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August 18, 2022
2022-5785

Colombia-Japan double tax treaty will be effective 1 January 2023

  • The permanent establishment rules follow the guidelines of the Base Erosion and Profit Shifting (BEPS) plan of the Organisation for Economic Co-operation and Development (OECD).

  • The treaty has reduced withholding tax rates for certain passive income.

  • The treaty also has reduced tax rates for certain capital gains.

Executive summary

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).

Detailed discussion

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.

Passive income

Under the DTT, the following withholding tax rates will apply to passive income:

Type of income

 Tax rate in the source country

Situation

Dividends (i)

0%

  • The beneficial owner is a recognized pension fund.

5%

  • The beneficial owner is a company that has directly or indirectly held at least 20% of the voting rights of the company that pays dividends in a six-month period (including the day of the dividend payment, and without considering changes in ownership resulting from reorganizations, such as a merger or spin-off of the company that pays dividends). 

10%

  • The beneficial owner is a resident of the other Contracting State.

15%

  • Dividends are paid by a Colombian company out of profits that were not subject to taxation in Colombia at the corporate level and the beneficial owner of the dividends is a resident of Japan.

  • Dividends are paid by a Japanese company that were deductible for the computation of the Japanese taxable income and the beneficial owner of the dividends is a resident of Colombia.

Interest

0%

  •  Interest is beneficially owned (or paid on guaranteed credits) by the other Contracting State (or a political subdivision, local authority, the Central Bank, or an entity exclusively owned by the other Contracting state, political subdivision, or local authority).

  • Interest is beneficially owned by a bank and derived from credits granted for at least three years.

  • Interest is beneficially owned by a financial institution of one Contracting State and paid by a financial institution of the other Contracting State.

  • Interest is beneficially owned by a recognized pension fund.

  • Interest is beneficially owned by a resident of the other Contracting State and derived from the sale on credit of equipment or merchandise.

10%

  • The beneficial owner is a resident of the other Contracting State.

Royalties

(ii)

2%

  • The beneficial owner is a resident of the other Contracting State and royalties are derived from the use, or the right to use, industrial, commercial, or scientific equipment.

10%

  • The beneficial owner is a resident of the other Contracting State and receives payments for any other type of royalties.

  1. Distributions made by a Colombian PE to its main office in Japan should be subject to taxation at a rate of 15% if the distribution is made from profits that were not taxable at the PE level, or 5% in other cases.

  2. Under the DTT, payments derived from the provision of technical services, technical assistance, and consulting are not considered as royalties.

Capital gains

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:

Taxation in the source State

Situation

Taxed without limitation

  • Profits are taxed without limitation when 50% or more of the value of the shares or comparable interest (such as interest in partnerships or trusts) is derived, directly or indirectly, from immovable property located in the source state at any time during the 365 days before the transaction. This rule does not apply to shares that are substantially and regularly traded on a recognized stock exchange and the tax resident (together with its related parties) holds less than 5% of the shares or comparable interest.

10% of the profit

  • The transferor has, directly or indirectly, held at any time during the 365 days before the transfer at least 10% of the capital of the company transferred.

A recognized pension fund will not be subject to capital gains tax in the source country.

Anti-abuse rule

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).

Additional provisions

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.

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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

 
 

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