Pacific Alliance Double Taxation Convention on pensions funds will apply beginning 1 January 2024

EY
EY Global

Ernst & Young Global Ltd.

26 Jul 2023
Subject Tax Alerts
Categories Individual Taxation
Jurisdictions Colombia, Mexico, Chile, Peru

Executive summary

On 2 July 2023, the Convention to Harmonize the Double Tax Treaties (DTT) of the Pacific Alliance (the Convention) entered into force. The Convention addresses the taxation of pension funds on their cross-border investments within the Pacific Alliance, which includes Chile, Colombia, Mexico and Peru (Convention members). The Convention will apply beginning 1 January 2024.

Detailed discussion

The Convention includes a Protocol regulating relations between Colombia and Peru (the Protocol CO-PE). The Protocol CO-PE seeks to properly integrate the Convention into Colombian and Peruvian law, such as Decision 578 of the Andean Community – CAN.

The Convention and the Protocol treat pension funds as tax residents and beneficial owners of income, allowing them to enjoy the benefits of the Convention and the applicable DTTs.

The Convention and the Protocol address the application of income tax to interest and the transfer of shares as follows:

Item of income obtained by the Pension Fund

Convention

Protocol CO-PE

 

Interest

  • A 10% withholding tax rate applies to interest income in the source State.
  • In the event that applicable rules provide more favorable treatment of interest income (less than 10% income taxation at source), the relevant DTT will apply.
  • The term “interest” includes income from debt securities issued by a resident of a Convention member.
  • A most favored nation clause on interest will continue to apply under the terms originally established in the DTT.
  • A 10% withholding tax rate applies to interest income  in the source State.
  • Interest is not taxed in the country of source (and might only taxed in the country of residence) if it is paid by a Contracting State, one of its political subdivisions, its Central Bank, or a  wholly state-owned bank).
  • Interest is defined to include income from the sale of debt securities issued by a resident of a Convention member.

Capital gains from the transfer of shares of a company that is a resident of a Convention member

  • A sale through a stock exchange that is part of the Latin American Integrated Market (MILA per its acronym in Spanish) should only be taxed in the pension fund’s country. of residence (if tax applies there), not in the source country.
  • It does not include disposal rules outside MILA, which should be covered under the relevant DTT.
  • Gains from stock that is directly or indirectly disposed may be taxed based on the location of the company whose shares are sold.
  • Sales through MILA will only be taxed in the pension fund's country of residence (if tax applies there), not in the source country.

The Protocol CO-PE’s benefits will only apply to interest and capital gains that derive from contributions towards the payment of future pensions (aportes con fines previsionales).1 It also includes (i) an interpretation rule similar to Article 3(2) of the OECD Model Convention, (ii) a provision to avoid double taxation, and (iii) a mutual agreement procedure (MAP) for disputes over its application.

The Convention’s second Protocol on the DTT between Mexico and Peru allows treaty benefits for interest and capital gains even though the income recipient is not subject to taxation in its country of residence.

The Convention will not apply automatically to a new State that adheres to the Pacific Alliance Agreement in the future. In that case, the new State must determine how it will apply the Convention and sign a Protocol on the Convention’s application with the other parties.

Next steps

As the taxation of pensions funds may be affected starting 1 January  2024, funds may wish to consult with their EY advisors about the Convention’s potential effects.

Contact Information

For additional information concerning this Alert, please contact:

Ernst & Young Colombia
  • Luis Orlando Sánchez
  • Jaime Vargas
  • Juan Torres Richoux
  • Andrés Millán
  • Zulay Arevalo
  • Amalia Borja
  • Isabel Rodriguez
Ernst & Young México
  • Koen Vant Hek Koot
  • Jose Pizarro
Ernst & Young Chile
  • Felipe Espina Valenzula
  • Juan Pablo Navarrete
  • Nicolas Brancoli
  • Alicia Dominguez
  • Victor Fenner
  • Pablo Greiber
  • Janice Stein
Ernst & Young Perú
  • Roberto Cores
  • Ramón Bueno-Tizón
  • Ingrid Zevallos
  • Yasmin Manzur

Published by NTD’s Tax Technical Knowledge Services group; Maureen Sanelli, 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.

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