Benefits and opportunities provided by 'place of effective management'
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Juan David Velasco Kerguelen
Posse Herrera Ruiz, Colombia
juan.velasco@phrlegal.com
In general, the term 'place of effective management' (PoEM) has a negative connotation. However, it may provide more opportunities and benefits than expected.
In Colombia, PoEM was introduced into the Colombian tax code by Law 1607 of 2012 with the purpose of reducing high levels of tax evasion and tackling base erosion and profit shifting.
At first glance, PoEM may have a negative connotation or may trigger adverse tax consequences, since a foreign company with PoEM in Colombia would:
• be taxed in Colombia on its worldwide income, rather than solely on its Colombian-sourced income; and
• have to comply with formal tax obligations in common with any other Colombian incorporated entity.
Despite the potential adverse effects, PoEM may also provide opportunities and benefits from which a foreign investor may benefit, including the application of the provisions of the Colombian reorganisation regime and the Colombia holding company regime, which is a participation exemption regime. To this end, foreign entities may voluntarily register before the Colombian tax administration as a domestic entity for tax purposes.
A foreign entity with PoEM in Colombia may apply the benefits of the Colombian reorganisation regime (capital contributions, mergers and spin-offs), since said regime applies to any entity that is considered a domestic entity for Colombian tax purposes.
The Colombian reorganisation regime may facilitate that, for instance, a merger procedure between a foreign entity with PoEM in Colombia and a Colombian entity is deemed as a tax-free event in Colombia when the foreign entity with PoEM is the surviving entity. Otherwise, such a transaction may be a deemed sale in Colombia and subject to either short-term or long-term capital gain tax.
Likewise, any capital contribution to a foreign entity with PoEM in Colombia would be deemed as a tax-free event and the transfer of the assets would not be taxed in Colombia to the extent that certain statutory tax provisions are met. Normally, contributions of Colombia-situated assets to foreign entities are deemed as a disposal of assets and subject to tax on an arm’s-length basis.
Secondly, foreign entities with PoEM in Colombia may apply to the Colombian holding company regime and claim its benefits. The Colombian holding company regime, enacted by Laws 1943 of 2018 and 2010 of 2019, is a participation exemption regime that may incentivise multinational enterprises to form a hub in Colombia for holding and managing operations across Latin America.[1]
In particular, the Colombian holding company regime may grant foreign investors the following benefits:
• exemption on dividends received by the Colombian holding company from a foreign entity;[2]
• exemption on dividends distributed by the Colombian holding company to a foreign investor;[3]
• dividends distributed by a Colombian entity to a Colombian holding company are not subject to withholding tax;
• exemption on the gain derived from the transfer of shares in foreign entities; and[4]
• exemption on the gain derived from the transfer of shares of the Colombian holding company, except for the value corresponding to profits obtained from activities carried out in Colombia.
The Colombian Tax Administration has already agreed on the position that a foreign entity with PoEM in Colombia may apply to the Colombian holding company and claim its benefits.[5] The revenue ruling of the Colombian tax administration should provide enough legal certainty to foreign investors.
In this sense, for example, a limited liability company (LLC) incorporated and domiciled in Delaware in the US, may apply to the Colombian holding company regime. The LLC would maintain the flexibility of Delaware corporate law and the judicial security of Delware’s courts and its case law, but at the same time would be able to claim the tax benefits of the Colombian holding company regime.
When enacting the Colombian holding company regime, the Colombian Congress mirrored the example of Spanish holding companies (Empresas Tenedoras de Valores Extranjeros). However, under a vis-à-vis analysis, the Colombian holding company regime appears to be more flexible than the Spanish holding company regime from a corporate perspective, due to the fact that a foreign entity with PoEM in Colombia may apply to the said regimen.
Last but not least, the tax compliance in Colombia of a foreign entity with PoEM in Colombia should be straightforward. As of the 2017 tax year, the taxable base of corporate income tax has to be computed under International Financial Reporting Standards (IFRS) with certain book-to-tax reconciliations determined by the Colombian tax code. Therefore, a foreign entity with PoEM in Colombia may continue its bookkeeping under IFRS to comply with Colombian tax law.
In conclusion, even though the PoEM has been considered as a criterion that implies potential limitations and may represent adverse tax consequences for foreigners, it may also be an opportunity for foreign entities and investors to carry out their businesses and activities in Colombia in a tax-efficient way. PoEM has become a key matter when tax planning a cross-border operation.
[1] The Colombian holding company regime provide a preferential tax treatment for Colombian companies, whose main corporate purpose is to invest or hold securities or shares in foreign and domestic companies.
Colombian statutory tax provisions establish that, in order to access the benefits of the Colombian holding company regime, the national company must have: (1) a direct or indirect participation in at least ten per cent of the capital of two or more national and/or foreign companies or entities for a minimum period of 12 months; and (2) develop its corporate purpose in Colombia, counting at least three direct employees and one administrative office in the country. The Colombia holding regime was created as an incentive for multinational groups to establish their headquarters for international investments in Colombia, through national companies with exclusive purpose.
[2] By general rule, dividends received by a Colombian company from a foreign entity are subject to a 37.9 per cent tax rate.
[3] Colombian statutory tax provisions establish that outbound payment of dividends are subject to a ten per cent withholding tax rate, to the extent they are distributed out of profits that were taxed at the corporate level.
[4] Normally, the gain derived from the transfer of shares is treated either as short-term or long-term capital gain, depending on the holding period. A ten per cent tax rate applies if the gain is treated as a long-term capital gain (holding period of less than two years). Otherwise, a 31 per cent tax rate applies if it is treated as a short-term capital gain (holding periods greater than two years).
[5] Revenue Ruling No 020426 of 2019.
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