latin america

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

November 19, 2011Written by LMN ConsultingLeave a comment
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.
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* Leopoldo J Martinez (lmartinez@lmnconsultingllc.net) 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 (ccontasti@lmnconsultingllc.net) 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*

April 25, 2011Written by LMN ConsultingLeave a comment

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.

PLANNING IDEAS FOR MULTILATINAS | By Leopoldo J Martinez*

December 13, 2010Written by LMN ConsultingLeave a comment

In the current context not only business become global, but families are global as well. This has become more frequent in Latin America. As a result, we find more closely held, family-controlled business, exposed to the need of sophisticated international tax and estate planning. On the other hand, the recent positive economic trend in Latin America has originated the emergence of the multinational Latin American companies (or Multilatinas), which more often than usual in other environments, are closely held rather than publicly traded corporations.

The main issues are not only to achieve tax efficiency for the company, but looking into structures efficient from the shareholders perspective as well; and in doing the same, protect assets from multijurisdictional estate taxation issues, while creating a reliable holding or control structure, which includes, avoiding black listed jurisdictions that normally present not only tax issues but also financial compliance challenges.
Considering this background, there are two important tools or vehicles for planning. The “Fundacion de Interes Privado” or Private Interest Foundation (PIF) in Panama, and the Barbados International Business Holding Company (Barbados IBC or IBC).
The Panama Private Interest Foundation: an alternative the Trust with legal efficiency in both common law and civil law jurisdictions.
The PIF was introduced by Panama Law 25 of 6/12/1995. It works the same as a German or Liechtenstein “Stiftung”, but in the heart of Latin America. With PIF a family can set aside certain business assets or other property at an independent legal structure, with the sole purpose of protecting such assets and establish specific dispositions favoring beneficiaries upon the death of the organizers or any other events. Although the PIF is not a commercial vehicle or holding company, it might be expected to receive dividends or other passive income from its endowment assets. In such event, for non-Panama beneficiaries or for income from sources without Panama, there are fantastic benefits derived from the Panamanian territorial income tax system. In addition, Law 25 specifically overrides inheritance laws of any other country, including those of Panama. The structure could achieve maximum international estate efficiency if the beneficiaries are other entities domiciled in Panama, or in any other jurisdiction without estate taxes as well, or if the assets to be transferred do not have “situs” in a jurisdiction presenting estate taxation issues for non-residents. On the other hand, Panama continues its crusade to be excluded from the OECD blacklist by entering tax treaties with countries, which are member to such organization.
Finally the PIF assets or endowment is not subject to legal actions (i.e. attachments or other measures) from related entities or the organizers, and most importantly, the legal entity is normally characterized both as a “Trust” from the USA tax law perspective; and as an independent and autonomous legal entity, from a non common law jurisdiction perspective. This dual or hybrid characterization resolves the many issues presented by trusts in the Latin American context, where such arrangements are not recognized and pose several questions for a tax perspective, more specifically when assets are held by non-financial institutions or private trustees or not recognized as “Fideicomisos” under local law.
Confidentiality is a relevant feature of the PIF, as panama law permits the organization of the Foundation with a Basic publicly registered deed, deferring relevant provisions to a privately executed deed or “Reglamento”.
Treaty networking with Barbados International Business Companies
The Barbados IBC presents a significant set of advantages.  Barbados is not a blacklisted jurisdiction, although it presents low taxation for the IBC. Barbados has important Tax Treaties network, as shown below. Therefore, the jurisdiction presents an excellent choice for the tax planning of global business ventures or businesses held by global families, as it has every measure necessary to manage the holdings: efficient or low income taxes, no estate tax, and every measure to prevent double taxation with major jurisdictions, including the following tax treaties:
TAX TRETIES TO AVOID DOBLE TAXATION IN FORCE IN BARABADOS
Country
Date of Signature
March 26, 1970
January 22, 1980
December 31, 1984
December 18, 1991
July 14, 2004
Finland
June 15, 1989
November 15, 1990
July 01, 1991
Agreement extended to Barbados by virtue of Agreement between Switzerland and the U.K., 1954
July 06, 1994
December 11, 1998
June 17, 1999
May 15, 2000
February 10, 2010
December 5, 2001
September 28, 2004
February 25, 2005
February 27, 2006
November 28, 2006
Republic of Seychelles
October 19, 2007
April 7th, 2008
Republic of Ghana*
April 22, 2008
December 1, 2009
June 21, 2010
In addition, discussions between Barbadian and Japanese officials over the possibility of a tax agreement took place in August 2006. Barbados has also advanced treaty negotiations with Italy, Spain and Vietnam. Discussions are continuing towards finalization of similar conventions with other nations, including Belgium, Brazil, Chile, Czech Republic, Iceland and India.
One relevant consideration for this article relates to the fact of the Treaty with Panama, which places the use of a Barbados IBC, controlled by a PIF in optimal tax efficiency. Also, when looking downstream in the potential holdings of the IBC, treaty networking could be achieved with most relevant European jurisdictions, as well as the United States or Mexico, nations where most Latin American global families or global business, including “Multilatinas”, have significant operations or exposure. The list also includes countries where asset protection strategies are critical, such as Venezuela, with whom the Government of Barbados has a Treaty for the Reciprocal Protection of Investments as well. The prospects of treaties with Brazil and Chile are promising for organizing regional business operations, and in the case of Brazil, it offers an efficient option that escapes the negative implications of domicile at blacklisted jurisdictions according to Brazilian income tax laws and transfer pricing regulations. Finally as a member for the CARICOM (the Caribbean free trade initiative), the Barbados IBC might offer an excellent platform for tax and trade treaty networking in the Caribbean.
Under Barbados law an IBC is a company that carries on the business of international manufacturing or international trade and commerce from within Barbados. International manufacturing is the business of making, processing, preparing or packaging within Barbados, any product that is exclusively for export. International trade and commerce includes any of the following activities, that is to say:
a. The business of being a broker, agent, dealer, seller, buyer or factor within Barbados of goods existing outside Barbados or of goods to be trans-shipped through or from Barbados.
b.             The business of the selling of services which, if originating in Barbados, are to or for, or on account of, persons resident outside Barbados.
A company will be granted an IBC License if:
a. It is resident in Barbados; and
b. It satisfies the Minister of International Business (by furnishing the requisite information) that it is financially capable of carrying on the business of international manufacturing or international trade and commerce.
Tax Regime of the Barbados IBC
IBC’s are subject to tax on all profits and gains based on the following scale:
2.5% on the first US$5,000,000.00;
2% on the next US$5,000,000.00;
1.5% on the next US$5,000,000.00; and
1% on the excess above US$15,000,000.00
No income tax is payable on dividends, royalties, interest, fees or management fees paid or deemed to be paid by an IBC to a company carrying on an international business or to a person resident outside Barbados.
An IBC is not obliged to withhold any portion of the dividends, royalties, interest, fees or management fees or other income paid or deemed to be paid by to a company carrying on an international business or to a person resident outside Barbados.
No tax, duty or other impost is leviable on an IBC, its shareholders or transferees in respect of any transfer of any securities or assets, other than a transfer of taxable assets, to another IBC or to a person resident outside Barbados.
Taxable assets are real estate situated in Barbados and held by or on the behalf of an IBC; as well as office equipment, supplies, furnishings and fixtures, machinery, vehicles and equipment used in Barbados in carrying on the business and affairs of the IBC.
An IBC may import free of customs duty, consumption tax, ad valorem stamp duty and other like duties, taxes and imposts, such plant, machinery, equipment, fixtures, appliances, apparatus, tools and spare parts, and such raw materials, goods, components and articles, as is necessary for the company to carry on its international business.
Where an IBC requires the services of specially qualified individuals in order to carry out its business effectively from within Barbados and
(a)           it is unable to acquire those services from within the CARICOM Region; and
(b)           it is unable to retain those services from outside Barbados without special tax concessions;
The Minister of Finance may authorise that a prescribed percentage of the salary of the specially qualified person (who is not a resident of a CARICOM country):
(a)           be exempt from income or other tax in Barbados,
(b)           be paid in a foreign currency in a trust account without being liable to income tax in Barbados as to the amount paid or any interest earned thereon, or
(c)            be paid in some other prescribed manner in another currency or otherwise without being liable to income tax in Barbados.
No person shall disclose any information relating to any application of a prospective IBC or to the affairs of an IBC, other than so far as such information forms part of the public record kept by the Registrar of Corporate Affairs, except when authorised by the prospective IBC or the IBC to do so, or when lawfully required to do so by order of a court of competent jurisdiction.  There are no currency exchange control restrictions in respect of the international business carried on by an IBC. An IBC must file annual audited financial statements with the Minister of Finance, and the annual renewal of the IBC Licence is contingent upon the said filing. You will therefore need to appoint local auditors for this purpose.
Conclusion
Global Latin American closely held businesses, Multilatinas’ shareholders or Global Latin American Families can benefit from efficient income and estate tax planning strategies by structuring a holding IBC in Barbados, controlled by a PIF in Panama.
* Leopoldo J Martinez is the Managing Partner of LMN CONSULTING LLC, an international strategic and tax planning specializing in the Latin American market place, with affiliates in Washington DC, Dallas, Miami, Mexico, Panama and Caracas.