By: Alfredo Collosa
January 17, 2023
Alfredo Collosa reviews the current status of value-added taxes and the digital economy in Latin America and the Caribbean, and looks at potential compliance tools that could improve tax reporting and collection in the region.
Although value-added tax is the largest source of tax revenue on average in the Latin American and Caribbean region—and LAC is one of the fastest growing e-commerce regions in the world—VAT reform in response to e-commerce growth has remained relatively limited.
The main VAT challenges relate to the strong growth in online sales of services and digital products to private consumers, such as apps, music and movie streaming, gaming, and ride-hailing, as well as to the exponential growth in online sales of low-value imported goods, often by foreign sellers, on which VAT isn’t collected effectively under existing rules.
Challenges of Digitalization
In the area of VAT, the Organization for Economic Co-operation and Development BEPS Action 1 Report identified that digitalization created both base erosion and profiting shifting risks and broader challenges.
BEPS risks arise from highly digitalized businesses structuring their affairs to pay little or no VAT on remotely delivered services and intangibles, while the broader tax challenges were associated with the collection of VAT on cross-border supplies of goods, services and intangibles from online sales, particularly cross-border business-to-consumer sales.
The recommendations in BEPS Action 1 have been integrated into the 2016 International VAT Guidelines and complemented by the 2017 report on Mechanisms for the Effective Collection of VAT/GST, where the supplier isn’t located in the jurisdiction of taxation, and the 2019 report on the role of digital platforms in the collection of VAT/GST on online sales, which provide guidance on implementation to jurisdictions.
Implementation of the BEPS Action 1 VAT recommendations has been very encouraging.
Over 50 jurisdictions have adopted rules for the application of VAT to B2C supplies of services and intangibles from online sales by foreign vendors. Of these, 40 have implemented simplified registration and collection regimes for the collection of VAT on the cross-border B2C supplies of services and intangibles.
The OECD BEPS implementation report confirms the assessment that implementation has greatly enhanced compliance levels and yielded substantial tax revenues for market jurisdictions, and has leveled the playing field between domestic suppliers and foreign vendors.
Jurisdictions are now increasingly turning their attention to the collection of VAT on imports of low-value goods, which has the potential to yield significant revenues for jurisdictions and importantly address competitive distortions.
Compliance Tools
To address the challenges posed by the digital economy in terms of indirect taxation, the OECD has developed guidelines that, in general terms, encourage the tax registration of digital companies that operate without a physical presence in the countries where they market their goods and services.
This implies adapting the procedures of tax administrations and having the necessary tools to facilitate their effective implementation.
To this end, CIAT—the Inter-American Center of Tax Administrations—with the support of NORAD, the Norwegian agency for development cooperation, developed an open software called DEC—Digital Economy Compliance—which among its main functions facilitates the simplified registration of the digital companies and compliance with their tax obligations.
The software has been designed so that each tax administration that implements it can adapt its parameters according to the needs and specific design of the administration.
This application is designed to run both in the cloud and in the facilities of the tax administration, which allows implementing it in a short time.
DEC has two main interfaces—one for taxpayers (that is, the companies abroad) and another for the tax administration. The application is multilingual, allowing, for example, a company in one country to interact in English and another in a different location, in Portuguese, and incorporates the highest computer security standards to ensure the privacy and accuracy of the data provided. As it is a standard interface, it facilitates voluntary compliance by companies in the countries where it will be implemented, significantly reducing their compliance costs.
Another important tool is the VAT Digital Toolkit for Latin America and the Caribbean, which provides detailed guidance for the successful implementation of a comprehensive VAT strategy directed at e-commerce. It is designed to help governments secure significant VAT revenues and to ensure a level playing field between brick-and-mortar stores and foreign online sellers.
The toolkit is directed at all types of e-commerce and takes account of the specific circumstances in LAC countries. It includes detailed guidance on designing policy and legislation, on the administration of effective collection mechanisms, and on a comprehensive audit and enforcement strategy.
In addition to building on the internationally agreed OECD standards, it draws on expertise and best practices from jurisdictions that have already successfully implemented these standards. It has been developed in close consultation with LAC tax authorities and regional organizations.
VAT and the Digital Economy in the LAC Region
CIAT, with the World Bank, the Inter-American Development Bank, and with the leadership of the OECD, are working on the creation of a set of guidelines to allow the collection of indirect taxes in the digital economy, aimed at LAC.
In summary, the proposal focuses on requiring the relevant companies to voluntarily adhere to the mechanism, collect the corresponding taxes in B2C-type operations (with consumers), and carry out the transfer of corresponding funds; all supported by a simplified mechanism for registration, declaration, and provision of information that wouldn’t require any physical presence.
The mechanism could be complemented by a withholding on the means of payment for transactions with companies that are unwilling or unable to join.
In addition, a country may decide, based on the general approach, how to define specific characteristics. These could include the type of economic activity covered, the information elements for registration and declarations, the procedure to follow in case of overpayments, the establishment of minimum thresholds of total operations to be incorporated into the regime, or of minimum limits for individual operations to require additional details on the transaction.
According to a recent survey, in January 2021 there were 81 countries that had implemented indirect taxes on transactions in the digital economy, such as VAT or general sales tax. Of those countries, nine are Latin American: Argentina, Brazil, Chile, Colombia, Costa Rica, Ecuador, Mexico, Paraguay, and Uruguay.
There were 11 countries with a bill or a consultation process ongoing to apply this type of tax, and four of them are countries in the region: Honduras, Panama, Peru, and the Dominican Republic.
The pioneer countries in applying VAT to these services were Argentina, Colombia, and Uruguay, which began collecting the tax in 2018, followed by Chile, Costa Rica, Ecuador, and Mexico that implemented it in 2020, while in Paraguay its application began in 2021.
The tax rates that apply correspond to the general rate of the tax and vary between countries. The highest rates, between 19% and 22% depending on the country, are applied in Argentina, Chile, Colombia and Uruguay; while in Mexico the VAT rate is 16%. In contrast, the lowest rates are applied in Costa Rica, Ecuador and Paraguay with 13%, 12% and 10%, respectively.
Of these eight countries in the region, half of them follow the OECD recommendations in relation to the obligation of VAT registration by nonresident providers of digital services: Chile, Colombia, Mexico and Uruguay. In addition to the mandatory registration of foreign taxpayers, in Chile and Colombia in certain cases there is a retention in operation in the means of payment used to pay these services (credit cards or fund transfers abroad).
In contrast, in Argentina, Costa Rica, Ecuador, and Paraguay, nonresident providers aren’t required to register as taxpayers, but VAT withholding is applied for the financial institutions that manage the means of payment used to pay for the digital services.
The tax administrations of these countries periodically publish a list of the nonresident companies that are subject to this withholding.
Potential Revenues
To showcase the revenue potential that e-commerce has, Santiago Díaz de Sarralde, director of Tax Studies and Research at CIAT, presented empirical evidence on the levels of VAT collection that could be levied through effective taxation of digital services.
Taking a sample of eight Latin American countries, it is estimated that yearly additional revenues could amount to $255 million in total, which represents between 0.03% and 0.06% percentage points of the national GDP in the selected countries. The areas with the highest potential for revenue are digital advertising and audio-visual productions, respectively.
In Jiménez and Podestá (2021) , estimates of the potential of VAT revenue on digital services are made in those countries that haven’t yet applied this tax to the sector—Bolivia, El Salvador, Guatemala, Honduras, Nicaragua, Panama, Peru, and the Dominican Republic.
The potential collection in terms of GDP would be comparable to that achieved by the Latin American countries that already tax these activities—between 0.02% and 0.06% of GDP annually once the tax is fully implemented.
According to the degree of penetration of the technology, the size of the countries, and the VAT rate, the annual resources that could be obtained in the countries where the tax isn’t yet collected range from $6 million in Nicaragua to $113 million in Peru.
Final Thoughts
It is well known that the governments of the LAC region need to strengthen their tax revenues to face the structural challenges summarized in the UN 2030 Agenda for Sustainable Development, and those derived from the Covid-19 crisis.
I believe that it is vital for the region to apply VAT collection to the business models of the digital economy. The importance of including all operations in the scope of the tax should be highlighted; this refers to operations involving crypto assets with the new business models of the tokenized economy.
To move forward, it will be essential for countries to take advantage of the best practices of those countries where VAT is already applied to the digital economy.
The tools to facilitate tax compliance are also important. They produce enormous benefits for both taxpayers and tax administrations and, above all, seek to reduce the cost of tax compliance.
In short, I am in favor of moving forward on this issue, always seeking cooperation and collaboration by applying multilateral measures.
Alfredo Collosa is a consultant and tutor in tax administration at the Inter-American Center of Tax Administrations, as well as a professor, investigator, lecturer, and author of books and publications. He holds an Official Masters in Public Finance and Tax Administration (UNED-IEF).
The author may be contacted at: aecollosa@gmail.com
Email your opinions, letters and commentaries to: letters@caribmagplus.com