Colombian tax reform proposes corporate rate increase, tax avoidance measures

The Colombian government introduced a tax reform bill on July 20 that includes an increase in the corporate tax rate, new measures to fight tax avoidance, and an electronic income declaration system. The reform aims to address public revenue shortfalls amidst an economic crisis in the country.

The tax reform now enters the legislative discussion phase, in which changes will be introduced, although structural modifications are not expected.

The reform effort opens a chance to enhance the Colombian market as a place that continues to generate opportunities for investors in sectors such as telecommunications, finance, new technologies, and real estate.

Economic and political context

Colombia faces its most drastic economic crisis in history. The Covid-19 pandemic exposed the vulnerability of health systems and different political, economic and social regimes.  

The public health crisis occurred amidst implementation of peace agreements that, in addition to the social and political challenges, demanded increased public spending, since they contemplated temporary universal incomes for the reinserted, coupled with a devaluation context that had been going on for a couple of years.

Poverty rates in Colombia, as in the entire region, have increased due to the pandemic. It is estimated that in the country about 20% of the population is in a state of poverty, with extreme poverty being close to 6%. The Venezuelan population stands out, which is estimated at about two million people, most of them in a precarious economic situation.

The situation described is difficult to measure in an economic context in which informality prevails, in which the “scavenging” economy (survive economy – sub employment) stands out apart from social security, payment of taxes and regularization of a payroll. This is a sector outside of legality.

The Colombian Government in 2020 implemented a variety of social programs. PAEF or payroll assistance sought to provide stability with respect to employees. Solidarity income provided a basic income for three million households. In addition, value-added tax (VAT) refunds were provided for the most vulnerable populations, extraordinary bonuses were offered for health employees, and a 50% payroll subsidy was granted to the tourism sector. New programs were also added to existing ones in education, pension, and housing subsidies, among others. Social spending rose to close to 7% of GDP.

The pressure on public spending was initially met with internal and external financing.

However, the national government has now introduced the tax reform bill, which not only focuses on collection but also includes measures for the reduction of, and more efficient, public spending at the national and local level. The reform is intended to meet the needs of the social spending that was created and allocate the difference to satisfy public debt.

Increase in corporate tax rate

In Colombia, unlike the OECD countries, taxation of income rests on the shoulders of entrepreneurs through corporate tax and not on individuals.

The first proposed measure in the tax reform is to increase the nominal corporate tax rate from 30% to 35% in FY 2022. It should be noted that although this is the proposed nominal rate, the effective rates in Colombia vary by sector. In addition, many sectors, such as construction, have tax benefits, such as the exemption from tax for income from the sale of affordable housing (VIS for its acronym in Spanish).

Other sectors – such as hotels, new technologies, investment in renewable and efficient energy sources, reforestation, transportation, among others – enjoy benefits that make it necessary for the investor to analyze the effective tax rate of the respective sector and the benefits that local legislation contemplates in the activity of its interest. Similarly, 50% of the amount for industry and trade tax (municipal tax on gross income) is considered a rent discount, which in itself impacts the effective rental rate being less than the nominal 35% proposed.

The corporate tax rate of financial entities will temporarily be 38% (i.e., the 35% income tax rate plus a 3% supplemental rate) until 2025.

Tax avoidance measures                                                                        

Another of the pillars of the tax reform is the fight against tax evasion, which is estimated at 30% of the total annual collection. Tax evasion results from various factors, including high levels of informality in the economy and, of course, the corruption that discourages the public from paying taxes.

In this respect, the reform accelerates the implementation of the electronic invoicing system, modifies the definition of final beneficiary – including participants in structures with and without legal status (fiduciary schemes) – and creates the registry of final beneficiaries linked to the tax registry. In addition, a new normalization tax allows legalizing omitted assets and purging nonexistent liabilities, especially those owned abroad.

Electronic income tax declaration

Under the electronic income tax declaration system, in terms of national taxes, the tax authority will be in charge of preparing the declaration annually and projecting the payment. The taxpayer who agrees will pay according to the invoice received for that purpose. Otherwise, the tax must be self-assessed within the term provided by the regulations.

Earlier tax reform effort

This is the second tax reform project that the national government is processing during 2021. The first failed attempt generated a social reaction of harsh protests and blockades that generated more damage to the economy, but which undoubtedly led to the government adopting a path of concession and fiscal adjustment of public spending.

The first project had sought to significantly modify the VAT by eliminating the exemption for basic goods, increase the individual rental rate, eliminate income tax benefits, and create a wealth tax for 2022–2025. It also would have established green taxes, such as taxes on carbon and the consumption of pesticides and single-use plastics.

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