The next few years will be difficult for Latin American countries. Low petroleum and commodity prices are adversely affecting the economies of the region. At the same time, there is increased pressure on the governments for economic and social reforms.
Colombia, which has had a strong economy, recently passing Argentina as the third largest in Latin America, is being buffeted by these cross winds. Colombia already has a budget deficit of COL$12.5 billion for next year. The situation is likely to get worse because governmental expenses will increase sharply in the next five years.
The existing tax structure in Colombia makes it impossible for the government to deal with these realities. Tax revenue is approximately $14.3 % of GDP. The low percentage is due in part to corruption and tax evasion. On the other hand, the state income taxes are high particularly for foreign companies doing business in Colombia.
At this point it is critical for Colombia to implement a structural tax reform that will be effective in raising revenue to cover obligations, including the agricultural sector, pension funds, education improvements, attention to early childhood, infrastructure, justice, public safety, and other commitments that will likely be part of a potential peace accord.
To address the budget deficit, the government proposed tax reform, which generated lots of vocal opposition. The private sector expressed serious concerns with the reform package. Particularly upsetting are the proposed increased property taxes. The private sector argues that taxation in Colombia is very high (between 52 and 71%) and, according to Fedesarrollo, with the proposed reform rates would increase by an average of three points.
There was a great deal of creative thinking about ways that the government could obtain the revenue it needs without hurting the private sector. In an attempt to reach a resolution, the government and private sector held several meetings, according to Colombian publication Portafolio. Two of the main issues discussed during these meetings had to do with a reduction in wealth taxes and the commitment to structural tax reform for next year. Also being discussed is a sharp increase in the CREE tax, called the income tax for equity. Consideration is being given to raising the VAT (currently 16%) by 2 points.
Last week, the Senate approved the reform package that began with 23 articles and ended up with 72. The Senate will also create a committee that will draft a comprehensive reform to last for the next 20 years.
In the final debate, the essence of the tax reform package was preserved. For example, the tax on financial transactions will be in place for the next four years, after which it will be gradually eliminated. Measures to control tax evasion remained in the bill. Also, the CREE tax and the wealth tax will remain in place with the latter gradually decreasing until it finally disappears in 2018.
It is important to highlight one of the adopted measures that promotes investment in infrastructure through Public Private Partnerships. There will be a rate of tax withholding at source of 5 percent instead of 14 percent, “for payments or deposits of accounts related to revenues or interest payments made to non-residents or persons not domiciled in the country, such payments or deposits should originate from loans or credit securities, for a term not equal or greater than eight (8) years, destined to funding projects of infrastructure.” The reform package was to be voted by the lower chamber of congress on Friday, December 12. However, due to time constraints it will only be debated today.
How does this affect foreign companies in Colombia?
A company will have to pay income tax if it is headquartered or has an effective administrative base in Colombia, where key and necessary commercial decisions are made to carry out the activities of the company as a whole. This is the location where senior executives and managers exercise the bulk of their responsibility and work. Under these circumstances, income generated in Colombia or abroad will be considered taxable income. Income tax for those companies established permanently in Colombia will be paid at the rate of 25 % from income and capital gains generated from that permanent establishment. It is important for companies to keep a detailed accounting system to explain clearly whether operations generating revenue are from the establishment in Colombia. Additionally, permanent establishments of foreign companies are to pay CREE tax.
For those companies doing business in Colombia, it is not enough to follow what is happening on tax reform. It is important for them to participate in the ongoing discussions.