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 (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.
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