Colombia's highest tax court sustains tax authority opinion denying activation of most-favored-nation clause in double tax treaties

The Council of State — Colombia's highest tax court — has declined to annul a Colombian tax authority opinion ruling that three double-tax treaties (DTTs) Colombia had executed were not affected by provisions in a later-executed DTT, because most-favored-nation clauses (MFNCs) in the three DTTs were not activated.

The 4 April 2024 decision (file number 25411) reviewed the Colombian tax authority's ("DIAN," per its acronym in Spanish) Official Opinion 0191 of 17 February 2020, which had ruled that the MFNCs in DTTs with Spain, Chile and Switzerland were not activated before Colombia's DTT with the United Kingdom (UK) entered into force.

Background

Colombian domestic tax law establishes that technical services (TS), technical assistance (TA) and consulting services (CS), whether rendered in Colombia or from abroad, are always taxed for the nonresident, usually via a withholding tax.

To continue taxing the income derived from the services provided by nonresidents, the first batch of DTTs that Colombia executed, following the Organisation for Economic Co-operation and Development/United Nations (OECD/UN) models, included these services in the definition of royalties (article 12), which are taxed in Colombia at a limited 10% rate.

Given that this taxation model does not necessarily follow international standards, MFNCs were included in the DTTs. In general, the MFNCs allow that, if in the future, a new DTT entered into force that established a more beneficial treatment for those services, the new rule would also apply to the DTTs that contain MFNCs.

DTT with the UK and potential application of MFNC

Colombia's 2020 DTT with the UK excluded services from the definition of royalties and, following the international standard, considered income from services to be business profits. Due to this, income flowing to the UK from Columbia for the rendering of services is not subject to income tax in Colombia, to the extent the income is not attributable to a permanent establishment in Colombia.

The change introduced by this new DTT raise the question of whether the MFNC in previously executed DTTs would lead to similar treatment. On this regard, the DIAN issued Official Opinion 0191 of 2020, analyzing the different DTTs and ruling that the MFNC in the DTTs with Spain, Chile and Switzerland were never activated. Therefore, according to DIAN's opinion, payments made to Spain, Chile and Switzerland for ST, AT and CS should still be subject to tax in Colombia, at a maximum rate of 10%.1

Council of State decision

The challenge to Official Opinion 0191 argued that the ruling was contrary to the provisions and principles of the DTTs with Spain, Chile and Switzerland and the 1969 Vienna Convention on the Law of Treaties.

The Council of State denied the claim of nullity, pointing out that for the MFNC to be activated an agreement had to be reached with a third State that provided a "tax rate" lower than the one agreed with Spain, Chile and Switzerland.

In the Council of State's view, because the Colombia-UK DTT did not provide for a lower tax rate, but rather excluded from the definition of "royalties" the income derived from the mentioned services and recharacterized it as "business profits," the assumption that the MFNC was activated was not met. Additionally, regarding the DTT with Chile, the Council of State also noted that there was no provision in the protocol (a section within the DTT) for automatic application of the MFNC.

Considerations and effects

Although this is the Council of State's final decision regarding the challenge to Official Opinion 0191 of 2020, the conclusion remains debatable. It remains unclear whether the decision is aligned with the intention and objectives of the texts of the DTTs, particularly regarding how they were negotiated and how the parties would expect the income to be treated for tax purposes, considering the DTT models under which such negotiations are carried out worldwide.

The appellate decision also could be considered by parties seeking to predict how the Council of State can be expected to analyze similar facts in the future.

Based on these considerations, tools such as the Mutual Agreement Procedures (MAP) should be useful mechanisms for taxpayers impacted by conflicting interpretations between countries. In this case, the objective of the MAP would be to reach a consensual solution by both tax authorities to resolve controversial interpretations or applications of the DTTs.

Contact Information

For additional information concerning this Alert, please contact:

Ernst & Young S.A.S. Bogota

• Luis Orlando Sánchez

• Zulay Andrea Arevalo

• Isabel Rodriguez

• Juan Torres-Richoux

• Andrés Millán

• Amalia Borja

• Ivanna Franco

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor

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