After several difficult years, Latin America seems well-positioned to close 2004 with a healthy growth rate of 4%, its best performance since 1997. Thanks to inflation-targeting policies, inflation is under check in most countries, Venezuela being the noted exception. Growth is strong in the major markets and Argentina and Venezuela have steadily rebounded from their latest crashes.
The recent spurt of growth can be attributed primarily to soaring sales prices of the raw materials plentiful in the region (soy beans, copper, oil, iron ore) to meet skyrocketing demand in the international markets, particularly China. Low interest rates in the international markets have also helped attract foreign capital as investors look for higher returns. Private capital flows to Latin America could top $43 billion in 2004, up from $19 billion in 2002, according to the Institute of International Finance. Finally, most countries in the region have devalued their currencies and adopted a floating exchange rate regime that has triggered a boom in exports, reversing the region's current account deficit to a small surplus.
But 2005 may turn out to be a tough year to keep the engines humming along. With the US election over, American interest rates are expected to rise and countries in the region may be forced to increase local interest rates to maintain foreign investors' thirst for higher returns. Should China's gargantuan appetite for raw materials slow down, prices of key raw materials are likely to tremble, triggering an adverse cascading effect on export revenues for many countries in the region. Latin America's public debt also remains a major issue, with many countries, notably Brazil, still in desperate need of in-depth fiscal reform.
As 2005 kicks in, a general overview of the major tax changes in 2004 should be helpful to understand the tax trends expected in the region in 2005.
Transfer pricing
In 2004, more countries in Latin America embraced transfer-pricing regulations, established specific penalties, and increased enforcement. Transfer-pricing issues are now a reality in Argentina, Brazil, Colombia, Chile, Mexico, Peru and Venezuela. In 2005, Costa Rica and Ecuador are expected to formally enact transfer-pricing regulations.
In line with the trends across the region, 2004 tax reforms in Peru and Colombia established significant fines for the lack of compliance and disclosure. Colombia announced during 2004 that transfer-pricing documentation will be required to be available for audit purposes in 2005. With a few noted exceptions most countries in Latin America now require that contemporaneous transfer-pricing documentation be readily available and that informational tax returns with transfer-pricing information be filed on a regular basis.
On the audit front, there was a perceptible increase in transfer-pricing-related audits by the tax authorities of Mexico, Brazil, Argentina and Venezuela.
While audit activity in Brazil has spanned all types of industries and company sizes, the main focus has been on certain industries, particularly pharmaceuticals, agrochemicals, high-tech, telecommunications equipment, as well as the automotive sector and its different tiers of suppliers.
In Argentina, the tax authorities have notably increased the focus of transfer-pricing audits on exporting companies, particularly in the grains and fisheries sector, given that Argentina's default on its foreign debt and the subsequent peso devaluation led to a substantial increase in export-led revenue growth.
Mexico has warned taxpayers that its future transfer-pricing audits will be fine tuned, focusing more on technical content, versus the traditional form over substance approach.
The most important change in transfer pricing in Mexico occurred at the beginning of 2004; maquiladoras now have new options to comply with transfer-pricing law, outside of the negotiation of an advanced pricing agreement (APA). These alternatives for maquiladoras now include the following:
maintain transfer-pricing documentation the same way non-maquiladoras do;
the safe harbour and;
the APA.
Given this favourable change, taxpayers should expect to see a substantial drop in the number of APA requests in Mexico given the high transaction and negotiation costs that have generated a substantial backlog of APAs awaiting review by the Mexican tax authorities. That in turn,should considerably free up resources in the local tax authorities to increase the number of transfer-pricing audits.
From a transfer-pricing standpoint, companies operating in Latin America are facing the increased administrative burden of documentation requirements, as well as the need for additional resources to respond efficiently and effectively to more frequent revisions by the tax authorities.
Thin-capitalization rules
Despite Latin America's substantial need for continuous foreign direct investment, a growing trend is making waves throughout the region, much to the dismay of the local business communities. Thin-capitalization rules are already a reality in Argentina and Chile. Similar rules are expected to come into force in Mexico on January 1 2005. In 2005 expect to see more jurisdictions in Latin America exploring ways to limit debt expansion and discussing the establishment of thin-capitalization rules.
Corporate tax reductions:
It is no secret that tax authorities in Latin America are ill equipped to enforce tax compliance. In light of the difficulty in collecting corporate income taxes, many governments facing steep competition on reduced corporate tax rates from jurisdictions around the world, appear ready to throw in the towel and slash corporate income tax rates in an effort to increase their competitiveness, at least from an income tax viewpoint.
Based on the current Mexican tax reform just signed by President Fox, the corporate income tax rate will be reduced from the current 33% to 28% over the next three years. A similar reduction will also apply to the maximum income tax rates applicable to individuals.
Paraguay will reduce its corporate income tax rate from 30% to 20% in 2005 and to 10% in 2006. Notwithstanding, from 2006 forward, earnings will be subject to a 5% dividend withholding tax on after-tax profits paid to Paraguayan resident shareholders and 15% dividend withholding tax on after- tax profits remitted to non-resident shareholders.
Colombia is also considering a reduction in its corporate income tax rate from 35% to 32%, though if approved, the cut would not take effect until 2008.
Costa Rica is considering a maximum income tax rate of 25%, starting from 2010, versus the current 30% and may also offer a reduced 15% corporate income tax rate to companies that meet certain criteria involving minimum national value-added content, initial investment amounts, use of new technologies or investment in social or community welfare initiatives.
Peru seems to be the lone ranger going against the tide in the region, having increased its corporate tax rate from 27% to 30% in 2004 and having imposed a dividend withholding tax of 4.1% on the distribution of profits to non-residents and individuals.
VAT base
The general trend of relying on value-added tax (VAT) rather than on income tax as a more efficient and significant source of tax revenues is gaining further momentum.
Colombia has presented to Congress a draft tax reform proposing a further broadening of the tax base for VAT purposes, coupled with an increase in VAT from 16% to 17%.
Costa Rica wants to transform its current sales tax into a new 13% general VAT that would tax not only goods but also most services as opposed to the current system, which limits its application to the transfer of goods and applies only to a list of specific services.
The Dominican Republic increased its VAT from 12% to 16%. El Salvador broadened its VAT taxable base in 2004. In Venezuela, although the VAT rate was reduced by 1% to 15% and is expected to be further cut to 13% or 14% in 2005, the taxable base of products and services subject to VAT will be broadened.
In Mexico, proposed rules in the current tax reform bill would broaden the costs and expenditures that can be allocated directly to taxable or non-taxable activities. If approved, these rules would reduce creditable VAT amounts for companies with exempt activities, boosting VAT tax collections.
Biography |
|||
Manuel Solano is the partner in charge of the international tax services group in Latin America for Ernst & Young and also the tax managing partner for Ernst & Young Mexico. Solano has a BS From Youngstown State University and a JD from Georgetown University Law Center. He also studied finance and economics at the Universidad Autónoma de Centro America. Solano, a member of the American Bar Association and the New York State Bar, has extensive work experience in international tax consulting and planning matters. His experience encompasses advising multinational corporations on the tax and legal implications of cross-border acquisitions and the establishment of foreign operations in Latin America. He has co-authored both the Tax Management Portfolio Doing Business in Venezuela and Tax Management Portfolio Doing Business in Mexico, as well as the Tax Management Portfolio on Transfer Pricing. Solano is a regular contributor of articles to Tax Notes International, Tax Management and the Journal of International Taxation. International Tax Review has also selected him as one of the leading Mexican tax advisers for the past five consecutive years. Euromoney's legal media group has also identified Solano as one of the world's 25 leading international tax law practitioners in its 2002 Guide - The Best of the Best. |
