Untitled Document

Tax accounting implications of new Colombian tax legislation

February 22, 2013

In brief

In December 2012, Colombia enacted legislation that reduced, effective January 1, 2013, the regular corporate income tax rate and introduced a new 'equality tax' (CREE is the Spanish acronym), which functions in addition to the regular income tax. The regular corporate income tax rate decreased from 33% in 2012 to 25% in 2013.  The rate for the new CREE tax was set at 9% (which is scheduled to reduce to 8% in 2016 and thereafter).

The newly enacted Colombian tax raises tax accounting questions including: where the new CREE tax expense should be reported in income (i.e., above-the-line or below-the-line), impacts of the non-deductible above-the-line component, how to appropriately determine deferred tax assets and liabilities under the CREE regime, and uncertain tax position analysis.

Organizations with operations in Colombia will need to determine the tax accounting implications of the new legislation for their financial statements that include the date of enactment or substantive enactment, which was December 26, 2012. In doing so, it is anticipated that organizations may need to remeasure deferred tax balances, reassess realizability of certain deferred tax assets, and consider the impact on their effective tax rate.

In detail

In general, the CREE taxable base equals gross revenue reduced by ordinary and necessary expenses, interest, and depreciation subject to the following: 1) the CREE taxable base cannot be reduced by current or accumulated net operating losses; 2) the super-deduction is not allowed, and 3) in no case can the CREE taxable income base be less than 3% of the taxpayer's net equity as of December 31 of the preceding taxable year. As such, the CREE tax is determined by applying 9% to a taxable income base defined as the greater of:

  1. CREE regular taxable income or
  2. 3% of net equity.

It is important to note that if the taxpayer's taxable income base is driven by 3% of net equity, unlike the historical Colombian regular income tax,  this incremental taxable base amount cannot be carried forward and used as an offset against a future period's CREE  regular taxable income.

US GAAP implications

Under US Generally Accepted Accounting Principles (US GAAP), as discussed in section 1.2.2.1 of the PwC Guide to Accounting for Income Taxes-2012 Edition, state franchise taxes based on capital are explicitly excluded from the scope of Accounting Standards Codification (ASC) 740, Income Taxes.
Certain jurisdictions impose on corporations a franchise tax that is the higher of a tax based on income or a tax based on capital.

As indicated in ASC 740-10-15-4, only the portion of the tax which is based on income and which exceeds the tax based on capital is subject to ASC 740.  
In such jurisdictions, there is the question of how ASC 740 should be applied in determining the applicable tax rate that is used to compute deferred tax assets and deferred tax liabilities for temporary differences and carryforwards. As the new statute in Colombia prescribes a single tax rate for the CREE income-based calculation, 9 percent, the tax rate is zero on the amount of taxable income for which the income-based tax calculation would equal the capital-based computation, and any additional taxable income is taxed at the 9% rate.

Illustration: Higher of an income-based or a capital-based computation

Background/facts

The CREE tax is the greater of (1) a tax based on income or (2) a tax based on equity. In this illustration, the company's equity is $200,000 each year. In year 1, pre-tax book income is $13,000 and taxable income is $16,000 due to an originating deductible temporary difference of $3,000.  The temporary difference is expected to reverse in year 2 and $15,000 is estimated taxable income for year 2.

Question

How should the CREE tax based on income be reported?
Analysis/conclusion

Based on the facts above, the current income tax provision would be calculated as follows:


Taxable income

$16,000

 

Income tax rate

9%

 

Current tax computed on income

1,440

 

Less: current tax computed  on equity

(540)

[$200,000 equity x 3% x 9%]

Current income-based tax

$900

 

 

 

 

 

In measuring the deferred tax asset and computing the deferred tax provision, an entity should base the applicable rate on the incremental expected tax rate for the year that the temporary difference is anticipated to reverse. The applicable tax rate at which the year 1 deferred tax asset would be calculated would be computed as follows:


Taxable income

$15,000

Income tax rate

9%

 

1,350

Less: equity-based tax

(540)

Incremental income tax

$810

Taxable income

รท15,000

Rate to be applied to deductible temporary difference

5.4%

As a result, the deferred tax asset for year 1 is calculated by tax-effecting the $3,000 temporary difference at 5.4%, resulting in a $162 deferred tax asset.

The journal entry to record the tax expense for the year is as follows:


Dr current income tax expense ($16,000 x 9%) less equity tax of $540

$900

 

Dr equity tax expense (included in pretax expenses)

540

 

Dr deferred tax asset ($3,000 x 5.4%)

162

 

Cr income taxes payable

 

$900

Cr equity taxes payable

 

540

Cr deferred tax expense

 

162

Another acceptable approach would be to use the applicable rate that the statute prescribes for the income-based computation. This approach is consistent with the principle that deferred taxes should represent the incremental effect that reversing temporary differences and carryforwards have on future tax amounts (ASC 740-10-10-3). If this approach is utilized, companies may need to perform additional analysis to determine whether a valuation allowance is required against the resulting deferred tax assets.

Additionally, under either approach, companies will still need to analyze each period's current tax calculation, and perform the appropriate bifurcation between the equity-based and income-based components.  In future periods, to the extent a valuation allowance is reassessed or the calculated applicable tax rate changes, there may be impacts to the effective tax rate.

As described above, the current or accumulated net operating losses may not be used to offset the CREE taxable income. As such, any associated deferred tax assets for net operating losses should be re-measured to reflect the 25% regular income tax rate.

IFRS implications

International Financial Reporting Standards (IFRS) does not provide guidance for specific tax regimes, and in particular does not consider a minimum tax based on net assets. We believe it would be acceptable to treat the equity-based minimum tax component as an operating expense, consistent with US GAAP. However, it would also be acceptable to treat the CREE tax entirely as an income tax. Management should determine an appropriate accounting policy based on the entity's circumstances and apply that policy consistently. The policy and the impact of applying it should be disclosed clearly when the amounts are material.

The takeaway

Companies should carefully analyze the tax accounting implications of this newly enacted legislation.
The changes in tax law will have both immediate and ongoing consequences for many companies.  Controls with respect to this area of financial reporting should be assessed for possible revision.

Resources to help you

Below is a recent publication that discusses the specific legislative developments that took place in Colombia.
Colombia (Substantively enacted December 26, 2012 and Enacted December 26, 2012):
http://www.publications.pwc.com/DisplayFile.aspx?Attachmentid=6335&Mailinstanceid=26554

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Let's talk

For a deeper discussion of how this issue might affect your business, please contact:

Tax Accounting Services

Ken Kuykendall,
Global & US Tax Accounting Services Leader
+1 (312) 298-2546
o.k.kuykendall@us.pwc.com

Doug Berg,
Global & US Tax Accounting Services
+1 (313) 394-6217
douglas.e.berg@us.pwc.com

Rafael Garcia,
Latin America TAS Leader
+1 (305) 375-6237
rafael.h.garcia@us.pwc.com

Marjorie Dhunjishah,
Latin America & US Tax Accounting Services
+51 (1) 211-6500
marjorie.dhunjishah@pe.pwc.com