The new tax reform is aimed at generating structural changes to the Colombian tax regime, with the purpose of redistributing the tax burden between legal entities and individuals, supplying better audit tools to the tax office, and avoid, in as much as possible, the creation of new taxes and/or the increase in the rates of the currently existing ones. The new tax code also includes a new regime for controlled foreign companies (CFC). Colombia’s Congress enacted Law No. 1819 of 2016 in late December 2016, introducing substantial changes to the existing tax and legal framework, including changes in requirements for transfer pricing documentation. Among other changes, the new law included several measures intended to align the Colombian tax system with the OECD’s Base Erosion and Profit Shifting guidelines.
Corporate Tax Rates
Under the new framework corporate income tax rates have been reduced and some exemptions eliminated. Until 2016 the Colombian corporate income tax rate was 40%, and was split into two taxes and a surtax: income tax, an income tax for equality, which is known as the CREE tax, and a CREE surtax. Law No. 1819 unifies the income tax and the CREE tax into a single income tax, as well as eliminating the CREE surtax. In addition, the law reduces the corporate income tax rate to 33%. However, it, temporarily, leaves the tax rate at 34% for 2017, and creates an income tax surtax of 6% for 2017 and 4% for 2018. This surtax applies to taxable profits in excess of COP800m ($240,000).
The reduction of the corporate tax rate was necessary. At 40%, the Colombian corporate income tax was the second highest in the world, and would have increased to 42% in 2017 and 43% in 2018 had Law No. 1819 not been enacted. It is, however, unfortunate that the reduction was not immediate, as added together the corporate tax and new tax on dividends will see the rates for 2017 and 2018 exceed 42% and 40%, respectively. Law No. 1819 also increases the income tax rate for firms located in free trade zones from 15% to 20% on goods and services. For firms in free trade zones newly registered and created between January 2017 and December 2019 in the municipality of Cucuta, the corporate income tax rate is 15%, provided certain conditions are satisfied.
Taxpayers covered by the progressive income tax rate under Law No. 1429 of 2010 are subject to the tax rates below, which are based on the number of years since the business began activity:
• First and second year: 9% + (General Rate-9%)*0;
• Third year: 9% + (General Rate-9%)*0.25);
• Fourth year: 9% + (General Rate-9%)*0.50);
• Fifth year: 9% + (General Rate-9%)*0.75); and
• Sixth year: Income tax general rate for the taxable year. Certain activities will be subject to a reduced 9% corporate rate starting in 2017, including editorial companies covered by Law No. 98 of 1993, and hotel services that qualify under Articles No. 3 and 4 of Article 207-2 of the Colombian Tax Code during the term the exemption was granted.
Income Tax Exemption
Additionally, the new law eliminated the income tax exemption that existed for several kinds of economic activities. The experts’ commission, the OECD and other organisations concluded that tax exemptions granted by Colombian law are one of the main reasons why the burden on the rest of the taxpayer base was so high. Getting rid of several of these exemptions was and still is not easy. In many cases, these exemptions are tied in with contracts or administrative resolutions, or were granted in exchange for investments. So taxpayers that benefit from them are protected either contractually or by the constitutional principle of legitimate trust. Pursuant to this principle, the incentives that taxpayers have received in exchange for making investments cannot be taken away until the term for which they were granted elapses.
According to the Colombian authorities, one of the structural deficiencies of the tax system is that it burdens firms, while being lenient on individuals. The reduction of the corporate rate came with the reinstatement of the dividend tax, applicable to resident individuals and non-resident firms and individuals. Profits distributed to individuals that are resident will be subject to dividend tax at rates of 0%, 5% or 10%, depending on the amount of dividends that they receive. However, profits distributed to non-resident firms and individuals will be subject to a withholding tax rate of 5%.
As in the past, when dividends are paid out from profits that were not fully taxed when in the possession of the company that distributed them, the shareholder that received the dividend payment will be responsible for the tax that was not paid by the company that distributed them as a transfer tax. In this case, the new dividend tax would apply on the dividend payment, or net of the transfer tax. The new dividend tax shall apply only to dividends paid out from profits obtained starting in 2017. However, the law does not establish an ordering rule for the distribution of dividends.
The tax basis is considered the accounting profits of companies as determined under the International Financial Reporting Standards (IFRS), with some tax adjustments. Colombia adopted the IFRS in 2015. The 2012 tax reform established a transition period of four years following the adoption of the IFRS, during which Colombian generally accepted accounting principles would continue to be used for income tax purposes. During the transition period, the government was supposed to analyse the impact of the IFRS adoption on the tax system in order to propose how to better integrate the IFRS and taxes. However, Law No. 1819 eliminated the transition period. Given that companies are still struggling to understand the IFRS and their impact on their businesses, and that tax officials do not seem to be knowledgeable about the IFRS either, it seems that having accelerated the adoption of the IFRS for tax purposes was not ideal.
The new law included a set of rules for the interaction between the tax rules and Colombian IFRS. Until 2017, tax rules were independent from accounting rules and relied on them only when required, but from 2017 onwards assets, liabilities, income, costs and expenses have to be accrued based on Colombian IFRS, unless the tax law provides for a different treatment. For this purpose, Law No. 1819 has included a list of situations in which accounting rules should not be followed for tax purposes, and has provided the rules that should be followed instead. Companies need to review carefully how the new system will impact their tax burden.
There have been several modifications to withholding tax rates on payments made to non-resident parties. In general, the modifications were positive for investors. There are changes that should be noted, however, regarding levying with income tax overhead expenses paid to related parties. While we sympathise with the intention of avoiding charges that may erode, without justification, the taxable base of Colombian taxpayers, the fact is that multinational firms by necessity incur centralised management expenses. Imposing withholding taxes on management expenses incurred abroad are likely to result in uncreditable withholding taxes for said firms and make global operations more difficult. Transfer pricing, exchange of information and tax auditing seem to be a more reasonable approach to avoiding tax base erosion.
Expenses & Intangible Property
The tax reform imposed several limitations on the tax amortisation of intangible property and deduction of royalty payments related to said property. It also levies, along with value-added tax (VAT), the transfer of industrial property. Royalty payments made in relation to finished goods are not deductible. It seems that the original intention of the limitation was to avoid taxpayers taking a double deduction on these royalties, one as part of the acquisition price of the finished goods and the other as a separate royalty payment. Notwithstanding, the rule issued simply denied the deduction of any royalty payment, which is something that is difficult to justify.
Regarding royalty payments for the use of intangibles formed in Colombia, Law No. 1819 establishes that payments made to foreign-related parties and to related parties in free trade zones, arising from the use of intangibles formed in Colombia, are not deductible. However, the law does not include a definition for “intangibles formed in Colombia”.
Regarding amortisation of intangibles acquired from related parties, Law No. 1819 establishes that payments to related parties for the acquisition of intangibles acquired separately or as part of a business are not amortisable. However, this limitation shall not apply when the transaction complies with transfer pricing regulations. Other limitations may apply to the amortisation of intangible property.
Law No. 1819 allows the tax authorities to reject costs and expenses, unless a business purpose is proven, which could be made through the application of the transfer pricing regime, arising from the following payments:
• Payments where, directly or indirectly the beneficial owner is the same Colombian taxpayer in a proportion equal to or greater than 50%;
• Payments made to non-cooperative jurisdictions or entities subject to a preferential tax regime; and
• Payments to a beneficiary who has not submitted a tax residence certificate.
Deduction Of Tax Losses
Colombian taxpayers are now entitled to carry forward tax losses for a period of 12 years, and not indefinitely as under the previous tax regime. There is a grandfathering rule for losses incurred prior to 2017, which may continue to be carried loss forward indefinitely. In addition, there is no ordering rule for the use of the losses.
The new tax code establishes a new framework that replaces the tax havens regime and provides that certain jurisdictions, as well as some ring fence regimes, may be subject to tax haven treatment. These are regimes that are eligible only for non-residents of the jurisdiction that offers them. The new legal framework establishes a higher tax withholding rate on Colombian source payments to those jurisdictions and entities considered part of a preferential tax regime. The already existing tax haven jurisdictions list continues to apply, while the list of preferential tax regimes (ring-fence regimes) is pending.
Law No. 1819 establishes a CFC regime that applies to Colombian tax residents, individuals or entities, that directly or indirectly hold a stake equal to or greater than 10% of the capital of a foreign entity or its profits. CFCs include investment vehicles, such as subsidiaries, trusts, collective investments funds and private interest foundations that are not resident in Colombia for tax purposes, and that comply with the conditions to be considered as related parties for transfer pricing purposes.
For income tax purposes, net profits derived from passive income obtained by a CFC should be recognised immediately in proportion equivalent to participation in the CFC’s capital or profits, and not upon receipt of dividends or profits. Passive income includes, with some exceptions, the following: dividend and other kinds of profit distribution; interest; income derived from the exploration of intangibles; income from the sale of assets in certain cases; income from the sale or lease of immovable property; income derived from the sale or purchase of tangible goods acquired from, or sold to, a related party, when their manufacturing and consumption occurs in a jurisdiction different from where the CFC is located or is tax resident; income from the performance of technical services, technical assistance, administrative, engineering, scientific, qualified, industrial and commercial services in a jurisdiction different from where the CFC is located or is tax resident. The Colombian tax resident that recognises passive income under the application of the CFC regime may deduct the costs and expenses related to said income, as well as request a tax credit for taxes paid abroad in relation to it. Dividends and benefits that are distributed by a CFC and have already been taxed in Colombia should be considered non-taxable income for a Colombian resident taxpayer.
Vat & Rates
One mechanism that the government has proposed to increase tax collections is increasing the VAT rate. Law No. 18919 increased the general rate from 16% to 19%, and taxes certain goods that were previously not subject to VAT at 5%. The law also extends the definition of taxable event for VAT purposes to the sale of all goods, including intangible goods, such as those related to intellectual property, and real estate, unless expressly excluded. VAT continues to not apply to the sale of fixed assets, except for real estate property for residential use, automobiles and other fixed assets sold in the ordinary course of business in the name of, and on behalf, of third parties. For this purpose, the law excludes real estate from VAT, unless the value of the first sale is higher than 26,800 tax value units, approximately COP854m ($256,000), which will be taxed at a 5% rate.
Vat On Foreign Services
Unless expressly excluded, services rendered from abroad will be subject to VAT. The assignment of rights is included as a form of service. The rendering of certain digital services, such as streaming media content, app distribution, online advertisement and teaching, are also subject to a VAT tax. The law states that the tax authorities are required to regulate the way in which foreign online service providers comply with formal VAT obligations. These obligations include registering with the Colombian tax authorities for VAT purposes, and filing and paying their VAT returns. Assuming the tax authorities finalise the regulations, foreign services providers are expected to comply with the VAT filing requirements starting in July 2018. If a foreign service provider does not fulfil the obligations within the due date, Colombian banks that issue credit and debit cards, prepaid cards sellers and cash collectors, among others, will be required to withhold VAT when the payment or the account deposit to the digital foreign services provider occurs.
Law No. 1819 also repeals Item No. 4 of Article 437-2 of the tax code, and as such in transactions involving VAT common regime and VAT simplified regime parties, the VAT common regime entity should not withhold taxes when acquiring taxable goods and services from the simplified regime entity. The law also modifies the provisions on VAT withholding on payments to non-resident individuals. VAT on the acquisition or import of capital goods may be deducted for income tax purposes during the period in which the acquisition or import took place. The law requires VAT returns to be filed and payments to be made either bimonthly or quarterly. The statute of limitations for the request of creditable taxes has also been increased from two to three bimonthly periods following the accrual period.
The reformed tax code also offers incentives for investing in areas that were affected by armed conflict. Significant investments will have to be made in these areas that have remained underdeveloped. The law includes tax benefits for companies that initiate economic activities in territories that have been more affected by violence. Companies that classify as small firms will be exempt from income tax between 2017 and 2021, subject to a rate equal to 25% of the general corporate rate from 2022 to 2024, and to a rate equal to 50% of the general corporate rate from 2025 to 2027. Medium and larger companies that initiate activities in the conflict area will pay 50% of the general corporate tax rate between 2017 and 2021 and 75% of said rate between 2022 and 2027.
Taxpayers may decide to invest up to 50% of their resulting income tax for a relevant year in directly developing certain works, such as infrastructure, in areas affected by armed conflict.
Modernisation Of Tax Function
Several non-government entities have concluded that the capacity of the Tax Office to manage tax functions, including the possibility of efficiently auditing taxpayers which is severely limited by the lack of technological and human resources. Law No. 1819 establishes that within 6 months following its enactment, the tax director must present a five-year plan for the modernisation of the Tax Office’s IT systems.
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