Colombian banks will be among corporates bearing the brunt of the new tax reform, recently submitted by President Iván Duque’s government in an attempt to close the country’s fiscal gap.
On July 20, the government sent a revamped tax bill to Congress, after a botched first attempt faced massive repudiation and sparked violent protests. Corporations, and lenders in particular, will now bear the greatest burden of tax collection, as corporate tax could be raised to 35% from 31%.
The tax reform would make Colombia’s corporate tax the highest in Latin America, according to a report by KPMG. Brazil and Venezuela currently hold the highest rate at 34%, well above the region’s average of 27.2% in 2021.
If the reform is ratified, banks could face net income losses of as much as 5% in 2022, according to Credicorp Capital’s Sebastian Gallego, a bank expert who focuses on Andean lenders.
“There is a very high likelihood that this reform will pass,” he said. “The subject of tax collection has changed completely.”
In April, the first tax reform proposal aimed to raise 2% of GDP by expanding the base for taxes such as VAT. The strong backlash from wide sectors of Colombian society forced the government to quickly withdraw the proposal.
With a new finance minister, the government is now testing the waters again. The shift in the reform’s focus, away from individuals and now placed on companies, gives it firmer political grounding and hence a greater chance of passing, according to analysts.
The updated proposal’s target of 1.2% of GDP in revenues represents a milder approach from its previous effort. The government aims to collect about 45% of the 15.2 billion Colombian pesos it expects to raise from the increases in corporate taxes. A second major driver would stem from reduced deductions that companies can be afforded under the Industry and Commerce Tax, known as ICA.
The impact on banks
On top of these changes, banks in Colombia will face an extended surcharge of 3% on income until 2025. Previously, lenders expected this differentiated rate to expire in 2023.
Credicorp’s Gallego estimates that as much as 400 million Colombian pesos will be generated from the extended surcharge. The government needs the funding to improve its financial position as well as to fund social expenditures amid a rise in poverty during the pandemic.
“There will be a greater contribution from the financial system in Colombia,” Munir Jalil, chief economist and executive director with investment bank BTG Pactual said. “Initially, the surcharge had an expiration date, but banks have accepted these new rules and showed no opposition to the extension.”
The effective tax rate could be lower, analysts say, because Colombian lenders have exposure to other counties in Latin America, and some of their lending assets enable them to be eligible for tax cuts. “It is a negative point for the sector,” Gallego said. “But banks usually tend to have a lower tax rate and they can definitely live with this. They could have an impact of between 4 [%] and 5% of profits by 2022.”
Market Intelligence data shows that the effective tax rate that banks paid in 2020 varied considerably. BBVA Colombia had the highest rate at 34.1%, followed by Grupo Aval, whose rate stood at 28.5%. Other institutions such as Banco GNB or Banco Davivienda paid lower effective rates, of 22.9% and 14.3% respectively. Bancolombia SA was the outlier, with a negative effective tax rate, due to an income tax cumulative recovery for the year of 6.6 billion Colombian pesos, as well as other tax deductions and reductions.
But with the new reform, the expectation is that the effective rate will increase.
A fragile economic recovery
For economists, the approval of some kind of reform is vital for the country to regain foreign investor interest. Following the failed passage of the initial tax reform, rating agencies downgraded Colombian debt to junk territory, stripping the country of its decade-long held investment-grade tatus.
According to Fitch Ratings, the withdrawal of the first version of the tax reform was “an important factor” in Colombia’s credit rating downgrade. In a recent note, it argued that “the revised reform is likely to pass.”
However, it warned that “the president’s low approval rating, upcoming congressional and presidential elections in the first half of 2022, and a possible resumption of anti-government protests could threaten the reform or lead to more watering down.”
The economy has felt the effects of the wave of strikes and protests that started in April, with monthly GDP dropping nearly 6% in May, according to official figures.
A frail economic recovery in the last two months and lingering unemployment still signal risks for banks’ loan portfolios. But with the vaccination campaign gaining momentum, some expect GDP to bounce back again as restrictions are lifted.
“In July there was a strong reactivation,” BTG’s Jalil said. “When you let the economy be, it simply grows.”
According to Credicorp’s Gallego, the decision to raise taxes could have an effect on bank rates, which would be detrimental for the general outlook for credit.
Even so, Gallego is hopeful that the decision should contribute to improving longer-term prospects for the economy.
“Without the reform, the fiscal spiral would be even worse and it would bring more problems from the investment point of view,” he said. “We see it as a positive step that closes the social [unrest] chapter that we have had so far.”
