Colombia: a new tax reform in sight
At the beginning of 2013, and after having had a very hard time trying to convince businesses to support the 2012 tax reform, the government promised that it would file a comprehensive tax reform to better articulate the tax system and in this way avoid the need of making reforms every other year to deal with budget constraints, writes Jaime Vargas, tax managing partner and international tax services leader at EY Colombia.
However, presidential elections got in the way – few things are as bad for a campaign as proposing tax increases – and so the "structural" tax reform was postponed. Ultimately, no structural tax reform bill was filed in 2013 or in 2014. At the end of 2014, after the presidential re-election, the Government had to do what it had promised not to, which was exactly what previous governments had done during several years, and one of the main reasons for the need of a structural tax reform: it proposed a new "temporary" tax on wealth and increased the corporate income tax rate with a surcharge. Nothing could have been further from the structural tax reform that was promised.
In February 2015, the Government appointed a commission of experts that later that year presented a report recommending a structural tax reform. Other organisations have also presented their recommendations to the Government. It is expected that with all this material, the Government will prepare a tax bill to be presented to Congress in October 2016, once the referendum to approve the peace treaties with the FARC, potentially ending Colombia's civil war, has been voted on.
In the meantime, the Colombian economy has started to face significant challenges. The main driver of its growth during the past years was oil exploration and production. With the price of oil low, the Government's income and GDP growth estimations for the country have been dramatically reduced. The fiscal deficit estimation for 2016 was increased to 3.9% of GDP, going down to 3.1% of GDP in 2017, partly because of a substantial reduction in the Government's investment budget. Credit rating agencies have announced that Colombia needs to implement a tax reform in 2016 in order to keep its credit rating.
As worrying as all the above may seem, the reality is that Colombia has solid economic fundamentals and is holding up better than many other economies. In 2015, Colombia's GDP grew 3.1%; it is expected that in 2016 it will grow 2.4% – not bad when compared to its neighbors' contracting situations. The IMF predicts that Colombia's GDP will grow 4.3% in 2020. But for its economy to continue on the right track, Colombia needs a tax reform.
What should the tax reform look like?
What to expect then from the tax reform? Will it really be a structural one? If yes, has the Government invested enough time in analysing thoroughly the changes that it will propose? How should the reform balance the urgent need of additional collections with the long-term need of a coherent tax system?
As mentioned, the commission of tax experts issued its report a few months ago. In a nutshell, the most relevant recommendations of the commission were to:
Increase the income tax collections from individuals by lowering the minimum level of income required to become an income taxpayer and reducing or eliminating tax exemptions;
It is unclear whether the additional taxes that low-income earners would contribute with are worth the administrative burden of their collection. However, from a citizen culture perspective it is worthwhile that all the individuals that are able to contribute to the state make their contribution. By the same token, there doesn't seem to be a clear reason for exempting pensioners from paying income tax, so the elimination of the exemption seems to be accurate, too.
Create a new "tax on business profits" to replace income tax and income tax for equality (CREE);
Income tax was split in two taxes back in 2012 to solve an issue that surely could have been solved in a better way, and making the tax system more complicated without a valid reason, so unifying the two taxes into a single tax is the right thing to do.
Use as tax basis the accounting profits of companies determined under international financial reporting standards (IFRS), with some tax adjustments;
As of 2015, Colombia adopted IFRS. However, the law established that Colombian generally accepted accounting principles (GAAP) would continue to be used for calculating taxpayers' income tax burdens for four years. During this period, the Tax Office was supposed to make all the necessary analyses to determine the impact that using IFRS instead of Colombian GAAP could bring on tax collections and on taxpayers. Although the four years have not elapsed, and no conclusions have yet been drawn from the analyses, the Government seems strongly inclined to move to using IFRS as tax basis.
Companies are still struggling to understand IFRS and their impact on them. Tax officials do not seem to be knowledgeable in IFRS either. It seems that accelerating the adoption of IFRS for tax purposes is not a good idea.
Reduce the corporate tax burden to a rate between 30% and 35%. The income tax rate is 25%, and the CREE tax rate is 9%, for a combined rate of 34%. However, there is a CREE surtax that increases the combined rate to 40%, and that will increase it to 42% (2017) and 43% (2018);
Reducing the corporate income tax rate is not only a good idea but a must. Colombia has the second highest corporate income tax rate of the world, the highest one in Latin America, and increasing it to 42% and 43%, which would happen in 2017 and 2018 if there are no changes to the law, is simply unthinkable.
Eliminate tax exemptions applicable to companies;
The experts' commission, the OECD and other organisations have concluded that exemptions granted by Colombian law are one of the main reasons why the burden on the rest of the taxpayers needs to be so high. However, tax holidays and other kinds of exemptions are not either good or bad. They are good whenever the positive externalities that they generate are higher than the fiscal sacrifice that they imply, and bad when they are not.
Getting rid of several of the exemptions that exist in Colombia is not going to be easy. They are tied by contracts or administrative resolutions, or have been granted in exchange for investments. So taxpayers that have them are either protected contractually or protected by the constitutional principle of "Legitimate Trust". Pursuant to this principle, incentives that have been granted to taxpayers in exchange for making investments cannot be taken away from them until the term for which they were granted elapses. In addition, now that it seems that the war with the FARC will come to an end, tax incentives could be a way of attracting investors to agroindustry, infrastructure and other economic sectors whose involvement would be required to develop vast and rich geographical regions that have been isolated from the rest of the country for decades due to violence.
Reinstate the dividend tax at a rate between 10% and 15%;
If the corporate tax rate is coming down, filling the gap with a dividend tax seems to be a good idea, as it would be shifting part of the tax burden from the companies to its shareholders, provided that the combined rate is within acceptable levels. Rates of 40% or more, even if the burden is split between a company and its shareholders, are inconvenient.
Adopt BEPS rules;
Together with reviewing Colombia's anti-abuse regulations in order to make them applicable, the commission proposed the adoption of rules to prevent base erosion and profit shifting. Colombia has already adopted some rules (e.g. thin capitalisation rules), but there is still a lot of work to do in this area. Controlled foreign company (CFC) regulations, taxation of indirect transfers, country-by-country reporting, just to mention a few, are yet not part of Colombian tax law, and their inclusion is being analysed by the Government.
In this regard it is important to remember that adopting BEPS rules was one of the commitments acquired by Colombia to be accepted as a member of the OECD.
Increase the VAT rate to 18% or 19%, eliminate exemptions and simplify the VAT system;
Together with increasing the tax rate, the commission has proposed eliminating several VAT exemptions. Despite the inflationary effects and how unpopular such a measure may be, increasing the VAT rate seems to be the only clear mechanism from which the Government may derive additional funds in the short term.
And, finally, review and strengthen the Tax Office's auditing powers and capabilities.
The OECD has pointed out that the number of officials that the Colombian Tax Office has is too low. In addition, the salaries that are paid by the Tax Office are not attractive. Granting the Tax Office the resources it needs to recruit and train personnel and to improve its IT capabilities is as necessary as the structural tax reform itself. Tax evasion is high in Colombia. According to the IMF, VAT evasion exceeds 40%. Corporate income tax evasion could be higher than 35%. Reducing tax evasion could be meaningful, and as productive as a structural tax reform itself.
Tax managing partnerInternational tax services leader
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Jaime Vargas is the tax managing partner of EY Colombia, and leads its international tax services practice. Before joining EY Colombia in November 2014, Jaime was a partner at Baker & McKenzie (2010-2014), corporate and international tax manager of Coca Cola Femsa (Mexico, 2007-2010), managing tax partner at Deloitte Colombia (2002-2007), managing tax partner at Andersen Colombia (2000-2002) and a partner at Baker & McKenzie (1995-2000).
Jaime has been advising companies on tax matters for almost 25 years. He has substantial experience in M&A, national and international tax planning and taxes applied to the oil and gas industry.
He has advised companies such as Enel, Telefónica, Chevron, Pacific Rubiales, Terranum, British American Tobacco, Cemex, Jeronimo Martins, Cemex, SAP, AT&T and Apple, among others.
Jaime is a professor of tax planning in the tax prograduate program at Universidad Externado de Colombia. He has also lectured in tax prograduate studies at Universidad Javeriana and Universidad del Rosario. He is a member of the International Fiscal Association and of the Colombian Institute of Tax Law.
Jaime is a lawyer of Universidad Externado de Colombia inBogotá, with a specialisation in tax law at Instituto Tecnológico Autónomo de México, Mexico City.
For many years, Jaime has been consistently recognised as one of the leading tax advisers in Colombia by specialised publications such as Chambers Law, International Tax Review, Euromoney and Which Lawyer, among others.