Last week, the Colombian government presented its new tax reform for approval by Congress, over two months after its original reform was withdrawn in the face of widespread political and social backlash. Given the importance of this tax reform, we are aiming to contextualize the changes and to help you better prepare for the potential impacts to the operating environment in Colombia.
What is different about the new tax reform as compared to the one presented in April?
As expected, Colombia’s new tax reform is substantially different from the one presented in April. The original tax reform ambitiously sought to expand the tax base in Colombia and increase tax revenue gained from the middle class and the VAT. The new tax reform abandons these central characteristics of the last reform and instead raises already high corporate tax rates, also eliminating certain tax deductions for firms. The new reform also aims to gather substantially lower levels of new revenue than the original, with the target falling from 24 billion pesos to 15.2 billion pesos.
Among the core elements of the tax reform are:
- A corporate tax rate increase from 30% to 35% in 2022
- An extension of the surcharge on the financial sector
- A reduced Industry and Commerce Tax deduction to 50%
- Aggressive austerity measures cutting operational costs of government entities.
There are several other elements of the reform as we encourage firms to closely review the details of the new reform and evaluate how it may impact their operations. This explainer from the Ministry of Finance offers some further details.
Is there any new government spending associated with this tax reform? What will be its effect on the economy and fiscal balance?
Yes. The new tax reform, dubbed by the government as the “Law of Social Investment,” has been drafted with new social spending in mind. This is as a response to both the effects of the pandemic and the widespread economic anxiety that has taken grip of much of the country and helped drive the outbreak of social unrest. The new expenditures include the extension of transfers to low-income households through the Ingreso Solidario program, formal employment subsidies, and subsidies for higher education.
The extension of such spending will be most visible through its impact bolstering the recovery of the formal labor market and supporting consumer spending. While this spending is largely set to expire in 2022, it is highly likely that social pressure and electoral exigencies will result in at least some of these programs becoming permanent expenditures for the government. This will therefore become a significant source of further fiscal imbalance for Colombia.
Will the new tax reform restore fiscal balance and put Colombia on the path to recover its investment grade?
We do not believe that this tax reform will be sufficient to restore fiscal balance in Colombia. Despite the watered-down nature of this reform, it is likely that it will not succeed in reaching even the government’s reduced revenue goals. This is because the new reform rests on uncertain pillars as the source of new revenue. These include greater tax revenue from businesses still recovering from the pandemic, and longstanding unfulfilled goals such as cracking down on tax evasion and sharp austerity measures targeting government operational costs and similar expenditures.
As previously mentioned, while temporary, the new spending contemplated with the reform will also likely become a source of fiscal imbalance as the political and social costs of allowing this spending to expire will likely be higher than Colombia’s political leaders are willing to pay. As a result, the government will likely need to pursue additional fiscal reforms in the near future.
Will Colombia’s new tax reform be approved?
The new tax reform has a very high likelihood of being swiftly approved by Congress. This reform excludes the core elements which provoked rejection of the original reform by Colombia’s Congress and the public, namely the increased tax burdens on the middle class and the expansion of the VAT. The expansion of social spending programs associated with the reform further ensures that this reform will be palatable for the Colombian public and political leaders anxious about the 2022 elections. Additionally, Colombian politicians are keenly aware that the rejection of this revamped reform would have catastrophic effects for Colombia’s fiscal situation. For these reasons, we expect the reform to receive minimal resistance in its approval by congressional leaders.
How will Colombia’s new tax reform impact Colombia’s business environment and economic recovery?
Colombia already has among the highest corporate tax rates among OECD nations with a 2020 rate of 32% compared to the OECD average of 22%. Raising already-high taxes on businesses in the midst of the recovery stands to promote uncertainty and discourage vital private investment. While larger firms will be able to absorb and/or pass along the costs of the new tax reform, small and medium enterprises may be more adversely affected. We are also likely to see some moderate delays or scaled-down investment from firms, particularly as we enter a period of heightened political uncertainty around the upcoming 2022 elections. The reform also brings some additional inflationary pressures stemming from firms likely passing along costs to consumers, as previously mentioned, as well as the expansion of social transfers and subsidies. Between these pressures and the acceleration of the economic reopening, we expect the Central Bank to have to increase interest rates in 2021.
Will Colombia’s new tax reform generate social unrest once again?
While protests have largely abated in Colombia, the country remains at elevated risk of seeing new spikes in protest activity. The vastly more socially palatable content of this tax reform along with protest exhaustion both make it less likely for a return of widespread social unrest as a response to this new tax reform.
It is worth noting that Colombia’s protest leaders have called for protests to restart this week, and some opposition and protests leaders have sought to mischaracterize the contents of the new tax reform. Nonetheless, even if spikes in protests activity do occur, it is unlikely that we will see a sustained return of unrest with similar levels of disruptions that were seen during the height of the protests in May and early June.
What actions should I consider for my business in response to the new tax reform?
General: Since the new tax reform will likely be insufficient to correct Colombia’s fiscal situation, firms should plan for repercussions from continued fiscal imbalance in Colombia, including the need for additional tax reforms in the medium term. In scenario planning, firms should consider the possibility that the government is unable to successfully pursue sufficiently effective measures of fiscal consolidation in the coming years, bringing additional repercussions, including downward pressure on the value of the peso and the delayed recovery of Colombia’s investment grade.
B2C: B2C firms should prepare for a stronger rebound in consumer spending in H2 and into 2022 as a result of new social spending and employment subsidies, bolstering the positive impacts from an accelerated reopening and falling COVID cases. B2C firms should ensure their channels are prepared to meet increasing demand in H2 and should consider raising prices and increasing marketing to capture more upside.
B2G: B2G firms will see a general decline in demand and downside effects due to new austerity measures primarily targeting operating expenses. B2G firms should consider lowering prices to win against low-cost competitors and maintain relationships and contracts to benefit once demand and spending normalize. B2G firms should also emphasize cost-saving options and products to clients with reduced budgets. In scenario planning, B2G firms should also consider potential delays to the execution of government capital expenditures not directly targeted by austerity measures, but which are affected by underlying fiscal imbalance and budget issues.
B2B: The B2B environment will also face downside pressures as a result of increased business taxes in 2022. B2B firms should offer cost-saving solutions and flexible payment and financing options and focus efforts on larger B2B customers that can more easily absorb the costs of the tax reform. As appropriate, B2B firms should also offer smaller or tailored packages that are better value for money for more price-sensitive customers still reeling from the impact of the pandemic and social unrest.
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