Economic Zones

How Colombia's new Tax Reform will affect FTZs

For decades, Colombian Free Trade Zones (FTZs) helped attract investment and grow the economy - but all of that is about to change. On August 8 2022, the Colombian government passed legislation which will strip FTZs of most of their tax incentives.
,  
October 14, 2022
October 14, 2022

Introduction

For decades, Colombian Free Trade Zones (FTZs) helped attract investment and grow the economy - but all of that is about to change. On August 8 2022, the Colombian government passed legislation which will strip FTZs of most of their tax incentives.

Colombia’s free trade zones are a development tool designed to spur job creation and new capital investment. They do this by offering tax and regulatory incentives which make it easier for businesses to operate in Colombia. As a result, 50% of the companies in zones receive foreign investment and primarily produce exports.

The new tax reform threatens the stability of Colombia’s FTZs. It includes higher taxes in the hydrocarbon and mineral industry, increases FTZ export rates, more bureaucracy in courier shipments, and a huge tax differential treatment between the different types of zones existing in Colombia. 

Overview of Colombia’s FTZs

Across the world, a Free Trade Zone is typically considered a "geographical area delimited within the national territory, where industrial activities of goods and services, or commercial activities are developed, under the special tax, customs, and foreign trade regulations." Article 1 of Law 1004 in Colombia adds that goods entering the Free Trade Zones are considered outside the national customs territory for import and export tax purposes. (1)

In Colombia, the first Free Trade Zone was created in 1958 in Barranquilla (2). Today, the country has 122 Free Trade Zones, which are classified into three types (3):

  • Permanent Free Trade Zones (multi-user): a determined area where several companies develop their industrial, commercial, or service activities.
  • Special Permanent Free Trade Zone: these are where a single company (industrial user), regardless of the geographical area where it is located, has the possibility of covering its activity with the incentives of the Free Trade Zone Regime. 
  • Temporary Free Trade Zones: these are temporarily authorized for the celebration of fairs, exhibitions, congresses, or seminars of transcendental importance for the economy and national or international trade of the country.

According to the 2018 Free Trade Zone Statistical Report, the highest growth of these territories occurred in 2009, when an increase of 60% was recorded compared to 2008. The trend has been positive for the following years, accumulating $44 billion, of which 13% represent foreign direct investment, and generating 114,603 direct and indirect jobs in the 22 states where they are present. (4)

Source: Matriz Plan Maestro ANDI, 2018

Colombia's Free Trade Zone regime has offered the same benefits for different users for years. However, the Law Decree 278 of March 15, 2021 (5) improves incentives for SEZs in the country. Changes include: Promoting the 4.0 economy and the export of services, electronic commerce availability, the reduction of 15.2% of the minimum amount of investment, and the number of requirements that have been reduced from 57 to 24. (6)

Among the tax benefits (7) are:

  • Income tax rate of 20%.
  • No customs duties (VAT and tariffs) are caused or paid.
  • VAT exemption for raw materials, inputs, and finished goods acquired in the National Customs Territory.

On the other hand, customs benefits (7) include: 

  • Nationalize as needed.
  • Nationalize raw material or finished product.
  • Partial processing outside the Free Trade Zone.
  • Sales between free zone users are exempt from VAT on inbound and outbound exports.

2022 Tax Reform

Colombia has had 21 tax reforms between the 1990s and 2022. Since 1990, with César Gaviria as President of the Republic, the country has had to adapt to 21 tax reforms every 18 months (8). However, taxation in Colombia is still high, and tax incentives in free trade zones tend to be lower than in other Latin American countries. 

Source: El País

On August 8, 2022, a bill was filed before the Congress of the Republic to adopt a new tax reform in Colombia, which aims to raise 25.9 billion annually (9). This has led to a review of taxes, as is the case of the free trade zones. The current free trade zone tax regime has been the target of permanent criticism not only because of the potential cost of the tax benefits granted but also because of the inequity in the tax treatment of companies operating outside them. For example, companies within the national customs territory (TAN) are taxed at 35%, and those in free trade zones are taxed at 20%. (10)

Under this new reform, Permanent Free Trade Zones (multi-user) and Temporary Free Trade Zones could maintain tax benefits at 20% if they comply with an approved Internationalization Plan. They would also need to have an area of more than 80 hectares and more than 40 users (both domestic and foreign companies are counted). The income tax rate proposed at a general level of 35% will be applicable for legal entities that do not comply with this requirement. (11)

Then, the first implication could be that Colombia breaches its commitments with the WTO since performance requirements cannot be created for FTZ, in this case, export commitments, in exchange for receiving a differential benefit in terms of direct taxes, such as income tax.

It is unclear whether the increase of the tariffs and the inclusion of new requirements for their application to existing users would be constitutional since they have complied with investment and employment generation commitments under the current rules, waiting for the application of the special tariffs.  Besides, conditioning the tax rate to export indicators could result in uncertainty for the taxpayer (tenants), who, in the end, could decide to sue the FTZ or local governmental agencies. In the worst scenario, even the WTO could sue Colombia. 

Meanwhile, the Special Permanent Free Trade Zone (SPFTZ) won´t have the option to implement an internationalization plan. As soon as this reform is implemented, this type of FTZ will be taxed at 35%. According to the government, the reasoning behind this measure is that 75% of companies that benefit from the FTZ tax regime do not export. 

Moreover, SPFTZ represented 50.1% of the exports made by the country's free zones and 6% of Colombia's non-mining-energy exports (11). Also, companies in these areas tend to invest in areas where there is usually no investment. 

One good example is Puerto Antioquia, a multipurpose port with an estimated investment of $672.4 million. Also, the Centro de Tratamiento e Investigación sobre el Cáncer (CTIC), an SPFTZ for health services operating in the north of Bogotá, and many other SPFTZ that are good examples of this development in the country in our Open Zone Map here.

Nevertheless, the second implication showcases that the tax rate increment would force the SPFTZ to change its business model or look for another regional destination to carry out its operations. 

Third, the VAT exclusion for courier shipments to Colombia would be modified, maintaining the limit at USD 200 but clarifying that its application would depend on the origin of the imported product and the international commitments acquired by the country. This obliges companies engaged in postal traffic to strictly observe the origin of the goods and Colombia's international commitments to avoid a mistaken application of the special treatment, meaning more bureaucracy and affecting the expected shipment timeline.

Fourth, free zone users engaged in the hydrocarbon and mineral industry will have to assume a new and higher tax on oil, coal, and gold exports. This would inevitably affect one of the biggest deals for Colombia, with the Dubai Multi Commodities Centre (DMCC) and UVentures, which signed an agreement to develop a free trade zone in Cartagena de Indias, Colombia. (12)

What do companies think about it? 

José Antonio Ocampo, the National Association of Foreign Trade (Analdex) president, debated the proposal. He believes “the problem of the SPFTZ is more significant than the others. The free zones were initially created to export. Still, today 85% of what they export is produced in the domestic market, and this competes inequitably with the companies established in the national territory, which have to pay 35%". (13)

On the other hand, Luz Stella Murgas, president of Naturgas, states that free zones are also a concern because "the investments made in offshore exploration and production are significant in comparison with the continental areas. So, the free zones were a mechanism that allowed boosting investment in these fields". (13)

References:

  1. https://www.funcionpublica.gov.co/eva/gestornormativo/norma.php?i=18704 
  2. https://www.lexbase.co/lexdocs/indice/1958/l0105de1958#:~:text="%20Congreso%20de%20Colombia%3A%20Ley%20105,con%20excepción%20del%20artículo%201º%20
  3. https://www.mincit.gov.co/CMSPages/GetFile.aspx?guid=33a36434-01f2-410f-86e5-62c0ff6ff989 
  4. https://www.andi.com.co/Uploads/ESTUDIO%20DE%20IMPACTO%20JURÍDICO%20ECONÓMICO%20Y%20FISCAL%20DE%20LAS%20ZONAS%20FRANCAS%20-%20Consorcio%20Araújo%20Ibarra%20Ibarra%20Abogados%20HJ%20Gómez.pdf 
  5. https://dapre.presidencia.gov.co/normativa/normativa/DECRETO%20278%20DEL%2015%20DE%20MARZO%20DE%202021.pdf 
  6. https://www.mincit.gov.co/prensa/noticias/industria/se-modifica-el-regimen-de-zonas-francas 
  7. https://exennta.com/beneficios/ 
  8. https://www.larepublica.co/economia/colombia-ha-tenido-21-reformas-tributarias-entre-la-decada-de-los-90-y-hasta-2022-3395596 
  9. https://www.garrigues.com/es_ES/noticia/colombia-proyecto-reforma-tributaria-2022 
  10. https://www.banrep.gov.co/sites/default/files/publicaciones/pdfs/borra657.pdf 
  11. https://www.larepublica.co/economia/cuales-son-los-efectos-de-la-reforma-tributaria-sobre-el-modelo-de-las-zonas-francas-3426036 
  12. https://www.vivirendubai.com/la-dmcc-de-dubai-desarrollara-una-free-zone-en-colombia
  13. https://www.valoraanalitik.com/2022/08/09/que-dice-la-reforma-tributaria-de-petro-de-zonas-francas/ / 
Tags
Economic Zones

How Colombia's new Tax Reform will affect FTZs

For decades, Colombian Free Trade Zones (FTZs) helped attract investment and grow the economy - but all of that is about to change. On August 8 2022, the Colombian government passed legislation which will strip FTZs of most of their tax incentives.
,  
October 14, 2022
October 14, 2022

Introduction

For decades, Colombian Free Trade Zones (FTZs) helped attract investment and grow the economy - but all of that is about to change. On August 8 2022, the Colombian government passed legislation which will strip FTZs of most of their tax incentives.

Colombia’s free trade zones are a development tool designed to spur job creation and new capital investment. They do this by offering tax and regulatory incentives which make it easier for businesses to operate in Colombia. As a result, 50% of the companies in zones receive foreign investment and primarily produce exports.

The new tax reform threatens the stability of Colombia’s FTZs. It includes higher taxes in the hydrocarbon and mineral industry, increases FTZ export rates, more bureaucracy in courier shipments, and a huge tax differential treatment between the different types of zones existing in Colombia. 

Overview of Colombia’s FTZs

Across the world, a Free Trade Zone is typically considered a "geographical area delimited within the national territory, where industrial activities of goods and services, or commercial activities are developed, under the special tax, customs, and foreign trade regulations." Article 1 of Law 1004 in Colombia adds that goods entering the Free Trade Zones are considered outside the national customs territory for import and export tax purposes. (1)

In Colombia, the first Free Trade Zone was created in 1958 in Barranquilla (2). Today, the country has 122 Free Trade Zones, which are classified into three types (3):

  • Permanent Free Trade Zones (multi-user): a determined area where several companies develop their industrial, commercial, or service activities.
  • Special Permanent Free Trade Zone: these are where a single company (industrial user), regardless of the geographical area where it is located, has the possibility of covering its activity with the incentives of the Free Trade Zone Regime. 
  • Temporary Free Trade Zones: these are temporarily authorized for the celebration of fairs, exhibitions, congresses, or seminars of transcendental importance for the economy and national or international trade of the country.

According to the 2018 Free Trade Zone Statistical Report, the highest growth of these territories occurred in 2009, when an increase of 60% was recorded compared to 2008. The trend has been positive for the following years, accumulating $44 billion, of which 13% represent foreign direct investment, and generating 114,603 direct and indirect jobs in the 22 states where they are present. (4)

Source: Matriz Plan Maestro ANDI, 2018

Colombia's Free Trade Zone regime has offered the same benefits for different users for years. However, the Law Decree 278 of March 15, 2021 (5) improves incentives for SEZs in the country. Changes include: Promoting the 4.0 economy and the export of services, electronic commerce availability, the reduction of 15.2% of the minimum amount of investment, and the number of requirements that have been reduced from 57 to 24. (6)

Among the tax benefits (7) are:

  • Income tax rate of 20%.
  • No customs duties (VAT and tariffs) are caused or paid.
  • VAT exemption for raw materials, inputs, and finished goods acquired in the National Customs Territory.

On the other hand, customs benefits (7) include: 

  • Nationalize as needed.
  • Nationalize raw material or finished product.
  • Partial processing outside the Free Trade Zone.
  • Sales between free zone users are exempt from VAT on inbound and outbound exports.

2022 Tax Reform

Colombia has had 21 tax reforms between the 1990s and 2022. Since 1990, with César Gaviria as President of the Republic, the country has had to adapt to 21 tax reforms every 18 months (8). However, taxation in Colombia is still high, and tax incentives in free trade zones tend to be lower than in other Latin American countries. 

Source: El País

On August 8, 2022, a bill was filed before the Congress of the Republic to adopt a new tax reform in Colombia, which aims to raise 25.9 billion annually (9). This has led to a review of taxes, as is the case of the free trade zones. The current free trade zone tax regime has been the target of permanent criticism not only because of the potential cost of the tax benefits granted but also because of the inequity in the tax treatment of companies operating outside them. For example, companies within the national customs territory (TAN) are taxed at 35%, and those in free trade zones are taxed at 20%. (10)

Under this new reform, Permanent Free Trade Zones (multi-user) and Temporary Free Trade Zones could maintain tax benefits at 20% if they comply with an approved Internationalization Plan. They would also need to have an area of more than 80 hectares and more than 40 users (both domestic and foreign companies are counted). The income tax rate proposed at a general level of 35% will be applicable for legal entities that do not comply with this requirement. (11)

Then, the first implication could be that Colombia breaches its commitments with the WTO since performance requirements cannot be created for FTZ, in this case, export commitments, in exchange for receiving a differential benefit in terms of direct taxes, such as income tax.

It is unclear whether the increase of the tariffs and the inclusion of new requirements for their application to existing users would be constitutional since they have complied with investment and employment generation commitments under the current rules, waiting for the application of the special tariffs.  Besides, conditioning the tax rate to export indicators could result in uncertainty for the taxpayer (tenants), who, in the end, could decide to sue the FTZ or local governmental agencies. In the worst scenario, even the WTO could sue Colombia. 

Meanwhile, the Special Permanent Free Trade Zone (SPFTZ) won´t have the option to implement an internationalization plan. As soon as this reform is implemented, this type of FTZ will be taxed at 35%. According to the government, the reasoning behind this measure is that 75% of companies that benefit from the FTZ tax regime do not export. 

Moreover, SPFTZ represented 50.1% of the exports made by the country's free zones and 6% of Colombia's non-mining-energy exports (11). Also, companies in these areas tend to invest in areas where there is usually no investment. 

One good example is Puerto Antioquia, a multipurpose port with an estimated investment of $672.4 million. Also, the Centro de Tratamiento e Investigación sobre el Cáncer (CTIC), an SPFTZ for health services operating in the north of Bogotá, and many other SPFTZ that are good examples of this development in the country in our Open Zone Map here.

Nevertheless, the second implication showcases that the tax rate increment would force the SPFTZ to change its business model or look for another regional destination to carry out its operations. 

Third, the VAT exclusion for courier shipments to Colombia would be modified, maintaining the limit at USD 200 but clarifying that its application would depend on the origin of the imported product and the international commitments acquired by the country. This obliges companies engaged in postal traffic to strictly observe the origin of the goods and Colombia's international commitments to avoid a mistaken application of the special treatment, meaning more bureaucracy and affecting the expected shipment timeline.

Fourth, free zone users engaged in the hydrocarbon and mineral industry will have to assume a new and higher tax on oil, coal, and gold exports. This would inevitably affect one of the biggest deals for Colombia, with the Dubai Multi Commodities Centre (DMCC) and UVentures, which signed an agreement to develop a free trade zone in Cartagena de Indias, Colombia. (12)

What do companies think about it? 

José Antonio Ocampo, the National Association of Foreign Trade (Analdex) president, debated the proposal. He believes “the problem of the SPFTZ is more significant than the others. The free zones were initially created to export. Still, today 85% of what they export is produced in the domestic market, and this competes inequitably with the companies established in the national territory, which have to pay 35%". (13)

On the other hand, Luz Stella Murgas, president of Naturgas, states that free zones are also a concern because "the investments made in offshore exploration and production are significant in comparison with the continental areas. So, the free zones were a mechanism that allowed boosting investment in these fields". (13)

References:

  1. https://www.funcionpublica.gov.co/eva/gestornormativo/norma.php?i=18704 
  2. https://www.lexbase.co/lexdocs/indice/1958/l0105de1958#:~:text="%20Congreso%20de%20Colombia%3A%20Ley%20105,con%20excepción%20del%20artículo%201º%20
  3. https://www.mincit.gov.co/CMSPages/GetFile.aspx?guid=33a36434-01f2-410f-86e5-62c0ff6ff989 
  4. https://www.andi.com.co/Uploads/ESTUDIO%20DE%20IMPACTO%20JURÍDICO%20ECONÓMICO%20Y%20FISCAL%20DE%20LAS%20ZONAS%20FRANCAS%20-%20Consorcio%20Araújo%20Ibarra%20Ibarra%20Abogados%20HJ%20Gómez.pdf 
  5. https://dapre.presidencia.gov.co/normativa/normativa/DECRETO%20278%20DEL%2015%20DE%20MARZO%20DE%202021.pdf 
  6. https://www.mincit.gov.co/prensa/noticias/industria/se-modifica-el-regimen-de-zonas-francas 
  7. https://exennta.com/beneficios/ 
  8. https://www.larepublica.co/economia/colombia-ha-tenido-21-reformas-tributarias-entre-la-decada-de-los-90-y-hasta-2022-3395596 
  9. https://www.garrigues.com/es_ES/noticia/colombia-proyecto-reforma-tributaria-2022 
  10. https://www.banrep.gov.co/sites/default/files/publicaciones/pdfs/borra657.pdf 
  11. https://www.larepublica.co/economia/cuales-son-los-efectos-de-la-reforma-tributaria-sobre-el-modelo-de-las-zonas-francas-3426036 
  12. https://www.vivirendubai.com/la-dmcc-de-dubai-desarrollara-una-free-zone-en-colombia
  13. https://www.valoraanalitik.com/2022/08/09/que-dice-la-reforma-tributaria-de-petro-de-zonas-francas/ / 
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