VAT the unknown and unwelcomed guest for US companies doing business in LatAm. By Leopoldo J Martinez and Carlos Contasti*

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 ( 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 ( is an Associate of LMN Consulting, with his practice based in Caracas-Venezuela.

Achieving Tax Efficiency with cross-border services and royalties in Latin America. By Leopoldo J Martinez*

In the global economy the growth of royalties and services associated to intellectual property and information technology has become critical for international taxation.  On one-side governments of importing countries regularly source payments as territorial, based on the jurisdiction or location of payor. On the other, exporting countries push to resolve the issue through tax treaties. Unfortunately for US companies, one of their natural expansion markets is a “no-tax-treaty battleground”: Latin America (only Mexico and Venezuela have treaties with the US. A treaty with Chile is expected to be ratified by both countries soon).

Achieving Tax Efficiency with cross-border services and royalties in Latin America presents an important tax planning challenge in outbound taxation for US companies; as the corresponding inbound activity in Latin American countries is subject to high rates of income tax withholdings, and eventually, reverse VAT issues. In countries like Brazil, on top the income withholding tax issues, the scenario becomes even more complicated when the CIDE tax becomes applicable. The CIDE tax is a 10% surcharge withheld on certain services or royalties considered to be importation of technology. As such, the CIDE tax will not be creditable against US income taxes under the Internal Revenue Code, as it is not an income tax nor in lieu of income taxes.
The subject has become increasingly important, particularly in absence of tax treaties. In the US, under the Internal Revenue Code, the tax credit system might be insufficient to resolve the issue from a cash flow perspective; and, secondly, it might present some tax optimization issues as well. Thirdly, another problem could arise when the royalty or service activity is parallel to certain support services, programming or commercialization activities in the importing country. Generally the use of independent contractors could be problematic and eventually not escape potential tax liability issues, including those emerging from the notion of “engagement in a local trade or business”, in absence of a protective permanent establishment provision per a tax treaty.
Three options to consider, from a tax planning perspective are:
1.     Playing as a local with a Tax Hybrid. Reducing withholding taxation on the overseas service payments by creating a Sociedad de Responsabilidad Limitada (hereinafter referred as “SRL”), which is the equivalent of an LLC (or other eligible entity under the check-the-box regulations). This option is optimal when treaty networking becomes complex, expensive or unviable, as well when the growth is focused or concentrates in a particular country.
The SRL (or eligible entity) will become a tax hybrid, thus a disregarded entity in the US but a legal independent entity in the Latin American country. Accordingly the entity is a blocker and a conduit at the same time. As such, the parent company is protected from tax exposure or any other liability issues locally (particularly relevant when there is related marketing or support activity in the importing country), but from a tax perspective all taxes paid flow-through as direct tax credits, and all expenses as deductions, including as the latter all indirect taxes paid.
The key in this planning technique is that income tax withholdings on local payments for services or royalties are very low (or none), compared to the high rates applicable to cross border payments for the same. Additionally, the withholding tax is applicable over the gross amount paid, whereas the entity is taxed on a net basis. Most jurisdictions in Latin America do not tax dividends when declared after previously taxed profits or earnings, but this is an important issue to look country by country as a pre-condition, because it is necessary to ensure that surpluses flow back without tax implications. Thus, with proper planning, the efficiency and savings are significant.
In countries like Brazil, where strategizing becomes highly relevant not only from an income tax perspective but from a CIDE tax and indirect taxation perspective as well, there are additional options to bring efficiency. Brazilian tax law allows that any legal entity provided that its income is below the BzR$ 2.4 million threshold, to elect taxation under the simplified “presumed profits method”. One alternative to consider is to create one SRL for each contract or revenue stream from royalties or services, to meet the income threshold necessary to meet the presumed profits method election. Accordingly, in a service scenario, the presumed profits are considered to be 32% of gross revenue. With nominal tax rates in the 35%, the effective rate of taxation upon this election becomes 11,2 (compared to a 25% flat withholding rate applicable, including the 10% CIDE tax, when the payments are made directly to a foreign provider or licensor). Finally, any net profits accumulated at the local entity in Brazil can be repatriated as dividends at 0% income tax withholdings. Another advantage of the presumed profits method is that it will significantly simplify local compliance and reporting packages.
2.     Treaty Networking. Avoiding withholding taxation on Service Payments adopting a Tax Treaty Country. Another approach if significant expansion is expected in several Latin American countries is to create an IP holding incorporated or filed on a jurisdiction with a good tax treaty network.
The critical factor is to overcome the limitation of benefit provisions provided under the treaties, as well as giving substance to the IP toolbox or holding. Jurisdictions of choice for Latin America are Spain and the Netherlands.
3.     Transactional Structuring. Another alternative to avoid withholding taxation on royalties and technical assistance is by creating and selling a legal entity. This approach is relevant in a transactional planning scenario. An entity is formed in an offshore low tax and non-blacklisted jurisdiction (preferably with a tax treaty) and capitalized with a contribution in pre-paid royalties and services. Thereafter, the local client, affiliate or partner purchases the stock in the capitalized offshore entity.
A jurisdiction to consider in this planning technique is Barbados, as it is not blacklisted by the OECD and has tax treaties with a number of countries, including the United States.

* Leopoldo J Martinez 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.

Top Considerations for MNCs doing business in Latin America

The potential for US businesses in Latin America is promising in the current global crisis scenario. Indeed according to the IMF “…the Latin America and Caribbean (LAC) … is now better positioned to weather the current downturn and is expected to emerge from the financial crisis earlier than the advanced economies…”. The commodities (natural resources) international market has played well for the Latin economies over the last decade, and it is prompting a more rapid turn-around for recovery in this international crisis, as indicated by the IMF projections.

On the other hand, the business-tax climate is better today than 10 or more years ago. The fundamental reason is that most of Latin American countries are under the following framework:

a. Multilateral or bilateral Free Trade Agreements in place (i.e. Nafta, Cafta-DR, Mercosur) and number bilateral trade agreements, such as the Peru-USA and the Chile-USA (and expected ratification of the Colombia / USA Free Trade Agreement). There are a number of major trade initiatives which continue to be in negotiation like the Mercosur and the EU Free Trade Agreement.

b. Greater macroeconomic stability, which in turn has left behind the evils of tight exchange controls (Venezuela the exception), making profit repatriation and remittances generally possible without the typical complications and restrictions of over a decade ago. The trade balances from a decade of good prices for commodities obviously helped!

c. A number of free trade zones and investments platform initiatives to compete for foreign investment (e.g. Panamá, Colombia, Chile) are in place.

d. More developed and stable banks and capital markets (i.e. there is no significant bank crisis in the region despite the international and U.S crisis).

e. Lower income tax rates and regularly one level of tax at the corporate level (i.e. no taxation of dividend if from previously taxed profits at the corporate level), with a number of investment incentives per industry available.

f. VAT has turned to be the main tool for fiscal revenues, and generally indirect taxation through VAT provides a better tax scenario to the investors. In general, tax enforcement has become stronger, but professionally managed.

g. Commitment to the World Bank’s Center for the Resolution of Investment Disputes and a fairly widespread availability of international arbitration.

h. A growing tax treaty network.

In this article, we would like to focus on the structuring alternatives available for Multinational Corporations (MNCs) available in Chile, Colombia and Panamá, as indicated above:

1. Chile Platform Investment law.

The Chile Platform Investment Company (PIC) law essentially creates a favorable tax holding company regime to organize business in Latin America. A holding company organized under this law is tax-exempt of its entire dividend or other income from foreign sources. Some restrictions apply to the participation by Chilean residents and to shareholders organized in jurisdictions considered as tax-havens. Dividends paid to the non-resident shareholders of the PIC are not subject to tax withholdings. Also the foreign investor is exempted from capital gains tax upon the disposition of their shares in the PIC.

There has been much discussion on whether a Platform Investment Holding Company could benefit from Chile’s tax treaty network, which includes countries in the Americas such as Canada, México, Brazil or Argentina; and European countries like Spain, the UK, New Zealand or Denmark. The reason for this discussion is rooted in the language of the statute which expresses that the company is treated as a non-resident for the purposes of the Platform Investment Law (which is an income tax statute), thus making the outbound dividend income of the company tax-free in Chile. The authorities in Chile have said that the PIC is a resident for all purposes but for the income taxes provision contemplated in the PIC statute and they are prepared to issue Certificates stating that the PIC is an entity organized and exiting under Chile Law. Therefore, the question remains whether the other jurisdictions will object to the treaty benefits under the treaty based on a limitation of benefits provision, or any other treaty provision. However, from a Chile perspective, the authorities will consider the PIC eligible for Tax Treaty benefits.

2. Colombia Free Trade Zones.

Colombia recently passed a free zone law allowing businesses to apply for the creation of a free trade zone at their location, anywhere in the country.

Business granted Free Trade Zone status receives a VAT exemption and a reduced Income tax rate of 15%. Exports from Free Trade Zones should benefit from all trade agreements in force with Colombia, which include the Andean countries (Peru, Ecuador, and Bolivia); the G-3 which includes Mexico and Venezuela; and it must be noted that approval of the US/Colombia Free Trade Agreement is pending Congressional action in the US.

3. Panamá “Colon Free Trade Zone” and “Export Processing Zones”.

Panamá tax laws provide a set of incentives to export and re-export operations under the Colon Free Trade Zone and the Special Regime applicable to Export Processing Zones.

Located near the northern entrance of the Panama Canal, the Colon Free Zone (CFZ) offers free movement of goods and full exemption from taxation on imports and exports. The CFZ is a major factor in facilitating the supply of goods from large industrialized countries to the consumer markets in Latin America. Firms located in the CFZ are exempt from import duties as well as from guarantees, licensing and other requirements and limitations on imports. There are no taxes on the export of capital or the payment of dividends. Companies operating in the Free Zone must separate their accounting systems for their external operations from their internal operations. External operations are defined as the re-export of merchandise from CFZ warehouses and are exempt from income tax. Internal operations are those in which sales are made from CFZ warehouses to customers located within the customs territory of Panama, including those made to ships and airplanes using canal facilities, and to passengers in transit. Profits arising from internal operations are not subject to any special treatment. In general, commercial or industrial enterprises are required to obtain a license to carry on their activities in Panamá. An annual business and industrial license tax is levied at the rate of 1% on the net worth of the company concerned, which is increased by amounts owed to any parent company or head office located abroad. This license tax may not exceed US$20,000. Companies engaged exclusively in off shore or CFZ are not required to have a license. Companies established in the Colon Free Trade Zone are exempt from the obligation of filing any type of tax return for income derived from “external operations”, which is the re-export of merchandise from Colon Free Trade Zone warehouses.

The Special Incentives for Export Processing Zones (EPZ) are provided pursuant to Law Nº25 of 1992, this are basically private free zones, that allow for import and re-export operations with total exemption from duties. Among the Enterprises that can participate in the EPZ are manufacturing enterprises; assembly enterprises (“maquilas”); finished or semi-elaborated products processing enterprises; services export enterprises; general services enterprises. The main tax incentives for an EPZ are:

• The enterprises, as well as its activities, are exempt from all local direct or indirect taxes, contributions, assessments, rights, and charges. Nevertheless, there is some discussion on whether income tax exemption will be granted to those foreign enterprises whose countries permit the deduction or crediting of taxes paid in Panama.
• Duty free importation of machinery, equipment, raw materials, tools, accessories, lubricants, and all goods and services required for operation.
• Exemption from license tax.