Colombia's latest tax reform highlights

Colombia's Congress enacted the country's latest tax reform (Law 2010/2019) on December 27, 2019. This reform, which was not scheduled for 2019, was rushed through the legislative bodies in the last months of the year, given that the Constitutional Court had declared the 2018 tax reform unconstitutional, due to procedural errors in its transit through Congress.

Initially, the Government's objective was to replicate the 2018 tax reform, but several modifications were made in Congress because of political agreements.

This article highlights the most relevant aspects of the Colombian tax reform, focusing on direct taxation issues.

Corporate income tax

Companies were the most benefited taxpayers in the last tax reform, as the government recognizes the importance of companies as the main employers and providers of social prosperity in the country. In this context (and continuing with the policies established in the previous tax reform), the corporate tax rate was gradually reduced from 33% for 2018, to 32% in 2020, to 31% in 2021, and finally to 30% 2022 and thereafter.

In addition, an accelerated cessation of the alternative taxation system of presumptive income (whereby individuals and legal entities are deemed to have had a minimum income according to the value of the wealth they hold) was approved, reducing the base for 2020 to 0.5% (from 1.5% in the previous reform) and to 0% as of 2021.

The tax exemptions granted by the 2018 tax reform for creative industries and for investments in agriculture and hospitality and tourism were confirmed and extended. The incorporation of a company to carry out activities in certain creative industries (which was extended to sports, leisure and recreational activities), once the Government approves the proposed project and the relevant conditions are met (mainly hiring a minimum number of workers and making a minimum investment), is eligible for a seven-year income tax exemption, and in the case of agricultural investments, a ten-year income tax exemption.

The latest tax reform also indicated that companies incorporated for the purpose of investing in agriculture do not need to have their main headquarters in the areas where agricultural investments were made, so they are allowed to incorporate in the main business centers, regardless of whether they have a presence in these areas.

As for hotels and tourism, the 9% tax rate was maintained for 20 years for hotels built in municipalities with less than 200,000 inhabitants, and a 10-year benefit was granted to those built-in municipalities with a higher population. As stated by the Constitutional Court in a recent ruling, companies that had opted for the 30-year tax exemption in the past will maintain that benefit, but their shareholders will receive a taxable dividend.

The modification of the "mega investment" regime, whereby projects whose investments reach approximately US$323 million benefit from a favorable tax rate (27%), with no dividend tax or presumptive income tax and tax stability, was extended to projects undertaken in free zones, as well as to the emerging technologies sector (where the direct employment requirement was reduced from 400 new jobs to 250).

The tax reform also extended the regional tax exemption regime applicable to areas adjacent to the Venezuelan border and to capitals with higher unemployment rates (called the Special Economic and Social Area-ZESE exemption) to the health and tourism sectors, thus boosting investment in these sectors.

Equity tax

The tax reform confirmed and adjusted the creation of a wealth tax for the years 2020 and 2021. This tax is triggered by the possession of a net fiscal wealth equivalent to 5 billion Colombian pesos (US$1.5 million) held by individuals, foreign entities or corporations and permanent establishments of the latter. The rate applicable to this tax is 1% on the net tax equity determined on January 1, 2020, and January 1, 2021. From the taxable base, taxpayers may exclude 50% of the value of disclosed assets (see "Tax on disclosure of assets" below) that have been effectively repatriated to Colombia and permanently invested in the country. Finally, 75% of the proceeds will be used to finance investments in the agricultural sector.

Tax on dividends

The tax reform introduced considerable changes in the taxation of dividends. These include:

a reduction (as discussed below) in the tax rate on dividends for individuals (from a maximum rate of 15% to a maximum rate of 10%).

an exemption (existing in the previous budget law) from withholding taxes on non-taxable dividends distributed to parent companies that have registered their control status with the chambers of commerce

an increase (from 7.5% to 10%) in the tax rate on dividends paid to non-resident individuals, companies or entities, as well as to permanent establishments of non-resident individuals or entities.

Personal income tax

The tax reform introduced positive adjustments to the taxation of individuals. These changes include:

a substantial reduction in the dividend tax rate (from a maximum rate of 15% to a maximum rate of 10%) on dividends that have been subject to tax in the distributing company and whose distribution has been approved to take place as of 2020 a clarification on the taxation of life insurance policies payable, so that the 10% capital gains tax will only apply to payments exceeding a threshold of approximately $130. A clarification - due to recent decisions adopted by the Constitutional Court - on the right of individuals to deduct, in the general personal income tax bracket, costs and expenses related to their income from professional services a reduction of the withholding tax on earned income was approved.

tax benefits (special premiums for living expenses abroad) for diplomats working for the Colombian Foreign Ministry were extended to Colombian diplomats working abroad and working for other government entities the reactivation of a substantive tax benefit that exempted from taxation the inflation component in financial products a gradual reduction (from 2020 to 2022) of the monthly social security contributions of pensioners was approved, in order to improve their financial situation, a tax benefit was introduced consisting of the deduction of interest paid on student loans granted by the government student loan agency; and a special provision for judges and prosecutors of the Superior Courts, which allows them to take the equivalent of 50% of their salary as tax-exempt representation expenses (for ordinary judges this percentage amounts to 25% of their salary).

Personal income tax

The tax reform extended for one more year the tax amnesty in force for the last four years and aimed at taxing undeclared assets (either in Colombia or abroad) and/or non-existent financial liabilities of residents, existing as of January 1, 2020 (and payable as of September 25, 2020). These will be taxed at 15%, a slight increase over the tax rate of previous years.

Simplified tax regime

The latest tax reform confirmed the existence of the Simplified Tax Regime (RTS) created by the 2018 tax reform, introducing only minor adjustments. This is a voluntary tax model that seeks to simplify compliance for small and medium-sized companies, by substituting income tax, excise taxes and municipal industry and commerce taxes, and integrating employer contributions to the pension system, through a tax credit. This tax, applicable to companies and individuals that meet certain conditions, has a favorable rate depending on the taxpayer's gross income bracket and activity, and is applied on their gross income.

This regime was challenged before the Constitutional Court for violation of territorial autonomy, due to the right of the municipality to tax individuals with industry and commerce taxes. By means of judgment C-368/19, the Court abstained from ruling on the merits of the case, considering that the complaint did not meet the formal requirements.

The adjustments made by the latest tax reform include an increase in tax rates (the highest applicable tax rate is 14.5% for professional, consulting, and scientific services, compared to a maximum alternative tax rate of 32% for companies and 39% for high-net-worth individuals) and the obligation for taxpayers subject to this regime to adopt an electronic invoicing system within two months of their adoption of this model.

Annual Foreign Assets Declaration Form

In the last tax reform, several changes were introduced regarding the obligation to file this form. Only foreign assets with a tax value of around US$22,000 must be declared in the form. An exemption for extemporaneous compliance is also established, whereby penalties that were calculated as a percentage of the value of the undeclared assets are substantially reduced.

Modifications to tax procedure

In procedural matters, the latest tax reform has introduced several adjustments, mainly to clarify and make the new regulations consistent with the pre-existing ones. In this regard, a three-year period was introduced to modify tax forms (previously it was two years) to harmonize it with the general three-year statute of limitations period. Also, a clarification was introduced so that taxpayers with tax losses, or subject to transfer pricing regimes, would be subject to an exceptional five-year statute of limitations period.

The "audit benefit" (i.e., an accelerated six-month statute of limitations period for taxpayers who increase their taxes by at least 30% over the previous year) was confirmed by the tax reform for the years 2020 and 2021. If the increase amounts to 20%, the statute of limitations period will be 12 months. It was also determined the extension of settlement facilities for ongoing judicial tax litigation, in which taxpayers can reduce penalties and accrued interest.

Finally, in compliance with a recent decision of the Constitutional Court (which provided a comprehensive definition of the word "law" as a complete set of rules, regulations and legal concepts), the latest tax reform established that, although rulings issued by the tax authorities are only binding for tax inspectors, taxpayers may structure their defense based on the law.

Amendments to indirect taxation (VAT and excise taxes).

Most amendments to VAT and consumption taxes benefit taxpayers by reducing taxes on goods or activities that are key to government purposes, such as reducing inequality, improving trade, improving mobility in cities and improving the environment. In this context, the purchase of goods such as bicycles and scooters (electric and mechanical), as well as electric scooters with a value of less than $540 was exempted from VAT. If the value is higher than $540, a VAT of 5% will be applied instead of a general VAT rate of 19%.

A three-day tax vacation period was also created on strategic dates of the year (before Christmas, before the start of school and in the middle of the year) during which VAT will not be applied to certain items such as household appliances, sporting goods, toys, clothing, schoolbooks, and other related items. A VAT compensation or refund system has been structured for the most impoverished sector of the population.

Regarding the consumption tax, the most relevant change was the elimination of this tax on the transfer of real estate. This tax had proven to be inefficient and harmed the construction and real estate sector, and on December 5, 2019, moreover, it was declared unconstitutional by the Constitutional Court, as it triggered the principles of tax equity and fairness.

Additionally, the tax reform established that the funds collected from the tax on the consumption of medical cannabis would be destined to eliminate illegal plantations in Colombia.

Other Taxes

The tax reform created several new taxes and contributions that lack the minimum conditions to be considered constitutional. A tax was created on the pre-merger notification and merger review process before the antitrust authority. A tax was introduced as "consideration" for the commercial use of beaches and coastal properties. Another partially retroactive tax was applied to airport concessions and public-private partnerships that have executed (or are executing) construction contracts to build, maintain or rehabilitate state-owned airports.

Also, an income tax surcharge of three basis points has been applied to financial institutions, increasing their level of taxation compared to other taxpayers. This surcharge has been challenged by the author before the Colombian Constitutional Court and a judicial decision is expected shortly.

The social investment tourism tax, which was activated with the entry of foreigners into the country, was modified in the sense that it will not only be applicable to the actual entry into the country but also to the purchase of airline tickets made outside Colombia. A flat rate of US$15 was established for this tax.

Finally, the $1 tax on leaving the country by air was modified to be applicable not only to foreigners but also to Colombian citizens. It is also established that the collection of this tax will be made by the Colombian Institute of Family Welfare and the proceeds will be destined to programs for the prevention of sexual exploitation of minors.

Other novelties

A new definition of "beneficial owner" was introduced, in which any individual who owns, controls or benefits (directly or indirectly) from a company or structure, and who meets certain criteria (such as owning more than 5% of the capital with voting rights or being entitled to more than 5% of the assets, profits or interests of the structure, among others), is considered as such. In addition, a public registry of beneficial owners was created, which will be administered by the tax authorities.

A modification of the crime of tax fraud was implemented, in the sense that criminal or malicious intent is not required for it to exist. However, negligent conduct in this type of offense is not punishable under Colombian criminal law, so discussions may arise as to its application. A change was also introduced to allow the cessation of criminal action when tax returns have been corrected and full payment has been made, regardless of the amount owed.

Reflections and conclusions

The tax reform, which sought to confirm the 2018 tax reform, and incorporated as permanent several temporary benefits included in the 2019 budget law, is a clear example of how to use tax policies to turn around a country's economic performance.

In the midst of a complex continent, marked by social protests, economic instability and political uncertainty, Colombia has risen and has been identified by Ernst & Young as the second most attractive country to invest in, surpassing countries such as Canada, Germany and the United Kingdom. While economic growth in the region was negative or below 1%, Colombia had 3.3% growth in 2019 (up from 2.6% in 2018 and 1.4% in 2017). This increase in growth comes from a stimulus to the economy by the government, by implementing tax incentives that generate massive hiring of labor, and therefore, more household spending.