Taxation of digital services in LATAM - Lessons from IFA Costa Rica 2018

Like when living in a cold freezing country (think of Sweden), being a tax practitioner in a fairly isolated country such as Chile requires you to move out of your comfort zone and go out there to see what is going on in your neighborhood.

The 10th Regional Latin American Meeting of the International Fiscal Association, held from May 23 to May 25 in San José, Costa Rica, was just that.

Being blessed with the opportunity of coordinating and participating in a panel with the likes of Pablo Baroffio (Argentina), Alvaro Villegas (Bolivia), Vanessa Arruda (Brazil), Ricardo Quibrera (Mexico), Luciana Ya?ez (Peru) and Fabian Birnbaum (Uruguay), I had the incredible opportunity to learn from these great people.

So, in the spirit of sharing, I decided to write this brief note.

First, it is worth mentioning that our panel dealt broadly with the topic of the taxation of cross border services. We divided it in three: (i) importation of services; (ii) exportation of services; and, (iii) digital services.

That said, since the taxation of digital services seems to be one of the hottest topics out there for us tax nerds, and taking into special account my interest in it as a millennial, I will focus solely on that. Here we go:

LATAM may be behind our "older" partners in a lot of things, but it is certainly picking up the pace regarding finding ways of taxing digital services.

Peru and Brazil seem to be the jurisdictions taking the lead on these issues, albeit with their own complexities.

For instance, Peruvian legislation seems to capture digital services in a broad manner, but at the same it might have created, perhaps inadvertently, a different treatment between digital consulting services and non-digital consulting services, just to name an example. It is to be praised the Peruvian sense of practicality on the withholding issue, by making it applicable only in transactions B2B (business to business).

Brazil on the other hand seems to have come up with a dual tax system for digital services, thus putting municipalities and regional governments or states on opposing sides of the street, fighting for the revenue generated by this industry. It is worth noting that Brazil has secured the collection of taxes on this type of income by extending the responsibility of withholding to financial intermediaries, a measure also adopted by Argentina.

Concerning how the home of Maradona and Messi addressed this topic, under the government of President Macri it was decided (and turned into a law) that digital services are to be subject to VAT. While the collection system is still in the process of being implemented, it should rely on the cooperation of financial intermediaries such as credit card operators.

Also relying on the financial intermediaries, Uruguay opted for taxing these services both with direct and indirect taxes when the consumer is located in said jurisdiction. I found it really interesting how Uruguay actually came up with a distinction between direct service providers (e.g. Netflix) and intermediaries (e.g. Uber). In the latter, Uruguay will only tax 100% of the operation when both provider and consumer are in Uruguay, whereas said burden will drop to 50% when one of them is not in the crib of one of the world's best Tannat.

Falling behind on this matter were Bolivia, Chile and Mexico. None of the above have yet come with comprehensive legal or administrative regulation tackling this issue, which thinking positively can be seen as an opportunity for good discussions to happen.

Likely the first question we ought to ask ourselves is, as well stated by my colleague from Bolivia: do we actually want to tax digital services?

Some may say no, relying on the fact that these services enrich our levels of productivity (e.g. SaaS), or that income will be taxed with employment tax or surtax on the hands of local partners (e.g. Uber drivers) or simply that we don't want another tax to make the life of our citizens even more expensive (e.g. VAT on Netflix or Spotify).

Others will argue that it is necessary to tax these services to level out the field with non-digital service providers who are often taxed as a result of a more traditional business model. Many will also argue that it is only but fair for these giant providers of digital services to share their wealth with countries in which their consumers or data providers reside, individuals which need better schools, roads, hospitals, etc.

Either way, if these services were to be taxed I believe two primary issues should be addressed: (i) how are we going to characterize this income in a way such to avoid future recharacterization disputes and prevent from favoring one type of provider versus another through taxes (e.g. digital consulting providers versus non-digital consulting providers); (ii) how are we going to tax and secure collection? do we want a digital PE? or are we better off with a general withholding tax circumventing double tax treaties?

This last point to me is crucial. We may love a just and fair approach such as a digital PE that will favor taxing effective income rather than gross sales, but how feasible is such an approach for developing countries?

If in parallel we go for a withholding approach, how are we going to secure it? through financial intermediaries? only B2B? or are we expecting individuals to be concerned with tax compliance in addition to grocery shopping?

One of the best examples of a failed system on this matter is actually the Chilean. Last year the Chilean tax authority ruled that payments for online games were to be characterized not as software payments (exempt of withholding tax and VAT if deemed as standard) but as remuneration for entertainment services, thus leading to a 35% tax be imposed.

Despite the fact that gamers were unhappy about this, the truth is that since in Chile withholding a tax is an obligation that lies with each taxpayer (individual or business), and that financial intermediaries are not liable for such (at least in my opinion), the government is unable to secure collection (unless it intends to audit every single gamer in Chile).

What Bolivia, Chile and Mexico will do remains to be seen. Maybe Mexico with a vast transfer pricing experience won't have major issues by opting for the digital PE model and accurately determining where value is created. Chile and Bolivia on the other hand may need to look at our neighbors and opt for a simplified withholding tax model either limited to B2B like Peru or involving financial intermediaries such as Argentina, Brazil and Uruguay do.

I know there is a lot temptation to look to what the OECD (supposedly in 2020) or Europe have to say about this (to once again copy/paste it), but looking at our neighbors (and learning from them) I realized we may not need to look that far away. Who knows, maybe there is a LATAM solution to this...

At the end of the day and like with wine pairing where some grapes are better than others for this or that type of food, after IFA Costa Rica 2018 I am going home with the hope of Latin America finding its own pairing to tackle the challenges arising from the digitalization of the economy, in a way such that is realistic considering our capabilities and coherent with our particular legal systems.

**************************************************************************

If you require guidance on the legislation of Argentina, Bolivia, Brazil, Mexico, Peru and Uruguay, I encourage you to contact my colleagues mentioned above from said jurisdictions directly (all of them have a presence in LinkedIn).

Should you wish to download our PowerPoint presentation, you can do it through the following link.