The 24-year-old had participated in the young drivers' test for the Indian Formula One outfit in July.
Colado will begin his stint at this weekend's Italian Grand Prix here and he will get behind the VJM06 on Friday for the first free practice session.
Team Principal Vijay Mallya confirmed his signing.
"I'm pleased to confirm that we've signed James as our third driver. We worked with him during the Silverstone test and he impressed everyone with his speed and consistency," Mallya said.
"We've always tried to support young drivers and this is a great opportunity for James to gain some valuable experience of driving during Formula One race events."
Mallya said Colado will get chances in other races as well.
"James will take part in the opening free practice session on Friday. He will also run in practice at several other races this year. It's always useful to get another driver's feedback on the car and it will help us evaluate James," he said.
In the past, Nico Hulkenberg and Di Resta were promoted from test drivers to racing seats.
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