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Tax reform, another measure that doesn’t solve the structural issues

According to what was announced, this reform i) looks to extend the income tax base for natural persons and VAT, ii) introduce differential income rates for legal entities, iii) partially accepts some proposals of the Commission of Tax Benefits (CBT) and iv) does not change the accounting structure and cost for legal entities.
 

During the pandemic (August 2020), with the decrease in tax income, increase in the fiscal deficit and economic recession was in full force, the Government summoned a Tax Benefit Expert Commission (CBT, for its Spanish acronym) to review the existing tax benefits and expenses (GT) in the Colombian tax system. The most important conclusion of this commission was:
 

The correct balance of the GT has been lost in Colombia, there are too many GT and the costs surpass, by far, the benefits. The CBT considers that there has been and will always be an excessive and systemic GT to remedy the structural issue of the tax system. This has produced a significant cost to Colombians: reduction of tax collection, greater horizontal and vertical inequalities, efficiency reduction, and more unnecessary complexity. (pages 11 and 12)
 

“Tax expense” is all existing regulation in the tax legislation that modifies the responsibility of specific groups of individuals or businesses. The conclusion of the commission confirms what many have said for the last 30 years: the frequent reforms with a persistent Congress lobbying, eroded the fiscal statute, turning it into an impenetrable labyrinth, in face of its inequality and low progressivity.
 

Read more: Colombia, a tax paradise for the wealthy  (In Spanish) 


It lacks horizontal equality, due to preferential treatment to private businesses, vertical equality, for the benefits to higher incomes, therefore it is not efficient and turns into a source for tax evasion and avoidance, as is excessively complex, as it forces people to hire professional accountants and legal counselors to file taxes. After this diagnosis, as could be expected, the CBT suggests extending the base, eliminating exemptions and deductions, updating appraisals of real estate assets and taxing goods detrimental to health and the environment.


The government accepted the suggestion of extending the tax base and turned it into its main option–in VAT and natural person income tax–, and hopes to collect Col $27.3B, Col $10.5N in VAT, and Col $16.8B from natural persons.


The CBT suggested the 19% VAT was sufficiently high and recommended not increasing it and playing between the exempt and excluded products, improving compensatory mechanisms. Income tax for natural persons aims at high exemptions and regressive deductions that are beneficial for wealthier households and suggests reducing them, eliminating exempt rents, and including pensions.

From what we know until now, the Government is proposing to extend the VAT taxable base, eliminating the category of “exempts,” for the internal market, with complicated and confusing explanations. The “exempt” VAT category means products not taxed and the VAT for intermediary inputs and goods paid for production is returned by the National Tax and Customs Administration (DIAN, for its Spanish acronym) so it does not have an impact on production chain costs.
 

By eliminating the exempt category, these products pass to the category of “excluded”, meaning that although the product is not taxed, its inputs and intermediary inputs are, and this paid VAT is not returned by DIAN and therefore included in the production costs, it impacts the chain and the consumer pays for it, i.e. consumer good are not taxed, but are taxed as greater consumption.
 

Listen: Tax reform, yes, but that this way(In Spanish)
 

With this artifice the Government looks to i) increase collection to Col $10.5B, ii) strip DIAN from returning VAT, and iii) consolidate a compensation mechanism for Col $2.5B, equivalent to 3% of the total collected.


But it is in natural persons income tax where the Government has its greatest collection aspirations: Col $16.8B, by extending the tax base, reducing exemption, reformulating the wealth tax, and increasing the rate for dividends. The taxable base is extended by lowering the tax filing threshold. Currently annual incomes of 1,400 UVT (Col $47,978,000M) equivalent to a monthly income of Col $3,998,166, which the government is proposing to reduce to Col $2,500,000, without determining the rate. With the new base, 2 million new people would have to file taxes, although the government has said nothing over the simplicity of the form, or the preparation of DIAN to receive the new mass of tax filers.


For now, the reduction of exemption is an expectation, although it would be the most progressive part of the reform and would compel wealthy households to pay more taxes; however, this means taking down the deductions for mortgages and voluntary contributions to pensions. Other ideas released are related to the wealth tax for natural persons, not for legal entities, greater tax for dividends, and tax pensions over Col $7M. While the tax and what is approved is still unknown, tax to high incomes will continue with great evasion possibilities, while there is no escape from work income.
 

Read more: Tax reform, VAT for leases? (In Spanish)
 

The CBT considers the legal entity income tax issue very complex and does not address it very deeply, it just refers to the need to build horizontal equality, eliminate taxes not based on income, ICA tax, and withholdings to dividends, and include proceeds not coming from income. They also suggest updating the appraisal of real estate and providing the Government the capability of purchasing assets that maintain a high historic price and accept as deductible expenses those covered by electronic invoicing.


The structural tax reform to build equality does not seem to be close as the CBT and the Government ignored it. The income tax transition from legal entities to natural persons is a must, but not to lower incomes but to wealthier households, this transition is not designed in this manner. The real action is in the accountable actions of costs and expenses of related legal entities and natural persons.


For the transition to be egalitarian it requires: i) legal entities to separate productive and unproductive assets and appraise them to market values, ii) for unproductive assets used by shareholders, owners, and executives to be transferred to them and be honest about the value of their patrimony, iii) for shareholder, owners, and executive expenses be filed in their income and not deducted on legal entities, iv) that transferals made to shareholders, owners, and executives be assumed as dividends and not as non-working income, and v) that dividends be taxed independently if that are delivered to a natural person or a legal entity.

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