Countries around the world have different methods of taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ing dividends and several have integrated their business and individual income tax systems with a credit imputation. This type of system minimizes the double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. of corporate income and can lead to a more neutral policy stance toward investment.
However, many countries have policies that create extra tax burdens on corporate income including dividend taxes. Colombia recently adopted a new tax policy on dividends that will raise taxes on shareholders and could hurt the ability of Colombian businesses to attract investors.
The Colombian experience shows how a country might implement a new dividend tax. Colombia adopted a dividend tax in 2016 with some changes in 2018 that increases the tax burden that people investing in Colombia will face in the coming years. As a partial countermeasure, the government has planned to progressively reduce the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate to offset some of the effect of the increase in dividend taxes.
Dividend calculations are different in some civil law countries than in the United States or common law countries. In those countries, including Colombia, dividends are calculated directly from profits. The profit definition is a positive net income at the end of the fiscal year; if a company does not have profits, then a dividend distribution is not possible. This is calculated as income – (costs + expenses + taxes). This is different from an earnings and profits criterion to determine if the amount distributed by a corporation is treated as a dividend, as it is in the United States.
Changes to Dividend Taxation
In 2016 the Colombian Congress enacted Law 1819, which modified the Colombian Tax Code, creating a tax on dividends. Prior law allowed dividends to be distributed tax-free once the corporate tax was paid on profits. According to this new law, dividends are taxed at the shareholder level when a dividend is credited or paid.
The dividend tax was amended in 2018 by Law 1943. The amendments in Law 1943 to the dividend tax include:
- an increase on the dividend rates,
- the obligation for corporations to withhold on distributions,
- a transition regime where the modifications made by the law apply before December 2018.
According to the Colombian law, distributed dividends are taxed at different rates depending on the previous treatment of distributed profits. If profits were not taxed before distribution, then dividends are taxed at a higher rate. The rates vary in the case of individuals and corporations. In the case of individuals, the applicable withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. rate is 15 percent when the amount of the distribution is over 300 UVT (approximately $3,321). For corporations, the withholding rate is 7.5 percent if the dividend was previously taxed at the corporate level.
The 7.5 percent withholding rate is applicable only for the first distribution between Colombian corporations. When a dividend is distributed a second time, from a corporate shareholder to a third shareholder, there is no further withholding applicable. A credit mechanism allows the credits derived from the withholding to be carried forward until the dividend reaches the individual who is the ultimate beneficial owner.
In February, the Colombian Tax authority (DIAN) issued a ruling clarifying that the dividend tax does not apply to dividends paid from profits generated before fiscal year 2017, regardless of when the dividends are distributed.
The tax legislation has also changed other aspects of corporate taxation. The corporate income tax will be reduced by 1 percentage point each year from 2019-2022, with a 2019 rate of 33 percent and a 2022 rate of 30 percent. Combined with the 2019 corporate tax rate, the new 7.5 percent withholding tax on dividends results in an effective tax rate of 38.025 percent on dividends for the year 2019. This does not include additional personal income tax if it applies.
The income tax withholding rate has also been increased from 15 percent to 20 percent for payments abroad in the following categories: royalties, leasing and technical, and consulting and technical assistance services.
Certainly, no tax system is perfect, and each country can work to improve their tax policy. In developing countries, corporate taxes are an important source of the revenue, but changes must be carefully drafted in order to minimize the impact on investors. The United States recently moved to a more territorial system with a dividends received deduction as part of the Tax Cuts and Jobs Act. However, in the case of Colombia, the authorities are going the other way with increased taxes on dividends. This may cause investors to look for other countries in order to invest in more competitive conditions. For Colombian residents with actual investments in the country, the reform puts local investors in a higher tax situation than some investors based in other countries in the region.
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 In Colombian legislation tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. s are not determined directly in Colombian currency. Tax brackets are divided in units of tax value (Unidades de Valor Tributario (UVT)) on which a different rate applies to each bracket in the progressive structure. The UVT value in Colombian Pesos is adjusted each year to make tax assessments simpler. The UVT value is adjusted according to inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. and the consumer price index. For the year 2019, 1 UVT is valued at 34,270.00 Colombian pesos, approximately $11.Share