Accelerating reform: Changes to the tax regime target transparency and participation

The tax reform approved by the government in December 2012 (Law 1607 of 2012) introduced important changes to the way foreign investors can acquire shares or an interest in Colombian companies. Prior to the reform, the acquisition of shares by foreign investors entailed the purchase of the goodwill, the cost of which was tax deductible against future profits of the operating company being transacted.

IMPACT: The tax reform discarded the idea of taking the amortisation of the mercantile credit as deductible, making amortisation possible only through the purchase of the business or acquisition of its assets. This alternative is disadvantageous as it involves a change of the operating entity and therefore all legal obligations need to be transferred to the acquiring entity, effectively restricting one of the advantages foreign investors had previously enjoyed. However, the income tax rate on occasional profits has been reduced to 10%. In our opinion, this is a veiled invitation to envisage the option of acquiring the business or its assets as attractive when tax disadvantages are not decisive. With its implementation, final owners of the business pay 10% tax on revenues made on the sale, which constitutes an advantage compared to the previous structures. The following outlines the main changes introduced by the tax reform in various situations:

CAPITAL GAINS TAX: This tax has been reduced to 10% for residents and non-residents, whether individuals or entities, in an effort to reduce tax evasion and to introduce a capital gains treatment, which is applicable to assets that are held for two or more years.

BRANCH PROFITS: Branch profits were re-categorised as dividends. Therefore, there is no impact if profits being remitted are taxed at the branch level.

MERGERS & DE-MERGERS: If merger or de-merger participants are unrelated, shareholders owning at least 75% of shares (85% if participants are related) must receive, as a result of the operation, a number of shares proportional to what they held prior to the merger or de-merger. At least 90% of the value of this must be released in shares (99% if participants are related). When selling these shares within two years from the merger or de-merger, shareholders must increase any income tax due on the sale by 30%.

In mergers and de-mergers between unrelated entities, any gains on the sale of assets from beneficiary participants within two years of the process will not be permitted to be offset with tax loss carried forward (this is only applicable where participants are unrelated). Taxfree status is available when participants of mergers and de-mergers are not residents of Colombia and assets held in the country represent at maximum 20% of the aggregate of the group’s assets.

THIN CAPITALISATION: The tax reform introduced thin capitalisation at a ratio of 3:1 for related or unrelated party interest-bearing debt (whether foreign or domestic). Interest applicable to debt exceeding this ratio will be permanently non-deductible. Further, this restriction will not be applicable to the loans granted by financial institutions nor does it apply to loans to finance public utility services under certain conditions.

GOODWILL: Tax amortisation of the goodwill is allowed on share purchases done by residents and non-resident entities, provided that a loss of value is technically proven and the acquisition of the share purchases remains separate from the entity owning the business (except in cases when reorganisation of the two entities involved is required by law).

SHARE PREMIUM: Capitalisation continues to be taxfree for shareholders. Under the reform, a registration tax of 0.7% will now apply to any cash or in-kind contribution, even if allocated to share premium.

EQUITY CONTRIBUTIONS: If a beneficiary disposes of assets within two years from contribution, any gain will not be eligible to be offset against available tax loss. The same applies to contributors disposing of shares within two years from contribution. Documentation on the contribution must represent the intent of the contributor and beneficiary to enjoy this non-taxable incentive. Contributions by resident entities (among others) of assets owned in Colombia to non-resident parties will be treated as taxable dispositions.

PERMANENT ESTABLISHMENT: The definition of a permanent establishment is no longer limited to branches. It includes, among others, the capacity to bind and conclude contracts by any individual (other than an independent agent) except for preparatory and auxiliary activities. Taxation on permanent establishments is limited to the domestic income attributable to them.

CORPORATE INCOME TAX: Companies incorporated in Colombia and foreign firms that make their profit through branches or permanent establishments here are subject to income tax at a rate of 25%. Foreign companies (those whose income is not attributable to branches or permanent establishments in Colombia) are subject to income tax at a rate of 33%. There is a 10% tax rate for complementary windfall profits. The assessment of corporate income tax is made by subtracting discounts, returns and recesses to gross income.

INCOME TAX FOR EQUALITY (CREE): This tax, which has been created for taxpayers that are eligible for the 25% rate, will begin at 9% from 2013 to 2015 and will be reduced to 8% in 2016. Revenues will be used to fund cuts on payroll taxes as well as health contributions to the social security system. Structurally, the CREE works as an income tax, except for certain limitations on the ability to claim costs and expenses.

WITHHOLDING OF CREE COLLECTION: Employers are exempt from paying social security contributions for employees earning less than 10 times the statutory minimum wage (around $3300).

NET INCOME TAX: Colombian regulation envisages a presumptive income system as an alternative method to determine income tax. This system exists to ensure that income tax is not less than 3% of net assets as of December 31 of the previous year. As such, the presumptive income is the minimum estimated profit of a taxpayer upon which the law expects to collect income tax. The presumptive income is therefore not a real income generated by the activity of the taxpayer, but a tax that operates by the rule of law. The basis and procedure for establishing the tax base for the calculation of tax equality is generally the same as for income tax, but the tax losses from previous years will not apply.

SMALL BUSINESS SUPPORT: Colombian law currently provides a special scheme for small businesses, defined as those with no more than 50 workers and whose assets do not exceed 5000 legal minimum wages on a monthly basis (around $1.64m). This scheme applies to entities that have been created since 2011.

Benefits ensured under this scheme include income tax at a 0% rate for the first two fiscal years of operation. This rises to 25% of the general rate for the third fiscal year, to 50% on the fourth and to 75% on the fifth year. Under this scheme companies begin to pay 100% of their income tax starting on the sixth year and are not subject to the net income tax during the period in which they enjoy a reduced tax rate.

SALES TAX: This national tax is levied on the sale of tangible personal property other than fixed and excluded assets, the provision of services within the country and the import of tangible goods that have not been expressly excluded. Goods and services subject to the consumption tax do not generate a sales tax. This tax is structured as a value-added tax (VAT). Therefore, for its determination, the deduction of VAT is allowed in order to pay the value of the VAT that was paid on goods and services use for the production of income from operations taxed. Some goods, services and imports are excluded from the obligation to pay the sales tax, such as most of the seeds, machinery, fertilisers and supplies for agriculture purposes, some fruits, vegetables and minerals in their natural state, and insurance policies, among others.

The sales tax charged to the responsible party for the acquisition of tangible goods and services, as for the import of tangible goods, can be offset from the VAT current account. There are also other goods and services that are exempt from VAT, like chicken eggs, some meats, fresh fish, milk and exported services ( subject to certain conditions). The difference between exempt and excluded goods is that producers and exporters of exempt goods are responsible for VAT, and therefore they are entitled to offset the collected VAT against the paid VAT. On the other hand, producers of excluded goods are not responsible for sales tax, and are not entitled to offset any VAT, although in some circumstances it is possible to apply for a refund.

CONSUMPTION TAX: The new national consumption tax came into effect in 2013 and applies to the provision of services, retail sales and imports by the final consumer of certain goods and services such as mobile phone services; the sale or import by the final consumer of a number of utility vehicles; and the sale of food and beverages by restaurants, cafes and supermarkets, among others, for consumption on site, to take away, or to be home delivered, including the sale of food and alcoholic beverages for consumption in bars, taverns and nightclubs. The consumption tax is generated by the nationalisation of the imported good by the final consumer, by the delivery of the good or service, or by shipment of the account, expedition of ticket, bill, invoice or equivalent document by the responsible party to the final consumer, and, in the case of mobile phone services, at the time of payment by the user. The consumption tax is a deductible expense in the income tax, as it is considered an increase in the value of the good or service purchased. It is not deductible on VAT, nor does it imply any right to deductible taxes.

WITHHOLDINGS: The tax system contemplates the withholding of taxes as a mechanism for advanced tax collection. This mechanism allows private or public entities to withhold or self retain certain taxes. Institutions that can be withholding agents are, among others, legal entities whose functions involve transactions where the law foresees tax withholding.

INDUSTRY & TRADE TAX: This tax falls under municipal jurisdiction and taxes income generated through the practice of industrial, commercial and service activities carried out by individuals and corporations. Each municipality will define the rate of this tax as per the following guidelines: for industrial activities, the tax can be set between 0.2% and 0.7% and for commercial and service-related activities between 0.2% and 1%. SUPPLEMENTARY TAX ON ADVERTISEMENTS & BOARDS: This is a territorial tax that complements the Industry and Trade Tax. It applies to the placement of billboards, signs and advertisements in public spaces. The taxable base is the amount payable on the industry and trade tax at a rate of 15%.

UNIFIED PROPERTY TAX: This tax applies to the ownership of land and real estate property located in urban, suburban or rural areas, with or without buildings. Taxpayers are the owners, possessors and real estate licensees, and the taxable base is the current assessed value, adjusted by the Consumer Price Index. In areas such as Bogotá, the taxable base is the self-assessment made by the taxpayer. The applicable rate depends on the nature of the property (rural, urban or suburban) and varies between 0.4% and 1.2%, taking into account the economic use of each property.

FINANCIAL TRANSACTIONS TAX (FTT): This instant tax applies to financial transactions through which funds are deposited in checking or savings accounts. It is collected via withholding, which is the responsibility of the central bank and other entities supervised by the Financial Superintendence. Certain transactions are exempt, such as withdrawals made from savings accounts or prepaid credit cards and disbursements for payroll payments, among others.

The FTT rate is 0.4% of the total financial transaction value. This rate will be reduced from 2014 as follows: 0.2% for the period 2014 to 2015, 0.1% for 2016 to 2017 and 0% from 2018 onwards. Regardless of the activity producing the income, 25% of this tax is deductible from the income tax until the 2013 fiscal period at which point it will be 50% deductible.

REGIME FOR EMPLOYEES: All individuals residing in the country are liable to pay income tax and complementary taxes. Both nationals and foreigners will be considered residents for tax purposes if they remain continuously or discontinuously in the country for more than 183 consecutive days during a calendar period of 365 days. When continuous or discontinuous permanence in the country is extended for more than one taxable year or period, the person will be considered a resident from the second taxable year or period.

Additionally, foreigners and nationals who meet one of the following requirements will be considered residents: spouse or partner who is not legally separated; minor dependent children with tax residence in the country; anyone for whom 50% or more income comes from national sources; anyone for whom 50% or more assets are managed in the country; anyone for whom 50 % or more assets are held in the country; anyone who, having been required by the Tax Administration to prove his condition of resident in a foreign country, is unable to do so; and any residents in a jurisdiction described by the government as a tax haven. The rate of income tax for domestic and foreign non-residents is 33%. For residents (domestic and foreign) the applicable tax is progressive, never exceeding 33%.

The tax reform introduced a new form of payment of income tax whereby a minimum tax is stated after considering all income earned in the respective tax period. This alternative minimum tax is paid after subtracting mandatory contributions (to the general social security system and on wages, among others) from the total income earned in the respective tax period.

FREE ZONE REGIME: The main incentive for investors who decide to establish operations in a free trade zone (FTZ) is a large reduction in the corporate income tax rate. FTZs registered prior to December 31, 2012, remainsubject to a 15% rate, while FTZs registered after December 31, 2012, are subject to a 15% rate in addition to the payment of the CREE. Under this scheme, the raw materials, supplies and finished goods sold from national Customs territory to FTZ users, as well as the sale of products to foreign markets, are exempt from VAT. OBG would like to thank PricewaterhouseCoopers for their contribution to THE REPORT Colombia 2013