Imagine this dialogue between the CFO and the LatAm Tax Director: ¿Did you have someone look into the income tax withholdings or Permanent Establishment issues with our LatAm advisors? … Yes but they also suggested we consider some planning for VAT! … VAT? … Yes, an unexpected visitor.
VAT is an indirect and non-accumulative tax that levies consumption of goods and services. It is imposed on the amount of value added at each stage of the production process or the supply chain, thus, an exporter of goods, a service provider or a technology company providing a license or collecting a royalty must work around VAT.
VAT is one of the most important revenue sources for LatAm governments. Therefore its compliance is strictly enforced. Accordingly, adequate VAT planning at the pre-business stage makes a difference.
Latin America countries differ from the European Union because there are no harmonized VAT rules and procedures. Each country has its own VAT system without any integration or collaboration between them. Moreover, some countries have a very complex indirect tax system, within the country. In Brazil, which is the largest economy in the region, the equivalent to VAT tax is disaggregated and distributed among its three territorial levels. Industrial products sales are taxed at the federal level (IPI); all other goods are the subject of state taxation (ICMS); and services are a matter of municipal taxation (ISS). In addition, there are significant differences in tax rates for ICMS and ISS among the cities and states. As a result, there is a regional and local war to tax transactions when the fiscal base is established in low rate state or city, but the customer is located in another place.
The lack of regional harmonization represents an important challenge for services exported into LatAm. For instance, most of the LatAm countries would tax all services rendered within their territories regardless of the place of use or enjoyment, or the customer’s location. In countries, like Venezuela, all services rendered within its territory, and services rendered from abroad (imported services), when used or enjoyed in Venezuela, are subject to VAT. Argentinean Law takes the approach of establishing that services rendered and used or enjoyed abroad are exempted from VAT. The use and enjoyment of the service approach is certainly an undetermined concept, and there are many different interpretations.
Normally, an exporter without an establishment or local presence deals with reverse VAT issues. Meaning that instead of collecting the tax from his client, the same is withheld by the client, who actually pays the tax. But other issues are relevant. In some jurisdictions it must be determined whether the transactions are a service or a royalty for intellectual property, in order to determine VAT exposure. Accordingly, contractually a license can be separated from related support services to optimize VAT exposure.
One key issue is VAT registration. In most LatAm jurisdictions it is prohibited that overseas companies register for VAT, unless they have some presence in the country, such as permanent establishment. However, in most of the countries in LatAm when a foreign entity permanently or habitually supplies goods or renders services it will be mandatory to register for VAT purposes.
There are some benefits associated with VAT registration. The potential benefits are: (i) the right to recover tax credits arising from export activities, (ii) the ability to manage VAT withholdings, and (iii) utilization of tax exemptions. Registration becomes particularly relevant when the company exporting services or goods into a VAT jurisdiction, for its commercialization or for support, is contracting with local providers charging VAT for their services, since VAT is estimated offsetting debits (VAT collected) with credits (VAT paid). Particularly relevant in LatAm –and here is a fundamental difference with the EU system– a non-domiciled company, one not registered for VAT purposes, can not file a refund of tax credit. Using this rationale, big companies tend to do business with registered companies with the objective of recovering the VAT output generated in the transactions. Also, most of the VAT regimes exempt businesses with sales below a threshold established by the law Accordingly, VAT registration could be the basis of a VAT optimization strategy. When such decision is made, then a holistic approach to dealing with VAT and Income Taxation becomes necessary.
There are some countries in LatAm that have established certain VAT withholding methods, such as Argentina, Brazil, Colombia, Mexico and Venezuela. Withholding obligations could take place when the taxpayer sells goods or renders services to the Federal, State or Municipal government or decentralized agencies, or because the transactions are made with a “special taxpayer”, normally a taxpayer with high revenues. VAT withholdings are not only a compliance problem; they represent a cash flow problem, because the final tax liability could result in a lower amount if there are VAT credits to offset the VAT debits.
VAT credits recovery is a practice in itself, whether from export activities, from inappropriate reverse VAT charges or from excess VAT paid as a result of a withholding imposed.
Finally, VAT compliance is an important issue to take into account. First, it represents an important cost. Second, non-compliance could trigger high penalties and business closures. Once more the lack of harmonization brings a complicated and entangled system. Commonly, compliance requirements such as bookkeeping, invoicing, record retention and return fillings are all treated in different ways, with some countries not accepting electronic invoicing (or requiring special approval for such practice). Electronic return filling has become popular in LatAm, but bookkeeping is especially entwined. In most of the countries there are books required by mercantile laws and specific books for VAT purposes.
VAT can certainly be an unexpected guest for U.S. companies doing business in Latin America. And without proper planning it can become a very unwelcomed guest.
* Leopoldo J Martinez (firstname.lastname@example.org) is the Principal of LMN Consulting LLC, a consulting firm specialized in tax, regulatory and compliance in Latin America, with operations in Washington DC, Dallas, Miami, Caracas, Mexico and Panama. Carlos Contasti (email@example.com) is an Associate of LMN Consulting, with his practice based in Caracas-Venezuela.