1. Income Tax Benchmark Proposal for Colombia
This chapter presents the proposed income tax benchmark for Colombia. The benchmark is based on a theoretical underpinning but adapted to the fundamental aspects of the current design of the Colombian tax system. The chapter stipulates the main rules and includes examples to help the reader better understand its implications.
This chapter presents the proposed income tax benchmark for Colombia. The benchmark is chosen such that it is aligned with key benchmark design principles including: the benchmark is well defined and transparent; it avoids discrimination across similar taxpayers and does not result in negative tax expenditures (TEs) whenever it is possible; the benchmark is consistent across tax provisions and taxes; it results in TEs that are “actionable” (i.e. they can be reformed); the benchmark is aligned with international obligations; and the chosen benchmark facilitates international comparability.
The income tax benchmark is chosen such that it increases transparency on the tax provisions that are deviating from the benchmark and their corresponding cost in terms of tax revenue forgone. It is based on a theoretical underpinning but adapted to the fundamental aspects of the current design of the Colombian tax system.
The chapter stipulates the main rules and definitions and includes examples and clarifications, which are presented in italics. This chapter could eventually be included in the TE report (without the examples included in italics) that DIAN plans to publish each year.
Annex C and Annex D provide a list of all TEs within the CIT and the PIT that have been identified in Colombia, based on the income tax benchmark proposal. These lists could serve as a template for the list of TEs that DIAN should aim at including in its annual TE report.
Tax expenditures (TEs) are tax provisions within the tax system that is in place in a particular jurisdiction and year that deviate from a benchmark tax system. Put differently, TEs are tax provisions (i.e. non-standard deductions, credits, reduced rates, exemptions and deferrals) that are not included in the benchmark tax system. The identification of a TE thus depends on how the benchmark tax system is defined. The definition of the tax benchmark therefore constitutes the first step in TE analysis and reporting.
The benchmark tax system represents the standard taxation treatment that applies to similar taxpayers or types of activity. It should be defined such that it is aligned, as much as possible, with the following principles: the benchmark should be clear and easy to understand; avoid situations of discrimination across similar taxpayers; avoid negative TEs; be consistent across taxes; result in TEs that are “actionable” (i.e. that can be reformed, if such a reform would be desirable from a tax policy perspective) and aligned with international tax rules and agreements.
The choice of a tax benchmark unavoidably involves judgment and, therefore, may be contentious in some cases (Australian Government the Treasury, 2021[1]). These judgments are informed by long-standing features of a country’s tax system as well as practice in TE publications in other jurisdictions.
The tax benchmark should not be interpreted as an indication of the way activities or taxpayers ought to be taxed. Instead, the benchmark is intended to bring transparency and coherence to the discussion and evaluation of the design of the tax system that is in place.
The proposed income tax benchmark for Colombia is defined on the basis of a theoretical concept of income that helps provide guidance and avoid as much as possible arbitrary decisions. However, the proposed benchmark is adapted to include structural aspects of the Colombian tax system. In other words, it is a hybrid approach as it considers a conceptual benchmark as the starting point but modifies it by taking into account fundamental features of Colombia’s actual tax system. This approach ensures that the report covers a wide range of tax measures, including measures that may not be considered tax incentives or substitutes to direct program spending.
The proposed benchmark is a practical variant of a comprehensive income tax base, following the Schanz-Haig-Simons (SHS) definition of comprehensive income (Schanz, 1896[2]; Haig, 1921[3]; Simons, 1938[4]). SHS define income as the sum of consumption and the change in net wealth (stock of assets) in a given time period.1 Consumption includes all expenditures except those incurred in earning or producing income. While the income tax benchmark overall follows the SHS definition of income, it also deviates in certain cases from this theoretical tax base. The major departures from a comprehensive income tax base are introduced and discussed below.
Major departures of the proposed income tax benchmark from a SHS comprehensive income tax base
The items that are listed below are characteristics of the proposed income tax benchmark, despite the fact that they imply a departure from a SHS comprehensive income tax base.2
Nominal income rather than real current additions to purchasing power is taxable.
The progressive personal income tax rate schedule and the exempt personal income tax bracket are included in the tax benchmark.
Withholding taxes do not give rise to a TE insofar as they are a prepayment of the final tax liability that taxpayers need to pay.
Imputed income on owner-occupied dwellings (i.e. the rental income that the owner-occupiers forego by living themselves in the house they own) is considered non-taxable income.
This implies that the non-taxation of imputed housing income under the tax system does not give rise to a TE.
The fact that imputed housing is considered non-taxable also implies that the corresponding costs that households incur in earning that income are non-deductible. As a result, mortgage interest is non-deductible under the income tax benchmark. The deduction of mortgage interest payments (for owner-occupied property) from taxable income under the tax system in place constitutes a TE. The deduction of recurrent taxes on immovable property from taxable income constitutes a TE.
The benefits derived from non-market household services, such as those provided by a non-working spouse, are non-taxable income.
A more detailed discussion of the income tax benchmark, and the implications for the definition of income TEs, is included in section 1.2 below. The proposed income benchmark description borrows heavily from the Australian and Canadian TE reports (Australian Government the Treasury, 2021[1]; Department of Finance Canada, 2021[5]).
The benchmark for the Personal Income Tax (PIT) and Corporate Income Tax (CIT), following the general approach described above, is further characterised as follows:
Unit of taxation
Taxation period
The fiscal year under the income tax benchmark is the calendar year.
Taxable income is assessed on an accruals accounting basis – that is, recorded when the right to the income arises (even if it has not yet been received) and when costs are incurred (irrespective of when the payment is made).
However, the taxation of income on a cash basis as a tax simplification measure, as it may apply to income under the PIT and/or as a tax simplification measure for small businesses, is also included in the income tax benchmark (i.e. not considered a TE).
Capital gains are taxable only when they are realized in exchange.
Under the benchmark, business and capital losses that are not deducted in the taxation period in which these losses arise can be carried over to subsequent taxation periods in recognition of the cyclical nature of business activity and investment.
Tax base
The benchmark CIT base comprises all sources of income for the corporation, including profits from carrying out business activity and investment income including rental income, interest income, royalties, dividends and capital gains, as well as other sources of income including government cash transfers and donations.
Any business income that is not fully included in the tax base gives rise to a TE. The differential tax treatment of non-profit organisations included within the special tax regime as well as the non-taxation of income received from contributions to Family Compensation Funds is viewed as a TE. Further, a reduction in the principal of a loan is viewed as taxable income. On the other hand, sources of finance that the business has issued or attracted (e.g. newly issued equity or debt) are not included as income insofar as the funding raised corresponds to a liability of the same value. See Annex C for provisions under the CIT that are considered TEs.
Current expenses incurred to earn taxable business income are deductible in the year they are incurred; this includes wages as well as corresponding payroll taxes and employer social security contributions and non-tax compulsory payments. The deduction of donations is not part of the benchmark (i.e. is viewed as a TE).
Government royalties and resource taxes are not deductible for income tax purposes under the benchmark.
The deductibility of interest payments from taxable corporate earnings is part of the income tax benchmark and, therefore, does not constitute a TE.
A dividend participation exemption that takes into account that CIT has been paid on dividend income that is received and ensures that these dividends are therefore not taxed again under the CIT at the receiving company is included in the income tax benchmark.
Depreciation deductions are made over the effective life of the asset, and balancing adjustments on disposal reconcile differences between the outstanding tax and economic value of the asset. Tax depreciation allowances that correspond to the economic depreciation of the asset are included in the benchmark; they therefore do not constitute a TE.3
Similarly to other assets, businesses are allowed to depreciate natural resource assets over time according to the economic depreciation of the asset. If the exploration is successful, the same applies to intangible exploration expenses, which need to be capitalized and amortized gradually. To determine the decline in economic value, the standard treatment of the tax benchmark stipulates “cost depletion” which allows depreciation in accordance with the percentage of resources extracted from the property. Unsuccessful exploration can be expensed immediately.
The deductions granted through the special exhaustion factor in hydrocarbon exploitation give rise to a TE.
The deduction rules that only apply to petroleum exploration carried out in private property or to concessions in force as of 28 October 1974, give rise to a TE as these rules include amortization rates unrelated to the percentage of the resource extracted.
The normal deductions for exhaustion that only apply to contracts in force as of 28 October 1974 as well as the deduction for depletion in the exploitation of mines or gases other than hydrocarbons and natural deposits for contracts in force as of 28 October 1974, give rise to a TE. As the taxpayer can choose a fixed percentage of the value of the product extracted or the actual cost (determined based on a technical estimate), the difference between the actual cost and the fixed percentage (if chosen) would be a TE.
Other rules regarding the amortization, depreciation and depletion of natural resources that only apply to contracts in force as of 28 October 1974 and that deviate from the benchmark treatment would also give rise to TEs.4
Taxpayers resident in Colombia are subject to tax on their worldwide income, while non-residents are taxable in Colombia on their income from Colombia sources only.
This implies that the CIT exemption on dividends distributed by non-resident entities to a Colombian Holding Companies is a TE.
The capital gain tax exemption on income derived from the sale or transfer of the participation of a CHC in non-Colombian entities is a TE.
The capital gains exemption on income derived from the sale of shares or participations in a CHC is tax-exempt, except for the portion corresponding to the profits derived from activities carried out in Colombia, is a TE.
The benchmark PIT base comprises all sources of income for the individual, including income from employment, pension income, personal business income, partnership income and income from trusts, income from investment including dividends, rental income, royalties, interest and capital gains, as well as fringe benefits and government transfers and donations.
Expenses incurred to earn employment income such as expenses for commuting to work are not deductible – the deduction of these expenses from taxable personal income would constitute a TE – as the basic tax allowance within the PIT can be interpreted as providing a deduction to cover these costs.
Although the individual is the tax unit under the PIT, tax provisions that introduce some characteristics of family-based taxation to strengthen the equity of the tax system are part of the benchmark.
Mandatory social security contributions are deductible payments from the income tax benchmark as the replacement income that these contributions will give rise to will be included as taxable personal income in the tax benchmark. Put differently, mandatory SSCs follow an exempt-exempt-tax (EET) treatment.
While mandatory health contributions are deductible from the income tax benchmark, the health benefits received will not be included in the income tax benchmark insofar as they constitute a payment to cover the costs incurred.
Instead, voluntary health and pension contributions follow a tax-tax-exempt benchmark. Voluntary contributions or payments do not constitute a tax-deductible expense under the income tax benchmark. The deduction of voluntary pension savings from the tax system that is in place would therefore constitute a TE. The return to these savings is not tax-exempt and, therefore, constitutes taxable investment income under the benchmark. The corresponding replacement income linked to the voluntary contributions made that will be received by the individual does not constitute taxable income under the income tax benchmark.
Similarly to voluntary pension savings, the deferral of taxation on returns realised by investment funds is viewed as a TE. That is, the fact that returns are currently taxed only when distributed to investors is considered a TE.
Any government transfer that represents replacement income is taxable under the benchmark. However, the compensation for damage or any wrong or injury suffered by a taxpayer constitutes non-taxable income.
The non-taxation of maternity leave payments or the non-taxation of severance payments constitutes a TE.
The exemption of compensation for work-related accidents or illness does not constitute a TE.
The non-taxation of a disability benefit that would be received on a recurrent basis would constitute a TE as in that case it would be considered replacement income.
Various other examples listed in the Tax Incentives Commission Report such as the non-taxation of the excess of basic salary received by officers, non-commissioned officers, and professional soldiers of the military, executive-level personnel, patrolmen and agents of the National Police are TEs.
The exemption of the remuneration of officials of international organisations is a TE.
Tax rate
The benchmark CIT rate is the statutory general CIT rate in effect at any given time. As a result, any reduced rate constitutes a TE while a surtax gives rise to a negative TE.
The benchmark PIT rate and bracket structure is the standard rate schedule as it applies at any given time; “standard” refers to the tax rate schedule that is generally applicable to that particular type of income. The benchmark therefore allows for a schedular tax treatment.
The zero-rate bracket that applies to labour, professional fees, capital, non-labour and pension income is included in the benchmark as it is universal in its application and seen as a fundamental aspect of the tax system and thereby not as a TE.5
The additional 12 000 UVT6 exemption that applies to pension income is a TE.
For dividends and occasional gains, the benchmark includes the proportional tax rate under the tax system that is currently in place.
The exemption of distributed dividends not exceeding 300 UVT is a TE.
If dividends are paid out of profits that were not taxed under the CIT, the tax system that is currently in place levies first a withholding tax rate that equals the CIT rate. This so-called “CIT recapture tax” constitutes a negative TE.
The non-taxation of dividends from mega-investments under the dividend withholding is a TE.
The difference between the 20% rate applied to occasional gains from lotteries and raffles and the 10% rate applied to other occasional capital gains represents a negative TE.
Tax provisions within the CIT that correct for atypical taxes and tax treatments
Taxes that are an integral part of the tax system currently in place, even if they are uncommon from an international perspective, are an integral part of the benchmark and do not constitute a TE. Tax credits and deductions linked to the payment of these taxes that compensate for the weakness in the design of the tax system, despite a strong tax policy rationale, constitute a TE.
The business turnover tax (ICA) and the tax on financial transactions, which are uncommon from an international tax perspective, are part of the income tax benchmark. As a result, the corresponding ICA credit and deduction of the financial transaction tax are TEs within the CIT.
The CIT credit to compensate for VAT paid on the acquisition, construction or formation and import of real productive fixed assets is a TE in the CIT. Also, the possibility to report a higher value of the assets (due to VAT paid) and to depreciate this value, gives rise to a TE. Instead, the unrecoverable VAT paid on fixed assets is a negative TE in the VAT.
Tax provisions that aim at avoiding double taxation
Measures that provide relief from double taxation are considered part of the benchmark income tax system. This includes double tax treaties and dividend participation exemptions.
Although obligations that follow from the Andean Community (CAN) treaty are legally binding, these tax provisions could be viewed as tax incentives by installing a territorial-like tax system amongst CAN countries. The OECD suggests considering these provisions as part of the benchmark (i.e. not as a TE) given that they are tax treaties but still measure and report the associated revenue forgone in an Annex of the TE report in order to enhance transparency.7
Tax base protection measures
Tax base protection measures are included in the income tax benchmark.
CFCs rules, transfer pricing rules and thin capitalization rules are part of the benchmark. Nonetheless, whenever tax provisions that are linked to these tax base protection rules would result in a more generous treatment than what would be the case under Colombia’s standard worldwide taxation regime, these provisions would be viewed as a TE.
In the absence of a tax treaty that applies, the standard withholding taxes included in the Colombian domestic law that apply to that particular class of income constitute the benchmark tax rates. Exemptions or reductions relative to these basic rates will give rise to a TE.
Reduced withholding rates for income from foreign portfolio capital investments, except for investments in public or private fixed income securities (25% if investor is domiciled in a low or zero taxation jurisdiction and 14% if the investor is not domiciled in a low or zero taxation jurisdiction) are a TE.
If a tax treaty exists, the benchmark rates of withholding tax for a class of income will be the ‘basic rate’, where the basic rate is the highest rate specified in the treaty for each withholding tax. Exemptions or reductions relative to the basic rates prescribed in a particular tax treaty will give rise to a TE.
Reductions to the CIT base or liability on account of payment of other taxes
While it is a policy choice of the government to allow certain taxes to be deducted from the CIT base, the desire for transparency implies that these deductions are excluded from the income tax benchmark and are therefore considered a TE. The only exception would be employer social security contributions and payroll taxes paid by the employer as these taxes are part of wage costs whose incidence is assumed to primarily fall on workers and wage costs overall are deductible from taxable corporate profits. For example, the following deductions give raise to a TE:
Additional tax benchmark design features
Tax simplification measures that aim at reducing compliance costs for incorporated or unincorporated businesses are included in the income tax benchmark and, therefore, do not constitute a TE.
However, tax simplification measures that would possibly result in a non-trivial tax advantage for the businesses or individuals involved would constitute a TE. For instance, a deduction of presumptive costs irrespective of the actual costs that the taxpayer has incurred would be considered a TE if the deduction is estimated to generally exceed effective costs.
Taxpayers that provide professional services and hire a maximum of two employees for less than 90 continuous or discontinuous days can choose to either:
i. have 25% of their income exempt; in this case, they are also obliged to observe the 40% net income ceiling, as is the case for employees. The difference between 25% of their income and the effective costs incurred, if positive, would constitute a TE.
ii. or deduct effective costs provided they meet the requirements listed in article 107 of the tax code. In this case, the total amount of deductions can exceed the 40% ceiling. This option does not give rise to a TE, as the deduction of business expenses is an integral part of the income tax benchmark.
Rather than deducting the actual labour costs, coffee growers have a deemed tax-deductible workforce cost equivalent to 40% of taxable income. The difference between the actual labour costs and the deemed deduction constitutes a TE.
References
[1] Australian Government the Treasury (2021), Tax Benchmarks and Variations Statement 2020.
[5] Department of Finance Canada (2021), Report on Federal Tax Expenditures - Concepts, Estimates, Evaluations.
[3] Haig, R. (1921), The Concept of Income—Economic and Legal Aspects, Columbia University Press.
[2] Schanz, G. (1896), “Der Einkommensbegriff und die Einkommensteuergesetze”, Finanzarchiv 13, pp. 1-87.
[4] Simons, H. (1938), Personal Income Taxation: the Definition of Income as a Problem of Fiscal Policy, Chicago: University of Chicago Press.
[6] U.S. Department of the Treasury (2021), Tax Expenditures.
Notes
← 1. Under a comprehensive income tax, income is taxed when it is accrued. Savings are made out of taxed earnings and the return on these savings (irrespective of whether the assets are owned directly or through a savings fund) is part of the benchmark and subject to income tax on an accrual basis. In return, the withdrawal of assets from such saving vehicles is fully exempted from tax; i.e. savings are taxed under a “taxed-taxed-exempt” regime.
← 2. This section is inspired by the U.S. TE report as well as the Australian and Canadian TE reports (Australian Government the Treasury, 2021[1]; Department of Finance Canada, 2021[5]; U.S. Department of the Treasury, 2021[6]).
← 3. Table A A.6 in Annex A compares tax depreciation rates in Colombia to economic depreciation rates estimated in the literature. Overall, these rates do not differ significantly. Hence, it could be argued that the standard depreciation rates in the Colombian tax system are aligned with the benchmark (i.e. do not give rise to a TE).
← 4. As provisions guaranteed in historical contracts cannot be changed, these TEs are likely non-actionable.
← 5. Even if the exempt bracket is viewed as part of the benchmark, the threshold in Colombia is particularly high compared to other countries. It is hence suggested that the revenue forgone associated with this provision is measured and reported in an Annex of the TE report.
← 6. Unidad de Valor Tributario (UVT) refers to the Tax Value Unit. In 2020, 1 UVT = COP 35 607.
← 7. Exempt income from the Andean Community treaty includes: income from capital gains obtained on the sale of assets located in another CAN member country, income from the exploitation of natural resources in another member country, income from royalties on intangible assets in a member country, income from interest and other financial returns whose payment is recorded and imputed in another member country. Dividends and participations are only taxable by the member country where the company that distributes them is domiciled.
← 8. The OECD recommends listing this regime as a TE in the report separately from the CIT and PIT TEs as the regime covers a wider range of taxes. Measuring revenue forgone from SIMPLE may be challenging due to the lack of information on benchmark revenues. However, the mere acknowledgement that the regime provides preferential treatment for small and medium businesses is considered informative and contributes to enhancing transparency.