Contributed By Baker McKenzie S.A.S.
Regarding estates, trusts, foundations and similar entities, recent regulations introduced by the most recent tax reform (Law 1943 of 2018) have been widely criticised and subject to the filing of lawsuits by failing to acknowledge the legality and validity of the actions of Colombian taxpayers before the entry into force of this law.
Private interest foundations and foreign trusts were not subject to tax regulations in Colombia until 2012, with the entry into force of Article 103 of Law 1607. The article established that distributions made by foreign trustees, private interest foundations or other similar fiduciary arrangements to Colombian residents are considered capital gains taxed at a 10% rate on the gross distributed amount.
Subsequently, by means of Article 37 of Law 1739 of 2014, it was established that the possession of rights held in foreign trusts, private interest foundations or other similar fiduciary arrangements had to be reported for normalisation tax purposes.
As set forth by Article 263 of the Colombian Tax Code (CTC), it is understood by possession, the economic benefit whether potential or real, of any asset in benefit of the taxpayer. It is presumed that whoever has legal tittle as owner has for its own the economic benefits of the assets.
The above-mentioned article would only apply for (i) beneficiaries not subject to any condition in a foreign trust or private interest foundation, or (ii) a settlor or founder of a trust of private interest foundation of a revocable and non-discretionary nature.
On the contrary, no possession can be established if (i) beneficiaries are conditioned and only have an expectation, and (ii) the settlor or founder of an irrevocable and discretionary trust or foundation irrevocably grants all economical and disposition rights to an independent third party.
Moreover, this interpretation was confirmed by the Colombian Tax Office throughout tax ruling No 34071 of 20 December 2017, which determined the main aspects to be considered by a taxpayer as settlor, contributor and designated third party of a trust: (i) the contributor assigning assets to a revocable trust must file the foreign assets return and has the obligation to report them in its income tax returns at cost basis as provided by the CTC, and (ii) the contributor assigning the assets to an irrevocable trust must report the assets in its income tax returns and in any other applicable tax return, if it possesses the economic benefits according to Article 263, CTC.
On the other hand, for income tax purposes, Article 882 of the Colombian Tax Code (introduced by Law 1819 of 2016) determined that any income realised by a foreign entity whose place of effective management is located in Colombia had to be reported.
With the entry into force of Law 1943 of 2018, these guidelines took a massive turn by establishing that if the underlying assets of an irrevocable and discretionary foundation cannot be attributed to the beneficiaries, the latter must be reported by the settlor, contributor or originator. This, without any consideration of the structure's irrevocable and discretionary character.
Based on the above, as of 1 January 2019, taxpayers who acted in good faith and followed the Tax Office's guidelines are now considered as taxpayers holding unreported assets. This situation had led to serious questionings from taxpayers who acted in good faith.
The above-mentioned situations led to the filing of various lawsuits requesting the annulment of the Normalisation Tax by considering that it holds no consideration for previous rules that were enforceable at the time and grants these new rules a retroactive effect. The reality is that the Constitutional Court may not admit many of the lawsuits.
Compensation for aggrieved parties in wealth disputes or disputes involving trusts, foundations or similar entities will imply civil liability (torts) in Colombia. Requesting compensation for damages is usually carried out before Colombian courts, which will determine the type of damage and amount of compensation.
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