Getting to Grips with How Latin America’s Tax Laws Impact Outsourcing Operations
With different tax laws, exemptions, double taxation treaties and free trade zones for services exports affecting outsourcing operations across Latin America, gaining a solid understanding of the distinct tax obligations in each country is imperative.
In a bid to attract investment, several Latin American countries have introduced double taxation treaties, free trade zones, and income tax discounts or exemptions that apply to BPO and IT services exports, although experts consulted by Nearshore Americas maintain that the relative lack of double tax treaties is a major challenge facing the region.
Comparing the tax implications for outsourcing operations cross Latin America is a complicated exercise, with different rules, regulations and incentives that both buyers and sellers need to be aware of in each country, meaning exhaustive due diligence is crucial to understanding the pros and cons of each location.
Alfonso Pallete, Principal in International Tax at KPMG, told Nearshore Americas that determining the tax obligations of a U.S. or multinational corporation outsourcing work to a service provider in Latin America is “a very complex question and it’s very country-specific.” Pallete explained that it typically depends on whether the buyer is considered to have a permanent establishment in the Latin American country, based on the activity that it is outsourcing to a third party. “If you’re considered to have a permanent establishment then you’re fully taxed as if you were a corporation from that country or you had a branch there,” he said.
While this should be the primary concern in most Latin American countries, there are many other important considerations, Pallete noted. “In Brazil because they have such high indirect taxes they’re not so worried about you having a permanent establishment,” he said. “Even if they don’t tax you at a corporate level because you have a permanent establishment, they know that any payment in or out of Brazil is going to have a very high level of indirect taxation.”
Ultimately, foreign corporations must consider each location on a country-by-country basis, Pallete said: “If you talk about tax laws in Europe or the United States there’s some level of uniformity there but in Latin America you don’t have that. Latin America has countries with completely different legislative environments and completely different levels of maturity of their tax systems and audits.”
Brazil’s Complex Tax Laws
When considering the tax obligations in different countries across Latin America, Murilo Mello, a partner at KPMG Brazil, told Nearshore Americas that the complexity of the different laws and regulations in each country mean it would be far too simplistic to just compare their corporate income tax rates. In Brazil for example, the corporate income tax rate is 15%, he explained, but a Brazilian service provider would liable to pay a total of 34% in income taxes when you take the surcharges and social contribution on profits into account. On top of that, “they would also have to pay gross revenue taxes and municipal service taxes. There are two rates for gross revenue taxes, depending on the tax regimes the companies are enrolled on. One is 9.75% and the other is 3.65%. Municipal service taxes are 5%,” Mello added.
Any foreign or multinational BPO or IT services providers that chose to set up operations in Brazil would be liable to pay the same taxes, he explained, but if a foreign corporation decided to set up a global in-house center in Brazil instead of outsourcing to a third party then they would become exposed to additional taxes and central bank regulations.
Unlike several other leading Latin American nations, Brazil does not have any free trade areas for services exports, Mello said. There are a broad range of exemptions available in Brazil but there is no one-stop shop through which companies can apply for these incentives, he added.
According to KPMG research, incentives relevant to outsourcing operations in Brazil include: reduction in social security contributions up to 50%; tax exemption on the import of software development materials; and tax deductibility on technology transfers, licenses and royalties. Moreover, spending on staff training and development, and research and development can be deducted against income tax. There are also state and municipal incentives, with major cities such as São Paulo and Rio de Janeiro offering local tax incentives for IT firms to set up offices there. However, KPMG notes, there are also “high taxes and restrictions on services exported from Brazil that inhibit the growth of the outsourcing business.”
PriceWaterhouseCoopers notes that under previous rules “double taxation was avoided to a certain degree by means of foreign tax credits granted in Brazil for income tax paid on the foreign entity’s profits.” Now, a new law “expressly extends those foreign tax credits to withholding tax paid abroad on the profits distributed to the Brazilian parent, with no time limitation.”
The Ins and Outs of Mexican Taxes
Luis Felipe Muñoz, International Tax Partner at PriceWaterhouseCoopers in Mexico City, told Nearshore Americas that when considering tax obligations in Mexico “it’s very important to distinguish whether the U.S. buyer and the Mexican service provider are related parties.” If they are unrelated third parties then only the Mexican firm will have to pay corporate income tax on the revenue from the U.S. company, he explained. “The general rate for corporate income tax is 30% and the general VAT rate is 16%,” Muñoz noted, although a 0% rate on VAT can be applied when services are being exported abroad.
“The U.S. company does not have to pay any VAT or corporate income tax in Mexico as long as it does not have a permanent establishment in Mexico,” he added. “In cases where the U.S. company has a link or a connection with a Mexican firm then the Mexican government may try to collect corporate income tax from that permanent establishment.” If the U.S. buyer wants to set up a shared services or global in-house center in Mexico then in order to reduce its tax obligations it must be established as a subsidiary that charges the parent company an “arms-length” or market-value fee for all work done in Mexico, Muñoz explained.
Mexico offers many investment incentives but the majority of them are not specifically related to tax. KPMG notes that outsourcing hubs such as Guadalajara, Monterrey and Queretaro have attracted foreign firms by “offering cash grants of up to 50% of the total investment and tax credits of up to 30% of R&D expenses.”
The most significant tax-related incentives include the double taxation treaties, which enable U.S. companies to export services without paying taxes in both countries; and the Maquila tax regime, which most often applies to U.S. companies with manufacturing activities in Mexico, but can also be applied too services. The primary benefit of the Maquila regime is that companies serving U.S. clients receive deductions in corporate income tax based on the payments they make to their employees, Muñoz said.
“Mexico has relatively low tax rates compared to other OECD countries,” he added. Mexico also has more double taxation treaties than any other country in the region, making it an attractive location for U.S. companies that want to establish a centralized hub for their Latin American operations.
Looking to the future, Muñoz noted, “The Mexican tax authorities are pursuing reforms in order to introduce free trade zones to encourage investment in the southwestern coastal area of the country. This will help us to compete with countries in Central America where they have territoriality tax systems that interest foreign companies looking to outsource from there.”
Elsewhere in Latin America
KPMG notes that Argentina’s government has prioritized the software industry in recent years and offers special benefits to IT and software companies, including exemption of 60% of the total amount of income tax. The basic corporate income tax rate is 35%. Neighboring Uruguay, which has a corporate income tax rate of 25%, has also sought to attract foreign software firms by establishing Zonamerica, a tax-free business and technology park in the capital city, Montevideo. All Services exported from Zonamerica to the United States are tax free.
Mello cited Chile, where the corporate income tax rate is just 20%, as one of the most business-friendly locations in South America from a tax standpoint. Chile has numerous free-trade agreements with the United States, Canada, Australia and China, as well as double taxation agreements that make it possible to export services without paying taxes in both countries.
Colombia, which has a corporate income tax rate of 25%, also offers a broad range of investment incentives for outsourcing companies. The Colombian government has established three free trade zones with BPO facilities in Bogota, Manizales and Pereira, while local governments in Medellin and Bogota have reportedly been working toward the establishment of free trade zones specializing in BPO. The existing free trade zones also offer tax breaks of up to 50% on sales into the local market. The government has eliminated VAT for BPO sector exports and service exporting companies can import capital goods exempt from custom duties and VAT. Colombia also offers legal stability contracts and a 40% tax deduction on the cost of purchased machinery.
In Central America, Costa Rica and Panama have both established free trade zones in which companies can export services to the United States and pay little or no corporate income tax. In Costa Rica, which has a corporate income tax rate of 30%, goods used for export services can also be purchased tax free and there are no restrictions on foreign currency management. Panama, where the corporate income tax rate is 25%, passed legislation in the late 1990s to create tax incentives for outsourcing companies and in 2007 it added more incentives for shared service centers. Aside from the free trade zones, the government has also created a “City of Knowledge” beside the Panama Canal that offers tax and immigration benefits to IT firms.
The Double Taxation Challenge
Pallete concluded that “one of the main challenges you have in Latin America is that there are very few double tax treaties. Mexico and Brazil are among the countries with more double tax treaties and Colombia is only just starting to sign such treaties but in general there aren’t many countries that have them in the region. The lack of those treaties means even if you don’t have a permanent establishment, any payment in or out of that country is going to be subject to a very high withholding tax.”
Having free trade zone is going to help you a lot, Pallete said, noting that “countries like Panama and Costa Rica are very popular for global corporations when they want to set up shared services centers in Latin America.” Yet even in these locations, the lack of double taxation treaties poses a problem. “You can have an absolutely efficient corporate tax system but if there’s no double tax treaty then every service you provide to any other country in Latin America can have a 30% withholding tax when they pay you for the services.”