Investors enjoy preferential treatment at free economic zones

Free economic zones (FEZs) have been an important draw for both domestic and foreign investment in Colombia in recent years. Companies operating in these zones enjoy preferential tax and Customs treatment in exchange for compliance with minimum investment and employment requirements. Overseen by the National Tax and Customs Directorate (Dirección de Impuestos y Aduanas Nacionale, DIAN), part of the Treasury, FEZs have proliferated since 2005, when new regulations, laid out in Law 1004 of 2005, expanded their use.

According to Proexport, the Colombian investment promotion agency, there were 15 permanent FEZs in the country in 2013. These zones, which operate similarly to industrial parks, are located in the northern and western parts of the country, with concentrations around Bogotá and along the Caribbean coast. There are also dozens of special FEZs, dedicated to the operations of a single company. A wide range of companies operate in both types of FEZs, including several manufacturers in the agribusiness, automotive, construction materials, cosmetics and metallurgy sectors. Colombia’s FEZs also host services providers, such as business process outsourcing and logistics firms.

Benefits & Requirements

The primary benefits of operating in an FEZ are low corporate income taxes, which at 15% have typically been about half those charged in the country at large, and exemptions from many value-added taxes and Customs fees usually charged on imported equipment. The government also promises stability, guaranteeing to all companies operating in an FEZ that the fiscal regime that is in force on day one will be maintained in perpetuity.

The requirements that must be met in exchange for these fiscal benefits vary based on a number of factors including industry, company size and whether a company is newly formed or already established. The Colombian government designed FEZs primarily to stimulate investment from new companies, whether they were recently formed domestic ventures or foreign companies arriving in Colombia for the first time. As a result, newly incorporated entities face the lowest minimum investment and employment burdens.

New companies operating in permanent FEZs with assets of 5000 to 30,000 times the monthly minimum wage ($1.7m- $10m based on the 2014 minimum wage of COP616,000, or $308) must make capital investments of slightly less than $1.6m over the course of three years and must employ at least 30 people from day one of operations. For companies with assets of more than 30,000 times the monthly minimum wage, these requirements are COP6.8bn ($3.4m) of investment within three years and employment of 50 people.

Larger companies often form special FEZs rather than renting or buying land in a permanent FEZ. Doing so requires higher levels of investment. For example, a newly formed agribusiness with assets of 75,000 times the monthly minimum wage would need to make investments of COP44bn ($22m) and employ 500 people. DIAN assesses fines for failing to meet the requirements, but companies have generally exceeded investment thresholds. According to the Chamber of Free Economic Zone Users, an industry association, in 2013 investments in FEZs exceeded requirements by 70%.

Old Company, New FEZ

Although Colombian FEZs are aimed at new companies, existing ones can make use of them, albeit with very high levels of investment requirements. In order for existing companies to qualify as special FEZs, they must significantly increase their taxable income (to compensate the state for lost revenue from the lower rate) and invest sums that typically exceed $200m within five years. To date, special FEZ status has been feasible only for some of Colombia’s largest companies embarking on projects that call for significant capital expenditures. Two notable examples are Reficar, a refinery in Cartagena owned by Ecopetrol, the state oil company, and Argos, the country’s biggest cement manufacturer. Reficar became a special FEZ in 2008 in advance of a significant expansion project that is projected to double its refining capacity by 2015. The project will cost $6.5bn, easily passing investment requirements and will generate savings on taxes and the importation of heavy machinery. In 2008 Argos created a special FEZ at the port of Mamonal near Cartagena for the construction of a new plant with production capacity of 1.8m tonnes of cement per year. The project cost $400m.

Foreign Competition

FEZs have become prevalent in Central America and the Caribbean, particularly in Panama, Costa Rica, the Dominican Republic and Guatemala. In all these countries, FEZs serve as low-cost locations for manufacturing, assembly or logistics for products on their way to the US and other American markets. Today, Colombia competes with these countries for foreign investment in FEZs, albeit with a quite different value proposition. For small Central American countries, FEZs can represent major drivers of economic activity whereas in Colombia they are only one part of a more diversified industrial economy (they accounted for 15% of Colombian industrial production in 2013). Since Central American governments are more dependent on the stimulus provided by investment in FEZs, fiscal regimes can be highly favourable, with taxes often eliminated. In Colombia, FEZs must attract investors with other factors, notably the country’s larger workforce and reliable energy supply, delivered on Colombia’s electricity grid which is one of the most effective in Latin America. “We look for ways to make those differentiations because we can’t compete with some other countries’ very aggressive fiscal models: we can’t set taxes at zero,” Edgar Martínez Mendoza, head of the FEZ chamber, told OBG.

Gateway To The Americas

A third factor that attracts foreign investment to Colombian FEZs is the country’s free trade agreements (FTAs) and shipping infrastructure. Ports along the Caribbean coast offer quick access to the US eastern seaboard, and Colombia’s FTA with the US, ratified in 2012, can lower export costs to the world’s biggest market. Many foreign companies benefit from this agreement by carrying out the final phases of manufacturing in Colombian FEZs. Sometimes this requires nothing more than assembly since only 30% of a product’s value must be added in Colombia for it to qualify for preferential treatment under the US-Colombia trade agreement. Colombia is also a party to the Pacific Alliance, the Latin American trade bloc whose other members are Mexico, Peru and Chile.

Challenges

Lack of logistics and transport infrastructure hinders the competitiveness of Colombia’s FEZs. Companies planning to manufacture in FEZs must choose between paying higher rates for land near ports or running the risk of having shipments delayed in transit between the interior and the coast. Colombia’s road network is underdeveloped and congested near the ports where industrial traffic bottlenecks. There are virtually no viable alternatives to shipping by road.

Despite the inadequacy of transport links, Colombia’s FEZs offer a highly competitive model for domestic and foreign firms that can commit to relatively large capital expenditures. Establishing operations in these free economic zones offers the chance for significant cost savings in exchange for relatively little risk.