Although the recent Tax Reform Law is not the structural tax reform the Colombian tax system has been demanding for several years, it introduces important measures regarding value-added tax, income tax, dividends, and indirect sale of assets. In addition, it creates a new Colombian Holding Company regime to incentivize multinational groups carrying out certain investment activities to establish their headquarters in Colombia.
The Colombian Congress issued Law 1943 (Tax Reform) on December 28, 2018, in order to restore the balance of the general budget and obtain the missing resources to execute the National Development Plan.
In respect of the modifications introduced by Law 1943 of 2018 regarding value-added tax (“VAT”), it is important to mention that one of the main purposes of the tax reform was to reduce the VAT rate; however, during the discussions for the expedition of the law this initiative did not succeed, and the rate for VAT remains at 19 percent.
Nevertheless, Law 1943 of 2018 introduced significant changes related to VAT, in particular for services rendered from abroad, as explained below.
Services Rendered from Abroad
According to paragraph 3 of Article 420 of the Colombian Tax Code, services rendered or intangibles acquired from abroad are understood to be rendered, licensed or acquired in Colombia if the beneficiary has its fiscal residence, domicile, permanent establishment or place of business in Colombian territory.
In this sense, legal entities that render services from abroad to Colombian customers will be responsible for VAT and, consequently, must initiate a procedure with the tax authority with the purpose of obtaining a Single Tax Number (“RUT”) that allows such entities to fulfill their tax obligations in Colombia.
However, paragraph 3 of Article 437–2 of the Colombian Tax Code, recently introduced by Article 6 of Law 1943 of 2018 establishes an alternative procedure for legal entities that render electronic or digital services from abroad and do not want to adhere to the traditional VAT system.
Pursuant to this procedure, providers of audiovisual services, online marketing, remote training services, provision of rights for the use or exploitation of intangible assets, among other services provided to users located in Colombia, can voluntarily submit to a withholding tax system, according to which debit or credit card issuing entities, issuers of prepaid cards or cash collectors on behalf of third parties, must apply a VAT withholding tax in cases where the payment for such services is made using these payment methods.
In addition, the above-mentioned Article establishes that the Colombian tax authority can designate, by means of a resolution, the service providers that will be subject to this treatment.
This withholding tax system will only be applicable for service providers that meet the following requirements:
- provide electronic or digital services;
- have not yet adopted the traditional VAT system and voluntarily submit to the alternative payment system; and
- the value charged to Colombian customers corresponds to the taxable base of the VAT.
Sale of Real Estate
Pursuant to Law 1943 of 2018, the sale of real estate assets is no longer subject to VAT, but will be subject to consumption tax at a rate of 2 percent; this rate will be applied to the full price of the asset when its price exceeds 918,436,000 Colombian pesos (approx. $300,000). The taxpayer will be the purchaser, although the person directly liable for the amounts collected will be the seller.
This type of disposal may affect the real estate sector in Colombia, considering that it will result in an increase of the price of the asset; however, it is important to bear in mind that consumption tax will only apply if the price of the asset exceeds 918,436,000 Colombian pesos, an amount that for the Colombian real estate market is relatively high.
On this point, we consider it is important to analyze whether the transfer of real property assets to corporations or trusts, as in-kind contributions, triggers consumption tax in the terms explained above. In our opinion, such transfer should not trigger consumption tax, given that special provisions set out in the Colombian Tax Code (Articles 319 and 102) must prevail—although it is still necessary to know what the interpretation of the tax authorities in Colombia with respect to this issue will be.
Income Tax Provisions
Law 1943 of 2018 also introduces significant modifications relating to income tax. First, it is relevant to highlight that Article 80 of the Tax Reform, which modifies Article 240 of the Colombian Tax Code, establishes a gradual decrease of the income tax rate for legal entities for the following years. The actual tax rate of 33 percent will remain for fiscal year 2019; however, it will be reduced to 32 percent for fiscal year 2020, 31 percent for fiscal year 2021, and 30 percent for fiscal year 2022.
In addition, financial entities with a gross income greater than 120,000 Tax Value Units (approx. 4,112,400,000 Colombian pesos) will be subject to a surcharge of 4 percent for 2019 and 3 percent for 2020 and 2021. (The Tax Value Unit is a unit measurement defined by the Colombian tax authorities which is linked to inflation for the previous year. This measurement is used to update all calculations of the current year for tax purposes.)
The above is in accordance with the guidelines of the Organization for Economic Co-operation and Development (“OECD”) and with the tax policies of its member countries.
On the above point, it is important to remember that in May 30, 2018, Colombia was accepted as a member of the OECD, whereby the country acquired several commitments that aim to make its tax policy fairer and more efficient. Therefore, most of the dispositions introduced by the tax reform are aligned with the guidelines and recommendations of the OECD and its member countries.
In relation to the taxation of dividends, Law 1943 of 2018 increases the withholding tax for dividends paid to national and foreign shareholders, and taxes the distribution of dividends to national corporations (which under previous legislation was not taxable). Thus, dividends distributed to Colombian companies, out of profits that were taxed at a corporate level, will be subject to a withholding tax rate of 7.5 percent.
On the other hand, dividends paid to Colombian companies out of profits that were not taxed at a corporate level will be subject to the general income tax rate and, afterwards, the remaining amount will be subject to a withholding tax rate of 7.5 percent.
Furthermore, dividends distributed by a Colombian company to its foreign shareholders, whether they are corporations, individuals or permanent establishments, will be subject to a tax rate of 7.5 percent. In addition, as mentioned above, if dividends are not taxed at a corporate level they will be subject to the general income tax rate, plus a withholding tax of 7.5 percent.
Law 1943 of 2018 also modifies the taxation of outbound payments, increasing the withholding tax rate from 15 percent to 20 percent. In accordance with Article 408 of the Colombian Tax Code, outbound payments for fees, royalties, personal services, consultancy, technical services and technical assistance would be subject to a 20 percent withholding tax.
Colombian Holding Company Regime
Finally, Law 1943 of 2018 introduces a new Colombian Holding Company ("CHC") regime, in order to incentivize multinational groups carrying out investment activities to establish their headquarters in Colombia.
The requirements to access the benefits of the CHC regime are the following:
- the main purpose of the CHC should be investment or holding of shares of subsidiaries and the administration of the investments;
- the CHC must have a direct or indirect participation in at least 10 percent of the capital of the subsidiaries in a 12-month period (minimum); and
- the CHC must develop its corporate purpose in Colombia, and have at least three employees and a management office there.
In accordance with this new holding regime, dividends distributed to the CHC from a foreign subsidiary are considered exempt from Colombian income tax. Therefore, no corporate tax will be applicable to such income.
On the other hand, pursuant to Article 25e) of the Colombian Tax Code, dividends distributed by a CHC to nonresidents are not considered Colombian-sourced income, as long as such dividends are attributable to activities performed by nonresident entities.
Regarding the tax burden derived from the sale of shares held by the CHC to a third party, it is important to highlight that the income derived from the sale of shares held by the CHC in a Colombian company is subject to income tax. However, if the CHC sells its shares in a foreign subsidiary, such income will be exempted from Colombian income tax.
In addition, new rules were adopted in respect of indirect sales of Colombian entities, which, as of January 1, 2019, would be Colombian taxable income for the seller, subject to certain exceptions as provided by Law 1943 of 2018.
- If you are a foreign service provider of digital and electronic services, it may be easier for your operation to adhere to the VAT withholding tax system. Bear in mind that you will have to fulfill some formal requirements with the tax authorities to be successfully covered by this system.
- You may need to consider that Colombian CFC rules are also applicable to a CHC in respect of any passive income earned by foreign subsidiaries.
- Regarding the distribution of dividends not taxed at the corporate level, please be aware of the reduction of the general income tax rate for the following three years. Therefore, if this is the case, it is recommended to retain profits until 2021 to take advantage of such benefit.
Natalia Guerrero is a Partner and Javier Orozco is an Associate with CMS Colombia.
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