Colombia’s Law 2277, the Tax Reform for Equality and Social Justice, could disincentivize foreign investment because its consolidation of resources to collect 25 billion Colombian pesos makes it as one of the country’s most ambitious tax proposals. Its changes apply to national and foreign companies, including corporate income tax, taxation of dividends, green and health taxes, and anti-tax evasion measures.
Corporate Income Tax
The CIT nominal rate remains at 35%. The new law, passed Dec. 13, introduced an OECD Pillar Two-inspired domestic minimum 15% effective tax rate, aiming to compute financial profits and to top-up tax due similar to Pillar Two’s Model Rules at the domestic level. This 15% tax limits de facto exempted income, itemized tax deductions, and other tax incentives.
The law dismissed many of the Pillar Two Model Rules proposals and introduced a unilateral domestic alternative minimum tax, which may cause technical problems in its applications with current statutory tax provisions. Special attention should be paid to determining “taxed profits” at the corporate level for computing the withholding tax base on outbound dividends distributions—technical inconsistencies may trigger some double-tax events.
The law establishes a higher CIT nominal rate for the financial and hydrocarbon sectors. Financial institutions will have an income tax rate of 40% until 2027, and those engaged in coal extraction will have a variable rate between 35% and 45%, depending on the international average price of coal. The tax rate for entities engaged in oil extraction will be between 35% and 50%, depending on the international average price of crude. For the hydrocarbon sector, the tax reform also determined that royalties no longer would be deductible for income tax purposes.
Taxation of Dividends
For foreign companies and entities, withholding tax over outbound payment of dividends distributed out of taxed profits at the company level increased to 20% from 10%. Beneficial owners of a domestic company, residents in a country where Colombia has a double tax convention in place, may claim a reduction of this 20% withholding tax on dividends down to 10%, 5%, or 0%, depending on the applicable convention.
Because of the law, estimated aggregated company-shareholder effective taxation would be taxed up to an effective 65.8% combined. This estimate may be reduced, depending on the industry and the capability of foreign investors to claim double tax convention benefits.
Green and Health Taxes
The harm that single-use plastics cause to the environment were also a reason to create a green excise tax, which levies upon the sale, withdrawal, or import of single-use plastic products for packaging and is charged based on a value per gram. The new law imposed a tax on the production, import, and sale of ultra-processed foods rich in sugar and sodium. The levy is at a 10% rate, which will increase to 20% in the following years. The law also imposed a tax on the sale of ultra-processed sugar-rich beverages, whose rate varies depending on the volume of the goods sold. The Colombian government says the revenue from these taxes will finance requirements of the health system derived from related diseases.
Anti-Tax Evasion Measures
The law extends the place of effective management criteria that will consider new standards, such as where the daily activities of a company take place and where the business and management decisions generally are carried out over the entity’s business. If a foreign legal entity meets the criteria, it will be considered a domestic entity in Colombia subject to tax on a worldwide income basis.
The law also adopts the rule of significant economic presence, which intends to tax non-resident persons or entities without a physical presence in Colombia. Under this rule, a non-resident person or entity without a physical presence in the country must maintain a systematic relationship with 300,000 or more customers located within the Colombian market in the current or previous fiscal year.
Foreign Investments
The law may significantly impact foreign investment. It eliminates certain income tax deductions for mining and oil and gas companies, including royalties paid for exploiting non-renewable natural resources by representing one of the sectors with the most significant presence and agency in Colombia. There also will be higher tax burdens on corporate dividends, limits on preferential rates in free zones, and taxes imposed on companies that, although not having a physical presence in Colombia, have a significant economic presence in the terms established by law.
Legal Protection Under International Law
Colombia has been a full member of the Organization for Economic Cooperation and Development since 2020, which should guarantee it will fulfill international commitments to keep implementing domestic measures to guarantee stability and economic growth for foreign investors. Colombia has constitutional protection for foreign investors from unjustified actions from public officials. It is a party to at least 15 investment agreements (including bilateral investment treaties and free trade agreements) that provide additional protection for foreign investors and the possibility of initiating international arbitration against unlawful government actions, if any.
The most relevant protections are the prohibition of unlawful or discriminatory expropriations, meaning those without a legitimate public purpose or appropriate compensation; the obligation to grant fair and equitable treatment, which includes the obligation to respect the legitimate expectations of the investor; and the obligation to grant non-discriminatory treatment to nationals or foreigners in similar circumstances.
Ratified investment treaties often allow investors to initiate international arbitration against the government to determine their international responsibility and damages. Also, foreign investors not covered by a treaty may undertake legitimate business planning to structure or restructure their investments to benefit from the applicable treaties.
Foreign direct investment in 2022 increased by 57.8% compared to 2021, as noted below.
Nevertheless, it must be analyzed closely, as 64.5% of the 2022 foreign direct investment came from the mining and oil and gas industries—one of the most affected sectors under the law. This leads to predicting an unfavorable foreign investment for 2023 and the following years due to the high tax burden on these sectors.
Ambitious Reform
While potential legal instability from introducing a new tax reform every 2 1/2 years on average in Colombia is some foreign investors’ primary concern, political and economic changes represent situations of uncertainty in all countries, especially in Latin America, with its recent and unstable democracies.
Proper adoption of legislation and international treaties largely guarantees the gaps that internal political instability could generate are filled. The assets and rights of foreign investors are not adrift.
Juan David Velasco at Baker McKenzie contributed to this article.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Juan Diego Fernandez is a junior associate in Baker McKenzie’s Bogotá Tax Practice Group. He previously worked in the oil and gas industry as a lawyer at Schlumberger, supporting the company in national and international transactions.
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