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The Commission of Experts on Tax Expenditures/Benefits suggests increasing certain tax rates and reducing the number of tax exemptions.

On March 17, 2021, the Colombian Government released the report prepared by the Commission of Experts on Tax Expenditures/Benefits (the Commission). The report is key to the tax reform proposal that the Colombian Executive Power has announced it will send to the Congress shortly. The complete report can be accessed here.

Background

According to the report, in 2019, tax benefits in Colombia totaled approximately COP 69.1 billion — COP 51.6 billion for value-added tax (VAT) benefits, COP 17.1 billion for income tax benefits, and the remaining amount for other tax benefits. The total tax benefits for that year represented 6.5% of the Colombian GDP. Tax evasion totaled an estimated COP 20.7 billion for VAT and COP 21.6 billion for corporate income tax. In addition, the rate of labor informality¹ is estimated at 49.2%

Colombia needs to increase tax revenue and that need has become more urgent with the growth of the fiscal deficit as a result of COVID-19 pandemic. Additionally, Colombia is at risk of having its credit rating reduced if Colombia makes no tax adjustments in the short term.

The Commission was established by Law 2010 of 2019 to make recommendations for improving Colombia's tax policy and began activities in August 2020. The Commission is led by five international experts² and has five working focus groups.³

Commission's conclusions

The Commission concluded Colombia has introduced piecemeal reforms to counteract the system imbalances and increase tax revenues. The tax system has narrow tax bases and high tax rates imposed on those who cannot avoid the tax. The tax system is complex and includes distortive taxes (e.g., debit tax, ICA (i.e., turnover tax⁴), VAT on investment).

The Commission also determined that acting to balance the tax system too quickly may harm economic recovery and abolishing tax benefits within each tax provision may be ineffective. Thus, the Commission suggests ambitious tax base broadening tax packages/reform. Additionally, Colombia needs to consider long transitional periods.

Accordingly, the Commission recommends: (i) requiring the tax authorities to produce annual reports, including item-by-item tax expenditure and benefit reports, (ii) adding a mandatory framework chapter to each law that explains the rationale of the tax reform and provides a detailed economic assessment, and (iii) creating an independent body of public finance experts to assist the Ministry of Finance in developing a strategy for implementing the suggested reform.

Key recommendations

The tax benefits were classified by each of the focus groups into the following categories: 1) no reform is needed (at least in the short run); 2) reform is desirable; 3) reform is conditioned (on other reforms); 4) unclear whether to reform or not. A table with these classifications is attached below.

The Commission generally recommended the following changes:

Personal income tax

• Significantly reduce the number of tax exemptions
• Avoid tax allowances that increase with income (e.g., benefits that correspond to an amount of total income)
• Reduce the basic tax allowances (broadening the tax base) and the number of tax brackets (avoid increasing statutory tax brackets)
• Tax pensions at a fair effective tax rate
• Improve how tax is levied on personal capital income
• Use market value (not historical) to determine taxable income
• Strengthen tax enforcement and collection, particularly on self-employed individuals

VAT

• Reduce number of excluded and exempted goods and services
• Ensure that the VAT compensation mechanism reaches the most vulnerable population
• Keep a 0% VAT for basic needs in the short term (while the compensation mechanism is improved)
• Increase the current reduced VAT rate from 5% to a rate in the range of approximately 10% to 12% (currently, the standard rate for VAT purposes is 19%)
• Credit input VAT paid on investments in fixed assets against output VAT (currently, input VAT on investments in fixed assets may be creditable for income tax purposes rather than for VAT purposes)
• Eliminate the national consumption tax and increase green taxes and taxes on unhealthy activities/goods
• Tax goods and services in free trade zones (in particular special permanent free trade zones) under the standard VAT regime

Business tax regime

• Abolish debit tax/financial transactions tax (or limit it to cash withdrawals)
• Replace the municipal turnover tax with immovable property tax (or grant/transfer tax)
• Broaden the corporate income tax base and reduce the rate to be competitive with international standards
• Align tax treatment across sectors (e.g., avoid reduced income rates for certain sectors)
• Abolish corporate income tax recapture on dividends paid out of profits not subject to income tax at the corporate level
• Merge the free trade zone regime with the standard corporate income tax regime
• Keep the tax simplified regime (SIMPLE)
• Strengthen the agricultural sector's compliance with the law, focusing on development and growth of the sector, including tax and non-tax measures

• Redesign certain special regimes (e.g., Zomac, Zese)

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ENDNOTES

¹ Informality is defined to include: i) employees who do not pay health contributions; and ii) self-employed who do not pay social security contributions (Brazil, Chile and Turkey), or whose business is not registered (Argentina, Colombia, Costa Rica, Mexico, Peru and South Africa).

² The international experts are David Rosenbloom, Brian Arnold, Jeffrey Owens, Pascal Saint-Amans, and Kent Smetters

³ The focus groups are:(i) Corporate Income tax, (ii) Non-taxable income and incentives for the countryside, (iii) Individuals, employment and dividends, (iv) Global trade, and (v) VAT.

⁴ A municipal tax levied on the performance of industrial, commercial or service activities within the territory of a specific municipality.

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ATTACHMENT

Report tax benefits commission of experts - Annex