Colombia-UAE DTA: Holding and Royalty Structures in a Post-BEPS Era

Colombia-UAE DTA: Holding and Royalty Structures in a Post-BEPS Era

January 1, 2024, marked a significant shift for Latin American business groups and family offices with cross-border exposure. From that date, the Double Taxation Agreement (DTA) between Colombia and the United Arab Emirates (UAE) became effective for Colombia, opening new avenues for managing investments and passive income. This instrument, coupled with the introduction of UAE corporate tax in June 2023, requires us to re-evaluate which jurisdictions are truly strategic for establishing holding or licensing structures. It is no longer about simple treaty shopping models, but a deep assessment of economic substance and post-BEPS anti-abuse rules.

A New Opportunity for Holdings

Traditionally, holding structures in Europe or North America have been the norm for many Colombian companies. However, the Colombia-UAE DTA offers an alternative worth considering. For dividends, the DTA establishes a significant reduction in source withholding: only 5% if the beneficial owner is a company that directly holds at least 10% of the paying company's capital. General rates in Colombia for dividends to non-treaty jurisdictions are considerably higher.

The appeal of the UAE is strengthened when considering the participation exemption under its new corporate tax law. Dividends received by a UAE holding company may qualify for this exemption, resulting in zero effective taxation in the UAE on such income. This creates a dividend flow with minimal withholding in Colombia and, potentially, no taxation in the UAE, which can be very efficient for reinvestment or subsequent distribution.

Royalties: A More Detailed Analysis

For royalty payments, the DTA limits withholding tax in the source country (Colombia) to 10%. Compared to Colombia's general rate of 20%, this represents a reduction. However, the net impact is more complex than in the case of dividends. Royalties received by a UAE entity will be subject to the 9% UAE corporate tax on net profit.

The efficiency of a royalty structure in the UAE will depend on the receiving entity's ability to generate significant costs and amortizations that reduce its 9% tax base. In our experience with clients, each case requires a meticulous evaluation. For example, if the intellectual property's development or acquisition costs are high and can be amortized in the UAE, the effective taxation can be competitive. If there are no relevant costs, the difference compared to direct receipt in other jurisdictions may not be as pronounced.

Economic Substance: The Fundamental Pillar

Soon after the implementation of this DTA, a point we consistently see in our discussions with family offices and business groups is the critical relevance of economic substance. Both the DIAN in Colombia, with its interpretation of anti-abuse rules, and the OECD's BEPS project minimum standard, reflected in the DTA through the Principal Purpose Test (PPT), are clear: treaty benefits are denied if the arrangement's primary purpose is tax-driven.

A holding or licensing company in the UAE must be genuine. This implies:

• Adequate offices: More than just a virtual address, a functional physical space is required.
• Managerial staff: Individuals with real decision-making capacity, not just nominal administrators.
• Active asset management: The entity must demonstrate that it actively manages the investments or intellectual property generating the income. This means, for example, negotiating contracts, making investment decisions, or managing intellectual property portfolios.

The post-BEPS era has redefined what constitutes a “valid structure.” Tax authorities, across all jurisdictions, are adopting a much more rigorous stance to identify and reject structures lacking genuine commercial or investment justification.

CFC and the New Tax Landscape

Additionally, Colombian tax-resident shareholders must keep in mind the Controlled Foreign Corporation (CFC) regime (Entidades Controladas del Exterior, ECE). Passive income, such as dividends or royalties, earned by a controlled entity in a jurisdiction previously considered low or no-tax, could be immediately attributed and taxed to the Colombian shareholder, eliminating any tax deferral.

The interaction between the Colombia-UAE DTA, the new UAE corporate tax law (with its 9% rate and specific exemptions), and the Colombian CFC regime is complex. We can no longer assume that the UAE automatically qualifies as a “low or no-tax jurisdiction” for CFC purposes in all cases. This requires an integrated analysis and proactive tax planning to confirm the efficiency of the entire structure and ensure compliance with all regulations.

Looking Ahead: The Next 12 Months and Beyond

Over the next 12 months, we anticipate an increase in the adoption of UAE structures, especially by Colombian groups that already have operations or interests in the Middle East region, or who seek to diversify their investment platforms. However, this adoption will only be successful for those who invest in establishing solid economic substance and who can justify the commercial logic of their presence in the UAE.

The Colombia-UAE DTA is a powerful tool for optimizing capital and intellectual property flows, but its successful application aligns with the principles of modern international taxation: the authenticity of operations and consistency with anti-abuse rules. At TaxCorp, we recommend that any structuring through the UAE be the result of a genuine operational and commercial strategy, not merely a vehicle for unsupported tax optimization.