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13.3.1. Main Rules

The Colombian Transfer Pricing Regime follows in general terms the OECD Transfer Pricing Guidelines (2010) and its standard. This standard is the Arm's Length Principle, which determines that a transaction between related parties must meet the conditions that would have been used in comparable transactions with or between independent parties.

In 2002, the Colombian Congress introduced the regime in the local legislation by means of Law 788. Later these standards were substantially modified by Law 1607 of 2012 and regulated by Decree 3030 of 2013.

The following description will define the conditions that must be met for the application of the transfer pricing regime and related formal obligations:

a) Companies that must comply with the transfer pricing regime

According to the Colombian legislation, there are three different situations under which companies have to comply with the transfer pricing regime:

  • When the transaction takes place with a related party located abroad.
  • When the transaction takes place with a related party located in a Free Trade Zone in Colombia
  • When the transaction takes place with a related party or even unrelated party, located in a Tax Haven, according to the list issued by the National Government: Decree 2193 of 2013 applicable for taxable year 2014, and Decrees 1966/14 and 2095/14 applicable from January 2015.

Notwithstanding the above, it must be determined whether or not these taxpayers are required to comply with the formal obligations derived from the transfer pricing regulations. In other words, they must prepare and submit an informative transfer pricing return or transfer pricing supporting documentation detailing therein the transactions carried out in any of the three cases mentioned above, and showing that they have complied with the arm's length principle.

Article 260-1 of the Tax Code and article 1 of Decree 3030 of 2013 consider that related parties are, among others:

  • Subordinates.
    • An entity is subordinated or controlled when its decision-making powers are subject to the will of another person, persons or entities who will be its parent company or controlling one, either directly, case in which this subordinate will be called “filial”, or with the contest or through the subordinates of the parent company, case in which it is called subsidiary.
    • A company is subordinated when it meets one or more of the following cases:
      • When more than 50% of its equity belongs to the parent company, directly or through the subordinates of the parent company, or their subordinates. To this end, shares with preferential dividend and no voting rights are ignored.
      • When the parent company and its subsidiaries, have, either jointly or separately, the right to issue the minimum deciding majority votes at a meeting of partners or assembly, or have the number of votes required to elect the majority of board members, if it exists.
      • When the parent company, directly or through its subordinates, because of an act or business with a controlled company or with its partners, exercises dominant influence in the decisions of the governing bodies of the company.
      • When a control situation under the circumstances provided in this Article, is exercised by one or more natural persons or legal entities through schemes of a non-corporate nature, either directly or through or with the assistance of entities in which they possess more than (50%) of the equity or configure the minimum majority for making decisions or exercise dominant influence over the management or decision making of the organization.
      • When the same natural person, or the same natural persons or legal entities, or the same non-corporate entity or entities, either jointly or separately, are entitled to receive fifty percent of the profits or more of the subordinated company.
      • Branches with respect to their main office.
      • Agencies, in respect of the companies to which they belong.
      • Permanent establishments with respect to the company whose activity they perform in whole or in part.
      • When two subordinates belong to the same parent company.
  • Other cases:
    • When the transaction is carried out between two subordinates that belong to the same parent company.
    • When the transaction is carried out between two subordinates that belong directly or indirectly to the same natural person or legal entity or other type of non-company structure.
    • When the transaction is carried out between two companies in which one natural person or legal entity, directly or indirectly, is involved in the management, control or capital of both. A natural person or a legal entity is deemed to participate directly or indirectly in the management, control or capital of another company when he: i) possesses, directly or indirectly, more than 50% of the equity of the company, or ii) has the ability to control business decisions of the enterprise.
    • When the transaction is carried out between two companies whose equity is owned directly or indirectly for more than (50%) by natural persons related by marriage, by consanguinity to the second degree or affinity, or by adoption.
    • When the transaction is carried out between related parties through unrelated third parties;
    • When more than 50% of gross revenues of the company are derived individually or jointly from its partners or shareholders, community members, associates, subscribers or similar.
    • When there are consortiums, temporary unions, participation accounts, other forms of association that do not give rise to legal entities and other business cooperation contracts.

In this regard, Article 260-2 of the Tax Code also considers that:

When a foreign entity related with a permanent establishment in Colombia, performs a transaction with another foreign entity, in favor of that establishment, the latter is required to determine its ordinary and extraordinary income, costs and deductions, assets and liabilities for these transactions in compliance with the arm's length principle.

Likewise, when income taxpayers conduct transactions with related parties located in Colombia, in relation to the permanent establishment of one of them abroad, they are required to determine their ordinary and extraordinary income, costs and deductions, and their assets and liabilities for these transactions in compliance with the arm's length principle.

b) Transfer Pricing Methods

Article 260-3 of Tax Code and the doctrine of the OECD recognizes six methods to determine if prices or profit margins agreed in transaction between related parties meet the Arm's Length Principle. It is important to note that there is no formal hierarchy ranking of methods in the Colombian transfer pricing regime. Indeed, whilst the CUP method is preferred whenever its application is possible, the overriding rule is that the taxpayer shall apply the one that is more appropriate taking into account the circumstances of each case and the requirements established by law. The methods are:

Traditional methods

  • Comparable Uncontrolled Price (CUP). This method is applied by comparing the prices agreed to between related parties for the transfer of property or the provision of a service with the prices agreed to between unrelated parties under similar circumstances.
  • Additional factors to determine the level of comparability are the volume, the quality, the market level, the geographical market, the timing and the effectively viable commercial alternatives for both parties. Minor differences may always be accepted provided that adjustments can be made.
  • Resale Price Method (RPM). This method is applied by determining the market prices for a purchase and sales transaction using as indicator the gross profit or margin obtained in similar transactions with unrelated parties. The RPM method is generally appropriate in those cases that involve the purchase and resale of property where no substantial value is added to the property. The analysis of functions preformed is key to determine the level of comparability.
  • Cost Plus Method (CPM). The CPM method is applied to determine the market price of a related party transaction by analyzing the gross profit margins on the cost obtained in comparable transactions with unrelated parties. The CPM method analyzes the value of the functions carried out and is generally appropriate for the provision of services and the manufacture of property for sale to related parties.

Non-traditional methods

  • Profit Split Method (PSM). This method evaluates whether the allocation of global profits and/or losses which are attributable to one or more transactions between related parties is made in a manner which is similar to that which unrelated parties would have carried out in comparable transactions under similar circumstances, considering the relative value of the contribution of each one of the related parties to said profits and/or losses.
  • Residual Profit Split Method ("RPSM"). This method evaluates the allocation of the combined profit earned by related parties which use in their operations items of intangible property in non-routine fashion. This method is applied by allocating the global profits and/or losses which are attributable to one or more transactions between related parties in accordance with the investments in assets and the risks assumed by each one of the parties in the generation of the transaction’s global profit. To this end, the combined profit from the transaction is determined by adding the profit of the enterprises (related parties). After that, the minimum profit corresponding to each of the related parties is determined in accordance with the respective functions, assets and risk. This determination is made without taking into account the use of important intangible property and by applying any of the aforementioned pricing methods. The residual profit is the result obtained from subtracting the combined profit from the minimum profit obtained as indicated above. The related parties then allocate this residual profit to each other (as parties to the examined transactions), taking into account, for these purposes, the utilization of significant items of intangible property and the proportion by which the residual profit would have been allocated with or between unrelated parties in comparable transactions.
  • Transactional Net Margin Method ("TNMM"). This method is applied by comparing the transaction profit obtained by one of the parties to the transaction being reviewed with the transaction profit earned by unrelated parties in comparable transactions. The level of comparability is determined with respect to the functions performed, the assets used and the risks assumed. This method provides certain flexibility with respect to the level of comparability with the unrelated parties to be used, because it accepts differences occurring in the products sold and focuses on the similarity of functions carried out by the enterprise being examined and the unrelated parties being used as comparables.

c) Comparability

The application of the Arm's Length Principle is generally based on the comparison of conditions of a transaction between related parties and a transaction made with or between independents parties. It is understood that two transactions are comparable if there are no significant differences between them, which can possibly affect the price or profit margin. However, operations are also comparable in situations in which such differences can be eliminated with sufficiently reliable adjustments that eliminate the effects of such differences in the comparison. Article 260-4 of Tax Code determines the criteria for comparability which include:

  • The characteristics of the transactions, including:
    • In the case of financing operations, elements such as the principal amount or disbursed amount, term, risk rating, warranty, customer arrears and interest rate. Interest payments, regardless of the agreed interest rate shall not be deductible if it does not meet the elements of comparability statements. This is because if the terms and conditions of the financing operations are such that they do not meet the Arm’s Length standard, such operations will not be considered as loans or interest, but as capital contributions producing the equivalent of dividends.
    • In the case of provision of services, elements such as the nature of the service and "know-how" or technical knowledge;
    • In the case of granting the right of use or disposal of tangible goods, items such as physical characteristics, quality, reliability, availability of goods and volume of supply; In the cases of the transfer of an intangible or the granting of exploitation rights pertaining thereto, elements such as the kind of right, patent, trademark, trade name or "know-how", the duration and degree of protection and benefits to be expected from its use. In the case of sale of shares, for purposes of comparison, it shall be considered the present value of profits or projected cash flows, or the market price of the relevant issuer on the last day of the sale.
  • The functions or economic activities, including assets used and risks assumed in the transactions, for each of the parties involved in the transaction.
  • The contractual terms and conditions agreed against the economic reality of the operation.
  • The economic or market circumstances, such as geographic location, size, market level (wholesale or retail), competition in the market, competitive position of buyers and sellers, the availability of substitute goods and services, supply and demand in the market, purchasing power of consumers, government regulations, production costs, transportation costs and the date and time of the operation.
  • Business strategies, including those related to the penetration, retention and market expansion.

d) Adjustments

According to article 260-6 of the Tax Code, when tax authorities of another country, with which Colombia has signed a Double Tax Treaty, make an adjustment to prices or profit margins of a taxpayer resident in said country, and as long the Colombian tax authority has approved it, the related party resident in Colombia is allowed to correct and modify its tax return without the corresponding sanction.