The use of investor-State dispute settlement mechanisms contained in international investment protection treaties, including investment arbitration, is becoming increasingly frequent.
With respect to Colombia, out of six cases concluded in arbitration, the State has only been condemned in one of them.
Although in most cases the Colombian State has obtained a favorable resolution, this does not prevent future decisions from being adverse and the State may end up being condemned.
For this reason, it is pertinent to ask about the tax treatment of the payments made by the State to foreign investors by virtue of investment awards. Nature of the amounts One of the positions is that the tax treatment will depend on the nature of the amounts paid.
According to those who defend this position, the condemnations to be paid contained in investment awards are indemnifications, to which the typical treatment of payments of such nature applies.
That is, the payment will have the condition of taxable or non-taxable to the extent that what is paid is for loss of profits or consequential damages, respectively.
The Constitutional Courthas referred to this line of thought
The Constitutional Court, when studying a claim of unconstitutionality filed against Article 130 of Law 1955 of 2019, which established a special contribution for arbitration awards of economic content (not applicable to international arbitration awards), pointed out that there are different types of compensation (for example, consequential damages and loss of profits), the nature of which will determine whether what was paid corresponds to an income constituting profit or benefit that should have been received in due time and, therefore, subject to income tax, or whether they are not susceptible of constituting taxable income, under the terms and conditions provided by law (C. Const, Sentence C-161/22. M. P. Alejandro Linares Cantillo).
In this sense, under this first position, the Colombian State should establish the underlying nature of the different amounts that make up the compensation, in order to determine their tax treatment.
If the payments for such concept constitute income susceptible of producing a net increase in the investor’s equity at the time of its receipt and have not been expressly exempted, the payment in favor of the investor would be taxed and should be subject to withholding at the source.
Otherwise, it would not be taxed and, consequently, would not be subject to withholding, under the terms of the applicable exception.
In other words, compensation corresponding to consequential damages would not be taxed, while compensation for lost profits would be subject to income tax. In the last scenario, the withholding rate would depend on whether the foreign investor is an individual or a legal entity:
(i) if the beneficiary of the payment is a non-resident individual, the withholding rate would be 35%, as provided in Article 401-2 of the Tax Statute (E. T.), but.
(ii) if the beneficiary is a foreign legal entity domiciled abroad, the withholding at source for income tax purposes shall be 15%, pursuant to Article 415 of the E.T. Withholding at source However, it is worth asking whether an instrumental mechanism, such as withholding at source, is sufficient to hold that payments made by the Colombian State to foreign investors under investment awards are domestic source income in light of the legislation in force.
The foregoing, to the extent that the beneficiary of the award would be a non-resident alien subject to income tax in Colombia only with respect to its income from national source.
According to article 24 of the E. T., income from national source is considered to be that derived from
(i) the exploitation of tangible and intangible goods within the country;
(ii) the rendering of services within its territory, on a permanent or transitory basis, with or without its own establishment, and
(iii) the alienation of tangible and intangible assets, under any title, that are within the country at the time of their alienation.
However, the compensation to be paid by the State would not fall within any of the aforementioned cases nor within the list included in the aforementioned article 24.
In this respect, the taxation of the indemnity could be sustained, considering that
(i) that the local vehicle in charge of developing the business activity in Colombia would have been taxed with respect to the income it had obtained in its ordinary activity, as domestic source, as well as its foreign parent company would have done when dividends were distributed to it, and
(ii) that the indemnification, despite having a different origin, has a supplementary character in relation to the amounts not received by the investor due to the action, omission or acquiescence of the State and, consequently, it would have to be included in one of the income from a national source.
However, it is not evident that the foreign investor has obtained income from a national source as a consequence of an investment award, to the extent that, by virtue of the principle of legality, the assumptions of the generating event of article 24 of the E.T. do not correspond to the concepts that support the payment of compensation for an investment award.
Rather, it could be argued that the amount to be recognized under the compensation should be adjusted in the award, calculating the taxes that the foreign investor would have had to pay if it had been able to exercise the economic activity that the State with its action, omission or acquiescence prevented. Therefore, it would not seem reasonable to subject to withholding tax the amounts included in the condemnation of investment awards.
The case To date, the only public case of condemnation of the Colombian State is that of Glencore International A. G. (Glencore) and C. I. Prodeco S. A., in which the arbitration tribunal of the International Centre for Arbitration of Investment Disputes (ICSID) ordered Colombia to reimburse C. I. Prodeco S. A. an amount equivalent to the value of a sanction imposed on the company by the Comptroller General of the Republic, and to recognize interest, defense costs and expenses related to the arbitration proceedings.
Since it is clearly a reimbursement for a value paid by the plaintiff, such payment did not raise the tax controversy analyzed, insofar as it did not have the potential to increase the plaintiff’s net worth and, consequently, to constitute an income, possibly of national source.
Since there is no legal provision that expressly pronounces on the taxable nature, or not, of the investment awards, nor any doctrine of the National Tax and Customs Directorate (Dian) that has been issued in that sense, in due time the Dian and the judges would have to pronounce on the issue raised.