How Colombia’s New Tax Reform Will Affect Free Trade Zones

For decades, the Colombian Free Trade Zone (FTZ) has helped attract investment and grow the economy – but that’s all about to change. On 8 August 2022, the Colombian government passed legislation that would strip FTZs of most of their tax incentives.

Colombia’s free trade zones are a development tool designed to encourage job creation and new capital investment. They do this by offering tax and regulatory incentives, making it easier to conduct business in Colombia. As a result, 50% of companies in the zone receive foreign investment and primarily export.

New tax reforms threaten the stability of Colombia’s FTZs. These include higher taxes on the hydrocarbon and mineral industries, increased FTZ export rates, more bureaucracy in courier shipments, and a massive tax differential treatment between Colombia’s different zones.

Overview of Colombia’s FTZs

Throughout the world, a free trade zone is generally considered to be “a geographical area bounded within national territory, where industrial activities or commercial activities of goods and services are developed under special tax, customs and foreign trade regulations.” Article 1 of Colombian Law 1004 adds that goods entering a free trade zone 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 Zone (Multi-User): A designated area where several companies develop their industrial, commercial or service activities.
  • Special Permanent Free Trade Zone: These are where a single company (industrial user), irrespective of the geographical area in which it is located, has the possibility to cover its activities with the incentives of the free trade zone regime.
  • Temporary Free Trade Zone: They are provisionally approved for the celebration of fairs, exhibitions, congresses or seminars of paramount importance to the country’s economy and national or international trade.

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

Colombia’s free trade zone regime has provided similar benefits to various users over the years. However, Law Decree 278 (5) of March 15, 2021 improves incentives for the country’s SEZs. The changes include: promotion of the 4.0 economy and export of services, availability of electronic commerce, a 15.2% reduction in the minimum amount of investment, and a reduction in the number of requirements from 57 to 24. (6)

Among the tax benefits (7) are:

  • Income tax rate is 20%.
  • No duties (VAT and Tariff) are incurred or paid.
  • VAT exemption for raw materials, inputs and finished goods acquired in the national customs territory.

On the other hand, tariff advantages (7) include:

  • Nationalize if necessary.
  • Nationalization of raw materials or finished goods.
  • Partial processing outside a free trade zone.
  • Sales between free zone users are exempt from VAT on inbound and outbound exports.

2022 tax reform

Colombia has undergone 21 tax reforms between 1990 and 2022. Since 1990, as President of the Republic of Cesar Gaviria, 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 are lower than in other Latin American countries.

Source: The Country

On August 8, 2022, a bill was submitted before the Congress of the Republic to adopt a new tax reform in Colombia, aiming to collect 25.9 billion (9) annually. This led to a review of taxes, as was the case with free trade zones. Current free trade zone tax systems have been the target of sustained criticism not only because of the potential costs of the tax benefits provided but also because of the disparity in the tax treatment of companies operating outside them. For example, companies located within a National Customs Territory (TAN) are taxed at a rate of 35%, and a free trade zone is taxed at a rate of 20%. (10)

Under this new reform, Permanent Free Trade Zones (Multi-User) and Temporary Free Trade Zones can retain tax benefits at the rate of 20% if they adhere to an approved internationalization plan. They must have an area of ​​more than 80 hectares and more than 40 users (counting both domestic and foreign companies). The proposed income tax rate at the general level of 35% will apply to legal entities that do not comply with this requirement. (11)

Then, the first implication could be that Colombia violates its commitments with the WTO since performance requirements cannot be made for FTZs, in this case, export commitments, in exchange for receiving a differential advantage in terms of direct taxes such as income taxes.

It is unclear whether it would be constitutional to increase tariffs and include new requirements for existing users to apply for them because they have made commitments to invest and create jobs under the current rules, pending the application of special tariffs. Besides, conditioning the tax rate on the export index may lead to uncertainty for taxpayers (tenants), who may ultimately decide to sue the FTZ or local government agency. In a worst-case scenario, even the WTO could sue Colombia.

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

Furthermore, the SPFTZ represents 50.1% of the country’s free zone exports and 6% of Colombia’s non-mining energy exports (11). Also, companies in these regions tend to invest in areas where there is usually no investment.

A 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 north of Bogotá, and many other SPFTZs are good examples of this development in the country here on the open zone map.

Nevertheless, the second effect shows that an increase in tax rate will force SPFTZ to change its business model or move its operations to other regional destinations.

Third, the VAT exemption for courier shipments to Colombia will be modified, maintaining the limit of 200 USD but clarifying that its application will depend on the origin of the imported goods and the international commitments achieved by the country. This forces companies involved in postal traffic to strictly monitor product origins and Colombia’s international commitments to avoid misapplication of special treatment, meaning more bureaucracy and affecting expected shipment timelines.

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

What does the company think about it?

José Antonio Ocampo, president of the National Association of Foreign Trade (Analdex), disputed the proposal. He believes “SPFTZ’s problem is more significant than others. Free zones were primarily created for export. Still, today 85% of what they export is produced in the domestic market and it competes unequally with companies established in national zones, which pay 35%. is”. (13)

On the other hand, Luz Stella Murgas, president of Naturgas, says that the free zones are also a cause of concern “Investments made in offshore exploration and production are significant compared to continental zones. Therefore, free zones are a mechanism that allows to increase investment in this area”. (13)

References:

  1. Act 1004 of 2005
  2. Act 105 of 1958
  3. Free trade zone system
  4. A study of legal, economic and financial implications of free zones
  5. Decree 258 March 15, 2021
  6. Changes to the Free Zone System
  7. Benefits of Free Trade Zone – EXENNTA
  8. Colombia has 21 tax reforms between 90 and 2022.
  9. Colombia: Tax Reform Project 2022
  10. Free trade zone in Colombia
  11. What is the impact of tax reform on the free zone model?
  12. DMCC has signed a historic agreement with Dhaka U-Ventures


Michel Barnier is an attorney specializing in commercial and international law. He is the Research Manager at Adrianople Group, a US business intelligence firm and focuses on companies and free trade zones as well as market research and geopolitical analysis.

Leave a Reply

Your email address will not be published.