) title transfer or rental of real estate, (v) compensation for technical services, technical assistance, and management.
•If the passive income of the ECE represents 80% or more of the total income, then the costs and deductions cause them to be considered passive income.
•Colombian residents who control ECE and are subject to these tax laws have the right to deduct foreign-paid taxes according to the parameters of article 254 of the Colombian Tax Code.
•Dividends, benefits, or remainders that the ECE pay out to the parent company are not considered to be a part of the income or non-recurring profits for the parent company. This is true ONLY when these dividends or benefits come from profits that have been subjected to the ECE tax rules.
Colombians’ Foreign Assets Will Be Subject to Taxation
With the implementation of the ECE laws in Colombia, passive income acquired by foreign-controlled companies will be subject to taxation. However, several questions have come up related to Law 1819 from 2016:
•The definition of an ECE as stated in the law does not only include controlled companies, but also associated companies according to number 5 of article 260-1 of the Colombian Tax Code. This states that those with at least a 10% stake are included. This differs from the parameters set forth in action 3 of the BEPS.
•Among the OCDE recommendations, it is stated that these laws will apply exclusively to companies subjected to lower taxes than those in the jurisdiction of the controller. However, in the wording of the new article 882, this limitation is not included. This implies that these Colombian laws are applicable to any controlled or associated organization, regardless of their tax burden.
•Within the Colombian law, the fact that the controller should include passive income from ECEs in their tax statement stands out as unusual. These profits are understood to be the quantity calculated as passive income less expenses and related deductions that originate from them according to the requirements of the tax code. Therefore, in order to determine the amount of passive income from an ECE, one should analyze where the foreign expenses that are associated with the passive income come from. Articles 107 from the Colombian Tax Code and those that follow should be used as guidelines.
The implementation of the ECE laws in Colombia seeks to counteract the practice by some international companies (who avoid paying taxes) that are controlled in countries with lower taxes. The goal is that these entities will pay tax in Colombia on passive income.
At the same time, as has occurred during the adoption of other international regulations by the Colombian tax system, there are significant differences between national law and international standards. This leads to some uncertainty on the part of the taxpayer as to how to best implement these regulations here in Colombia.
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