In 2021, venture capital investment will reach a record US$15.7 billion in Latin America, more than the amount attracted by startups in the region over the past ten years, according to the Latin American Private Equity Investment Association (LAVCA).
In the local environment, Colombia today has 1,100 startups and its entrepreneurial ecosystem is one of the four most competitive in the region, together with Brazil, Mexico, and Argentina.
According to KPMG’s Colombia Tech Report 2021, the country’s startups raised more than US$800 million last year. Sadly, the promising future for these companies is about to change forever.
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.
The tax reform bill presented contains rules that directly impact both tech-based ventures whose development is based on growth and exit strategy (highly scalable startups backed by venture capital) and those whose nature or objective is not the medium-term sale of the company but rather profit through dividends (more “traditional” ventures).
The startup business works very differently from traditional companies, so these valuations often do not reflect the company’s actual value. For example, a company valued at US$500 million does not have that kind of money in equity. Venture capitalists consider “intangible assets” and not the company’s money.
How will this affect the industry?
Although the equity tax already existed (for those who owned as of January 1 of each year, a net worth equal to or greater than 5 billion Colombian pesos), with the new reform, both the taxable base and how the shares owned in a company are valued are modified. Previously the nominal value (acquisition value) was taken – and now the intrinsic value (net worth divided by the number of shares outstanding) is proposed.
This new form of valuation seeks to reflect the equity reality of the shareholders of those consolidated companies, i.e., the source of income and considerable profits that take into account the contributive capacity, an objective that was not achieved with the previous rule.
The tax reform aims to increase the occasional profit tax, which is currently at a rate of 10% to 15%. Does the government want to discourage money, a product of several years of hard work in entrepreneurship, brought back to Colombia to continue generating development by investing in new startups or donating it to social causes?
Elimination of the 50% discount on the Industry and Commerce Tax – ICA.
Article 115 of the ETN contemplates the possibility, at the entrepreneur’s choice, of: i) taking 50% of the industry and commerce tax (ICA) as a tax discount or ii) a 100% deduction of the ICA in the income tax.
The reform bill eliminates this benefit and leaves only the possibility of taking it as a 100% income tax deduction. The difference is that the discount is applied directly to the tax already paid, while the deduction is part of the subtracted items to determine the tax.
The impact will depend on each case, but as a general rule, a 50% discount is more beneficial than a 100% deduction of the ICA tax.
This modification would imply a higher tax burden for ventures that are in the commercial, industrial, or service businesses, meaning that e-commerce entrepreneurs will now have to pay more income tax because of this change.
Elimination of the orange economy benefit
Before this reform, entrepreneurs from creative industries who won the orange economy benefit were allowed to pay 0% income tax for 5 years. But now, this would not be possible.
According to the principle of non-retroactivity of taxation provided in article 363 of the Colombian Constitution, those ventures that benefited from the exempt income programs of the orange economy program provided in article 235-2 of the ETN continue to maintain 100% of the exempt income for the years granted. However, unfortunately, the benefit would be lost for entrepreneurs who would like to access it in the future.
35% income tax rate for large and small businesses alike.
Although the reform would not modify the income tax rate for legal entities and maintains it at 35%, it does not provide special treatment or rates for startups.
While it is true that during the early years, startups do not yield profits, precisely because all their income and capital are destined for the growth of the company, it can happen, and taxing a startup with an income tax at a rate of 35% is to leave the entrepreneur without any incentive.
The reform aims to increase the payment rate for dividend distributions, which are currently subject to 10% and could reach up to 39%. For non-residents (individuals and corporations), a withholding tax of 20% will be applied.
What do companies think about it?
Faced with this “reform,” Endeavor entrepreneurs launched a counter proposal before the tax reform project in Colombia. They propose an exception so that the value of the shares revolves around the fiscal cost, not the intrinsic value.
Daniel Botero Acevedo, co-founder, and CEO of Lizit, said that the tax reform would virtually wipe out the ecosystem of startups or fast-growing digital ventures in Colombia.
In conclusion, the National Government must understand the entrepreneurial ecosystem and establish differentiated and progressive tax rules and combined tariffs that allow them to be competitive with their peers in other countries.
Michelle Bernier is an attorney specializing in international law and commercial law. She is currently studying Master of Laws and International Business with a double degree from the Universidad Internacional Iberoamericana in Mexico and the Universidad Europea del Atlántico. She is also a part of Students for Liberty’s inaugural cohort of Fellowship for Freedom in India.
