Navigating the grey zone
In recent years, tax planning has proliferated in the domestic and the international sector. In a global economy with liberalised financial markets a taxpayer may seek to take advantage of the most favourable tax systems. Nevertheless, taxpayers lie in a grey zone as the abuse of law has subjective areas, and the limits between tax avoidance and tax evasion remain unclear. Factors that facilitate tax planning include the fiscal disharmony between countries, the existence of more favourable tax regimes or deferred taxation systems, and the existence of nil- or low-tax jurisdictions.
Tax systems have developed anti-abuse provisions to remedy avoidance. Anti-abuse rules were developed as preventive measures, although the reality is that they combat tax planning by imposing additional taxes or preventing their avoidance by the taxpayer.
Latin American legislations are not homogenous from a tax-planning perspective. Costa Rica, El Salvador, Guatemala, the Dominican Republic, Nicaragua, Panama, Paraguay and Uruguay have territorial tax regimes that typically do not impose taxation on foreign-source income. On the other hand, the Dominican Republic has a hybrid regime that imposes taxation on foreign-sourced passive income only.
Most Latin American countries have comprehensive tax regimes with anti-abuse provisions, the most common of which include the doctrine of substance over form, thin capitalisation rules, transfer pricing rules, and controlled foreign corporation (CFC) rules or regulations on tax transparency.
The doctrine of substance over form allows tax authorities to ignore the legal form of an arrangement and look to its real economic or commercial substance to prevent artificial structures from being used purely for tax avoidance purposes. Argentina, Colombia, Ecuador, El Salvador, Brazil and Venezuela have implemented this principle. Mexico and Chile do not include a substance-over-form provision in their domestic legislative regimes, although their tax authorities are allowed to reclassify artificial transactions.
Thin capitalisation rules impose a limit on the deductibility of interest as an expense when the capital of a subsidiary is primarily from shareholder loans rather than capital. The consequence is that interest payments are reclassified as dividends and are therefore non-deductible for the subsidiary. Most Latin American countries that have enacted thin capitalisation rules have established a ratio of debt to equity of 3:1, although Argentina, Brazil and Venezuela have a lower ratio.
Transfer pricing rules typically prevent companies from diminishing the taxable base by applying artificial prices between related parties and exporting profits to low-tax jurisdictions. The golden rule of transfer pricing is that transactions between related parties must be conducted at arm’s length. Most Latin American countries, including Brazil and Chile, use blacklists for transfer pricing purposes, to identify low-tax jurisdictions. Others, such as the Dominican Republic and Colombia, are in the process of implementing such lists.
The rules on tax transparency – the CFC rules – result in shareholders being taxed on the undistributed income of a foreign corporation, as they disregard the independent legal personality of the foreign company, thus denying the benefits of tax deferral. Argentina, Mexico, Peru, Uruguay, Venezuela and Colombia have implemented CFC regulations, in particular those realising passive income.
To complement anti-abuse rules, many countries have mechanisms for the exchange of information between tax administrations to verify and enforce tax compliance. These systems are established in double-taxation treaties, as well as tax information exchange agreements (TIEAs) and multilateral conventions. Many Latin American countries have TIEAs with certain Caribbean, Central American and Latin American financial centres. Argentina has TIEAs with Bahamas, Bermuda, Cayman, Costa Rica and Uruguay. Brazil, which had long been reluctant to enter such agreements, now has TIEAs with Bermuda, Cayman and Uruguay. Mexico has TIEAs with Bahamas, Belize, Bermuda, Cayman, Costa Rica and Curaçao.
The OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters requires members to exchange information on request, and allows members to agree on automatic exchange of information. The Convention is in force in Argentina, Costa Rica and Mexico and is pending ratification in Brazil, Colombia and Guatemala.
Change is coming to Latin American shores, and the trend is towards stricter anti-avoidance rules and greater information exchange.
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