Colombia’s New Dividend Policy Raises Taxes on Investors
Countries around the world have different methods of taxing dividends and several have integrated their business and individual income tax systems with a credit imputation. This type of system minimizes the double taxation 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 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 withholding 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.
 In Colombian legislation tax brackets 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 inflation and the consumer price index. For the year 2019, 1 UVT is valued at 34,270.00 Colombian pesos, approximately $11.
Source: Tax Policy – Colombia’s New Dividend Policy Raises Taxes on Investors
State Individual Income Tax Rates and Brackets for 2019
Individual income taxes are a major source of state government revenue, accounting for 37 percent of state tax collections.
Forty-three states levy individual income taxes. Forty-one tax wage and salary income, while two states–New Hampshire and Tennessee–exclusively tax dividend and interest income. Seven states levy no income tax at all.
Of those states taxing wages, nine have single-rate tax structures, with one rate applying to all taxable income. Conversely, 32 states levy graduated-rate income taxes, with the number of brackets varying widely by state. Hawaii has 12 brackets, the most in the country.
States’ approaches to income taxes vary in other details as well. Some states double their single-bracket widths for married filers to avoid the “marriage penalty.” Some states index tax brackets, exemptions, and deductions for inflation; many others do not. Some states tie their standard deductions and personal exemptions to the federal tax code, while others set their own or offer none at all.
Individual income taxes are a major source of state government revenue, accounting for 37 percent of state tax collections. Their prominence in public policy considerations is further enhanced by the fact that individuals are actively responsible for filing their income taxes, in contrast to the indirect payment of sales and excise taxes.
Forty-three states levy individual income taxes. Forty-one tax wage and salary income, while two states–New Hampshire and Tennessee–exclusively tax dividend and interest income. Seven states levy no income tax at all. Tennessee is currently phasing out its Hall Tax (income tax applied only to dividends and interest income) and is scheduled to repeal its income tax entirely for tax years beginning January 1, 2021.
Of those states taxing wages, nine have single-rate tax structures, with one rate applying to all taxable income. Conversely, 32 states levy graduated-rate income taxes, with the number of brackets varying widely by state. Kansas, for example, imposes a three-bracket income tax system. At the other end of the spectrum, Hawaii has 12 brackets, and California has 10. Top marginal rates range from North Dakota’s 2.9 percent to California’s 13.3 percent.
In some states, a large number of brackets are clustered within a narrow income band; Georgia’s taxpayers reach the state’s sixth and highest bracket at $7,000 in annual income. In the District of Columbia, the top rate kicks in at $1 million, as it does in California (when the state’s “millionaire’s tax” surcharge is included). New York and New Jersey’s top rates kick in at even higher levels of marginal income: $1,077,550 and $5 million, respectively.
States’ approaches to income taxes vary in other details as well. Some states double their single-bracket widths for married filers to avoid the “marriage penalty.” Some states index tax brackets, exemptions, and deductions for inflation; many others do not. Some states tie their standard deductions and personal exemptions to the federal tax code, while others set their own or offer none at all. In the following table, we provide the most up-to-date data available on state individual income tax rates, brackets, standard deductions, and personal exemptions for both single and joint filers.
The 2017 federal tax reform law increased the standard deduction (set at $12,200 for single filers and $24,400 for joint filers in 2019), while suspending the personal exemption by reducing it to $0 through 2025. Because many states use the federal tax code as the starting point for their own standard deduction and personal exemption calculations, some states that are coupled to the federal tax code updated their conformity statutes in 2018 to either adopt federal changes or retain their previous deduction and exemption amounts.
Notable Individual Income Tax Changes in 2019
Several states changed key features of their individual income tax codes between 2018 and 2019. These changes include the following:
- As part of a broader tax reform package, Kentucky replaced its six-bracket graduated-rate income tax, which had a top rate of 6 percent, with a 5 percent single-rate tax.
- New Jersey created a new top rate of 10.75 percent for marginal income $5 million and above.
- In adopting legislation to conform to changes in the federal tax code, Vermont eliminated its top individual income tax bracket and reduced the remaining marginal rates by 0.2 percentage points across the board.
- Iowa adopted comprehensive tax reform legislation with tax changes that phase in over time. For tax year 2019, income tax rates are reduced across the board, and in 2023, subject to revenue triggers, nine brackets will be consolidated into four, with the top rate reduced to 6.5 percent.
- Idaho adopted conformity and tax reform legislation that included a 0.475 percentage point across-the-board income tax rate reduction.
- Missouri eliminated one of its income tax brackets and reduced the top rate from 5.9 to 5.4 percent as part of a broader conformity and tax reform effort.
- Utah reduced its single-rate individual income tax from 5 to 4.95 percent.
- Arkansas is unique among states in that it has three entirely different rate schedules depending on a taxpayer’s total taxable income. In 2018, Arkansas adopted low-income tax relief legislation that reduced marginal rates in the lowest-income schedule, as well as the lowest rate in the next income schedule.
- Georgia reduced its top marginal individual income tax rate from 6 to 5.75 percent as part of a conformity measure, but this provision is set to expire at the end of 2025 when income tax changes are scheduled to sunset at the federal level.
- North Carolina’s flat income tax was reduced from 5.499 to 5.25 percent.
 U.S. Census Bureau, “State & Local Government Finance,” Fiscal Year 2016, https://www.census.gov/data/datasets/2016/econ/local/public-use-datasets.html.
 Tennessee Department of Revenue, “Hall Income Tax Notice,” May 2017. https://www.tn.gov/content/dam/tn/revenue/documents/notices/income/income17-09.pdf.
 Morgan Scarboro, “Kentucky Legislature Overrides Governor’s Veto to Pass Tax Reform Package,” Tax Foundation, April 16, 2018, https://taxfoundation.org/kentucky-tax-reform-package/.
 Ben Strachman and Scott Drenkard, “Business and Individual Taxpayers See No Reprieve in New Jersey Tax Package,” Tax Foundation, July 3, 2018, https://taxfoundation.org/individual-income-tax-corporate-tax-hike-new-jersey/.
 Jared Walczak, “Toward a State of Conformity: State Tax Codes a Year After Federal Tax Reform,” Tax Foundation, Jan. 28, 2019, https://taxfoundation.org/state-conformity-one-year-after-tcja/.
 Jared Walczak, “What’s in the Iowa Tax Reform Package,” Tax Foundation, May 9, 2018, https://taxfoundation.org/whats-iowa-tax-reform-package/.
 Katherine Loughead, “Five States Accomplish Meaningful Tax Reform in the Wake of the Tax Cuts and Jobs Act,” Tax Foundation, July 23, 2018, https://taxfoundation.org/five-states-accomplish-meaningful-tax-reform-wake-tax-cuts-jobs-act/.
 Jared Walczak, “Toward a State of Conformity: State Tax Codes a Year After Federal Tax Reform.”
 Nicole Kaeding, “Tax Cuts Signed in Arkansas,” Tax Foundation, Feb. 2, 2017, https://taxfoundation.org/tax-cuts-signed-arkansas/.
 Jared Walczak, “Tax Changes Taking Effect January 1, 2019,” Tax Foundation, Dec. 27, 2018, https://taxfoundation.org/state-tax-changes-january-2019/.
Source: Tax Policy – State Individual Income Tax Rates and Brackets for 2019
IRS’s Dirty Dozen scams — 2019 edition
The IRS highlighted the 12 abusive tax schemes it wants taxpayers and tax practitioners to be on the alert for this year. Phishing and scam phone calls were the biggest repeat offenders.
Source: IRS Tax News – IRS’s Dirty Dozen scams — 2019 edition
Tax Competition of a Different Flavor at the OECD
Last week the Organisation for Economic Co-operation and Development (OECD) hosted a public consultation on several proposals to rearrange international tax rules. The policies up for discussion include three separate approaches to reallocate taxing rights among countries and two proposals to institute a minimum level of taxation for multinational corporations. In the context of the Base Erosion and Profit Shifting (BEPS) Project Action 1, the OECD has categorized the separate proposals as Pillar 1 (rearranging of taxing rights) and Pillar 2 (minimum tax approach) policies.
The Pillar 1 proposals include a rearranging of taxing rights based on:
- Profits derived from user contributions in a market country
- Profits attributable to marketing intangibles investments
- Allocation of taxing rights using a formula including sales, assets, employees, and potentially users
The Pillar 2 proposals include stronger base erosion protections including:
- A global minimum tax approach like the U.S. Global Intangible Low Tax Income (GILTI)
- A tax on base eroding payments like the U.S. Base Erosion Anti-Abuse Tax (BEAT)
The public consultation provided a forum for stakeholders to provide their views on these proposals. Respondents included tax professionals, business leaders, and civil society organizations. The Tax Foundation participated in the consultation and had previously submitted a written response to the OECD consultation.
Several key themes arose during the discussion including concerns over the potential complexity of implementing the proposals, a desire for evaluation of recent changes to international tax rules prior to adoption of new approaches, a warning to avoid creating double taxation scenarios, and a willingness to work toward a pragmatic solution.
The potential complexity could arise from several standpoints. The reallocation of taxing rights would create new tax liabilities for businesses in jurisdictions where they currently do not pay tax for one reason or another. When those liabilities arise, businesses may face challenges in filing tax returns or understanding why a withholding tax applies in a particular jurisdiction.
Respondents noted that complexity could also come from new rules being layered on top of current international tax rules without reconciling differences between the two. Conflicts over the application of current transfer pricing rules (which guide the taxation of cross-border transactions within companies) could be exacerbated if the uncertainties of transfer pricing valuations are relied upon in calculating which country taxes what share of a business’s profits.
Current international tax rules and their intersection with double tax treaties are by no means simple. Any proposal to change international tax rights should take this complexity into account.
One respondent specifically identified ways that current rules create challenges for customs authorities and that shifting to a new set of rules could create challenges not only in tax administration, but also for customs and trade authorities.
There was also discussion of how the OECD might create safe harbors either for countries or for businesses to allow them alternatives for simpler compliance or administration of the new rules. Those simplifications could, potentially, provide businesses with more tax certainty than they currently have.
Several respondents also pointed out that the U.S. GILTI and BEAT policies have created significant compliance and tax burdens and may not be the best models for the OECD to follow. Concerns were raised that these policies may not fit well with current tax rules and could create very complex tax outcomes for some industries.
Evaluation Before Implementation
Several respondents noted that countries have only recently been implementing proposals resulting from the BEPS project. These include tougher transfer pricing regulations, patent box nexus rules, controlled foreign corporation rules, and country-by-country reporting. Respondents at the consultation noted that the effectiveness of these recently adopted policies should be evaluated prior to the OECD work on new policies to minimize base erosion.
This is an important issue for the OECD to consider. The current push for rearranging international tax rules has loosely defined objectives, and it is possible that the current policies on the books meet those objectives. However, it is still too early to measure the effectiveness of these policies on profit shifting.
Respondents including the Tax Foundation noted the importance of not only understanding the state of policy as it stands right now, but also the importance for the OECD to be measuring how various Pillar 1 and Pillar 2 policies could impact revenues and business activity.
Don’t Tax Us Twice
Another key theme from the consultation was the potential for double taxation of the same income under various scenarios. Multiple respondents focused on how Pillar 2 options could create likely scenarios for several layers of tax on the same income.
One respondent walked the audience through a scenario where a company with offices in four countries could face five different layers of tax due to the interaction of various BEPS and Pillar 2 policies. Multiple layers of tax on the same income create both administrative and economic burdens as the tax paid may not align with profits generated in one jurisdiction over another.
The OECD was encouraged to study the potential for double taxation and to allow for dispute prevention between taxing jurisdictions so that companies could avoid having income taxed by more than one tax authority at a time.
Some respondents provided comments admitting that they were willing to be pragmatic in working toward a solution. However, as one respondent noted, a pragmatic solution without principle might result in an unstable agreement. The OECD should therefore focus on adopting new proposals that align with shared principles and an agreed-upon rationale.
The pragmatism was also evidenced in the suggestion of a formulaic approach to rearranging taxing rights. A formula approach based on some measurable metric like sales in a jurisdiction could simplify both tax compliance and tax administration. Unfortunately, at this stage there is not enough detail in either the OECD approaches or the suggested formulas to determine the effects of any of the approaches.
The public consultation resulted in general agreement that something needs to change in the international tax rules, but also that there could be significant challenges to implementing that change. As Tax Foundation reminded the audience during the consultation, it is important to recognize that businesses are central to tax collection systems and the importance of having a discussion that is informed by the facts.
The OECD will continue to review the comments that have been received and is expected to publish a work plan in early summer. The OECD has a goal of reaching an agreement on a new policy in 2020. Tax Foundation will continue to monitor the OECD’s work on these proposals and will follow up with further analysis.
Daniel Bunn discusses the need to look at how each policy impacts the cost of capital and incentives to invest as well as overall tax complexity. Click the image above to watch.
Scott Hodge emphasizes that corporate income taxes impact workers and consumers as well as businesses. Click the image above to watch.
Source: Tax Policy – Tax Competition of a Different Flavor at the OECD
Increasing Individual Income Tax Rates Would Impact a Majority of U.S. Businesses
Most U.S. businesses are not subject to the corporate income tax. Instead, most U.S. businesses are pass-through businesses, such as partnerships, S corporations, LLCs, and sole proprietorships. These businesses “pass” their income “through” to their owners, which is reported on the owners’ individual income tax returns. Overall, pass-through businesses account for more net income than corporations, meaning an increase in individual income tax rates will impact a majority of U.S. businesses.
Pass-through businesses represent the ideal tax treatment of a business form. Unlike C corporations, pass-throughs are only subject to one layer of tax, the proper tax structure. Over time, the size of the pass-through sector has increased. Since the 1980s, the number of corporations has decreased from a high of almost 2.6 million in 1986 to about 1.6 million in 2013. On the other hand, the number of sole proprietorships has increased from about 9 million in 1980 to more than 24 million in 2013. The number of S corporations and partnerships increased from 2 million to almost 8 million over the same period.
This growth in pass-through businesses relative to C corporations means more net business income is reported on individual income tax returns than on traditional C corporation returns. Aside from a brief period in the mid-2000s when corporate income spiked at the top of a business cycle, noncorporate business income has consistently exceeded corporate income since 1997.
Pass-through business income is concentrated among high-income taxpayers. In 2016, more than 45 percent of pass-through business income was earned by taxpayers making more than $500,000 annually. Specifically, taxpayers making more than $1 million accounted for nearly a third of pass-through income.
This data shows that a large amount of business income is hit by the high marginal individual income tax rates. As a pass-through business earns more income, higher marginal rates gradually take more out of each dollar. Under the Tax Cuts and Jobs Act, individual income tax rates take 37 cents of every dollar of income earned in the top tax bracket, though this rate is reduced for some qualifying pass-through businesses by the TCJA’s Section 199A provisions which allow qualifying taxpayers to deduct 20 percent of their pass-through business income from federal income tax.
Progressive marginal rates can discourage pass-through business owners from conducting business activities that would increase their income—such as investing in new capital, hiring workers, and producing goods for consumers.
When we think about who is subject to the individual income tax, this data shows us that a significant burden is borne by businesses. Changes to the individual income tax, especially to top marginal rates, can affect a business’s incentives to invest, hire, and produce.
Source: Tax Policy – Increasing Individual Income Tax Rates Would Impact a Majority of U.S. Businesses
Easing the Kentucky Combined Reporting Transition
Last year, Kentucky adopted a major tax overhaul: it dropped its income and corporate taxes by a point, removed numerous credits and carveouts from the income and sales taxes, reduced the archaic inventory tax, and adopted single-sales factor apportionment and combined reporting for business taxes. Altogether, the package (enacted over Governor Bevin’s veto) raised some $395 million in annual revenue, to address the state’s crushing public employee pension shortfall.
Combined reporting, effective in Kentucky as of January 1, 2019, requires all corporations within one business group file a consolidated return for their activities in the state. It is distinct from separate reporting, a filing method where each subsidiary files its taxes as a distinct entity. Proponents of combined reporting say without it, multistate corporations will artificially move income between subsidiaries in different states to reduce tax liability. Opponents say defining the unitary group and calculating income is more complex than it’s worth, that subsidiaries exist for legitimate business reasons and punishing every company for a few bad actors harms the economy as a whole, and that combined reporting results in arbitrary assignment of income to different states (the thing it supposedly combats).
Counting Kentucky, 26 states and D.C. currently use combined reporting as the default filing method, and it is a hot topic in state corporate tax policy. This isn’t Kentucky’s first foray into changing business filing defaults, with the General Assembly permitting voluntary combined reporting from the 1990s until 2005, then prohibiting combined reporting from 2005 until this new law requiring it. (Confusingly, Kentucky’s Court of Appeals ruled on January 4 that this was the case even though the Department of Revenue was directing corporations to file on a combined basis at the time.) Everyone’s playing catch-up to the new default, and many in the business community want to repeal combined reporting outright or make it voluntary only.
Setting the merits of combined reporting aside, there is something Kentucky could consider to ease the one-time transition costs. A sudden switch of tax regimes benefits some companies and negatively impacts others. A third category is businesses that are not negatively harmed on an ongoing basis, but must revalue their assets as a result of either a reduced value of tax loss carryforwards or other change in assets or liabilities. Under current accounting rules, those “asset” write-downs must be taken quickly and reported on financial statements, harming a company’s valuation even if the tax change boosts profits going forward.
Other states like Connecticut, Massachusetts, and New Jersey have turned to the ASC 740 deduction as a clever fix for this problem. The state creates a narrow and limited deduction in the amount of any asset write-down as a result of the tax regime change, with only publicly traded companies that have to produce public financial statements eligible. Companies have to apply for the deduction by a given date not long after combined reporting is adopted, although the state need not pay out the deduction for years. (Connecticut in 2015 passed a law to pay out the ASC 740 deduction for seven years beginning in 2018 but later amended it to pay it out over 30 years beginning in 2021; Massachusetts was originally seven years starting in 2012 but is now 30 years starting in 2021; D.C. has put theirs off until 2020; and New Jersey until 2023.) In fact, the state can choose to keep extending when it will pay out the deduction, since what matters to the company is not the money but the deferred tax asset it can put on its books to offset the liability. The date and eligibility restrictions prevent it from being abused for unintended purposes.
Hopefully one day accounting and tax can be harmonized to the point where profitable companies aren’t punished because of the decline in value of their tax “assets” because of lower and simpler taxes. A big step was the 2017 federal tax law allowing companies to expense purchases of new equipment immediately rather than depreciating them for tax purposes over many years, removing a tax accounting rule that was disconnected from real-world cash flows, punished investment, and artificially rewarded borrowing. In the meantime, states adopting combined reporting can reduce the shock to balance sheets of that change with tools like the ASC 740 deduction.
Source: Tax Policy – Easing the Kentucky Combined Reporting Transition