After a heated out-of-Congress controversy on July’s tax reform proposal by both sympathizers and detractors, the Government has withdrawn it replacing it with a less ambitious one seeking to secure a prompt approval in Congress, where it was presented on the second week of November.

Enactment of this tax bill is almost certain and should be approved by the end of December. Therefore the newly adopted measures would be applicable as of January 1st, 2007, with some likely but limited exceptions where application could occur as of the date of enactment.

There are many changes introduced that could be very important for your investments or business interests in Colombia, requiring a thorough review of the tax bill. Here are our comments on some of them:

SPECIAL TRANSFER PRICING REGIME FOR MINING ACTIVITIES. Since 2004, Colombia has in place OECD-like income tax transfer pricing rules similar to those currently in place in Mexico. The tax bill introduces a special transfer pricing regime for Mining Activities that would be applicable as of FY2007. The measure would affect mining activities only, specifically those producers/exporters of any mineral (including coal) with yearly exports of US$ 50,000,000 or more. The measure provides that the income tax effects of these sales would have to be assessed considering the official price listed by the Mines and Energy Administration, which must correspond to the price paid by the final consumer; regardless of the price effectively paid to the producer/exporter in the sale, and disregarding for income tax purposes any cost or expense incurred by the exporter on transport, shipment, and brokerage fees.

25% INVESTMENT VALUE DEDUCTION. Pursuant to the new tax bill, the current and temporary special deduction lapsing on FY2007 allowing income taxpayers to deduct 30% of the acquisition value of tangible fixed assets in the fiscal year of acquisition, would be replaced by a similar permanent deduction but reducing the allowance to 25% of the acquisition value and also allowing a carry-forward of any tax loss generated by this benefit.

This permanent tax benefit should be adopted in the same terms and conditions of the current temporary one. Therefore, it should not prevent the taxpayer from benefiting from other statutory deductions on this type of investments, such as depreciation. The requirements to qualify for this special deduction are exigent and should be reviewed on a case-by-case basis. Current requirements can be consulted in our Colombian_Tax_Flash®: July 2004, Vol.1 – No.2.

MINIMUM PRESUMPTIVE INCOME METHOD 50% BASE REDUCTION. Income tax regulations ordain that taxpayers use two methods to assess their income tax liability: the ordinary method, similar to any ordinary income tax assessment method in other countries, and the Minimum Presumptive Income Method (MPIM) that works as an alternate mandatory method to assess the minimum income tax liability to be paid. Should the income tax liability resulting from the application of the ordinary method be lower than the income tax liability resulting from using the MPIM, the taxpayer will have to pay her income tax using the latter (minimum income tax liability payable).

The MPIM taxable base is currently 6% of the taxpayers’ previous year net-worth, to which the income tax rate is then applied to assess the minimum income tax liability payable. The current tax bill proposes a 50% reduction of the MPIM taxable base, i.e. from 6% to 3%. Should Congress pass this proposal, it would result in an effective 50% reduction of the minimum income tax liability payable under the MPIM as of FY2007.

NET-WORTH TAX EXTENSION. The tax bill proposes an extension for an additional four-4 years, i.e., for FYs 2007-2010, of the net-worth tax that lapsed this year, increasing its rate from 0.3% to 1.2%.

DIVIDENDS AND BRANCH PROFITS TAXES ELIMINATION. The tax bill proposes a reduction to 0% of the current 7% dividends tax rate and the elimination of the 7% branch profits tax. Should Congress pass this proposal, it would mean that as of January 1st, 2007 there should be no additional dividends or branch profits taxes upon distribution by Colombian corporations or Colombian branches of foreign companies, respectively.

ELIMINATION OF 7% REMITTANCE WITHHOLDING TAX ON CROSS-BORDER PAYMENTS. The tax bill is proposing the elimination of this tax which currently affects almost all payments abroad and that today results in an effective increase of the withholding tax applicable, meaning that there will be a reduction of the withholding tax applicable to payments abroad such as Royalties.

LEASING PAYMENTS DEDUCTIBILITY EXTENDED. The new tax bill proposes the extension until FY2011 of the full deduction treatment for lease payments, otherwise lapsing on December 31st, 2006 and benefiting: 5-year (or higher term) real estate leasing; to 3-year (or higher term) M&E leasing; and to 2-year (or higher term) vehicles and computer equipment leasing. This treatment would benefit leasing agreements executed on or before December 31st, 2011 by small and mid-size enterprises.

STAMP TAX ELIMINATION AND INCOME TAX RATE REDUCTION. The first tax reform proposal withdrawn by the Government included the elimination of the 1.5% stamp tax and a reduction of the current statutory 35% income tax rate reduction. These proposals were not included in the November 2006 proposal. Nevertheless and although uncertain yet, unconfirmed information indicate that the Colombian Congress could be considering reintroducing these two proposals.

INFLATION ADJUSTMENT ELIMINATION. The inflation adjustment system as applicable today will be eliminated and replaced by an adjustment system applicable to fixed assets using the same index used to update what will now be called the Tax Unit (“Unidades de Valor Tributario”); a Tax Unit method introduced by the tax bill to update tax figures in the tax rules, similar to that currently in place in Chile using “Unidades Tributarias”

TAX CONTROVERSY SETTLEMENT. Pursuant to the tax bill and provided that the Tax Court has not issued its final ruling on the matter, tax controversies where the lawsuits have been filed before the enactment date of this new law can be settled directly with the Colombian Tax Service (“DIAN”) observing the following rules: (i) where the tax litigation has no appeal stage or is already in its appeal stage, the taxpayer can benefit from not paying penalties and interests on the disputed income tax liability, by paying 100% of the disputed income tax liability assessed by the Tax Service; (ii) where although having an appeal stage the tax litigation is in its lower stage (i.e., Lower Tax Court), the taxpayer can benefit from not paying penalties and interests on the disputed income tax liability, by paying 80% of the disputed income tax liability assessed by the Tax Service; (iii) where the tax controversy is on a penalty only, the taxpayer can benefit from not paying 20% of the disputed penalty by the remaining 80% of the indexed amount of the penalty. This authorization to the Tax Service to settle is only applicable to Income Tax, VAT, Withholding Tax and Stamp Tax controversies.

RECOMMENDATIONS:

At this stage we recommend swiftly seeking advice on how these and other relevant changes that could be introduced may affect your interests or those of the Colombian subsidiaries of your companies in order to identify the potential advantages, disadvantages that will be faced should this tax bill be passed

November 2006, Vol. 3 –No. 7
© LEWIN & WILLS –Attorneys and Counsellors at Law
____________________________________________________________
Member of LATAXNET- Latin American Tax & Legal Network