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August 18, 2022
Colombia-Japan double tax treaty will be effective 1 January 2023
On 5 August 2022, Colombia and Japan completed the exchange of diplomatic notes, confirming that they concluded their domestic procedures for the ratification of the double tax treaty (DTT) signed by both countries (approved in Colombia by Law 2095 of 2021).
The DTT will be effective 1 January 2023. However, Articles 25 (Exchange of Information) and 26 (Assistance in the Collection of Taxes) will apply from 4 September 2022 (the date on which the DTT will enter into force) regardless of the tax year in which taxes are levied.
The DTT aims to eliminate double taxation on income without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements).
Persons covered and tax residency
The DTT does not apply to entities or agreements that are deemed, wholly or partially, as transparent entities or arrangements for tax purposes (unless the relevant item of income is deemed as income of a resident of a Contracting State under its domestic tax law).
The DTT includes a "saving clause" to ensure that the DTT will not affect a Contracting State’s ability to tax its residents (with certain exceptions).
Recognized pension funds are considered residents for purposes of the DTT.
If a legal entity is deemed a tax resident in both Contracting States, the competent authorities will determine by mutual agreement the Contracting State in which the legal entity is deemed to be a resident. In the absence of an agreement, the entity will not be entitled to the DTT’s benefits.
Permanent establishment (PE)
The PE rules follow the guidelines of the OECD’s BEPS plan. Accordingly, the DTT includes an anti-fragmentation clause under which the overall activity resulting from the combination of separate activities (which separately are deemed as auxiliary or preparatory) will not have an auxiliary or preparatory character if such activities constitute complementary functions that are part of a cohesive business operation.
The DTT broadens the agency PE concept by including scenarios in which the agent habitually plays a leading role in the conclusion of contracts without significant modifications by the foreign enterprise.
Under the DTT, the following withholding tax rates will apply to passive income:
Capital gains resulting from the sale of shares, as well as the sale of interests in partnerships or trusts, will be taxed in the source State as follows:
A recognized pension fund will not be subject to capital gains tax in the source country.
The DTT includes a principal purpose clause as well as a limitation on benefits (LOB) clause. The LOB clause focuses on the benefits of Articles 7(5) (Distributions of PEs), 10 (Dividends), 11 (Interest), 12 (Royalties), and 13 (Capital Gains).
Additionally, the DTT includes a special rule for triangulations through a PE situated in a third jurisdiction (i.e., an enterprise of the State of residence derives income from the source State and the State of residence attributes such item of income to a PE in a third jurisdiction and, consequently, the PE is exempt from tax in the State of residence).
The DTT contains a special provision for silent partnerships (in the case of Japan, Tokumei Kumiai) and similar arrangements. Under this rule, any income received by the silent partner may be taxed in the source State in accordance with the domestic rules, provided the income arises in the source State and is claimed by the payor as a deductible expense in the source State.
For additional information with respect to this Alert, please contact the following:
Ernst & Young S.A.S. Bogota
Ernst & Young LLP (United States), Latin American Business Center, New York
Ernst & Young LLP (United States), Japanese Tax Desk, New York
Ernst & Young LLP (United Kingdom), Latin America Business Center, London
Ernst & Young Tax Co., Latin America Business Center, Japan & Asia Pacific