Expected 2012 tax trends in the Americas regionMarch 30, 2012
Many countries in the Americas region did not sustain massive collateral damage as a result of the global financial crisis — at least not to the levels currently seen in many European countries and other mature markets.
However, there certainly were impacts to address, and as illustrated by Table 3 below, a key trend in reported data is that many countries have adopted what might be described as “a mild case of austerity.”
While resulting tax measures cannot be described as “severe” when compared with those of many other countries (significant corporate tax, personal income tax or VAT increases with little or no warning in many European countries, for example), wide-ranging tax increases have been either implemented or proposed for 2012, covering many tax types and different taxpayer segments.
This move toward a more austere outlook has been accompanied by a heightened readiness to respond to any new economic challenges.
By and large, defined stimulus programs have largely expired in the Americas region.
And almost without exception, after a year of little substantial tax policy change, countries in the region have started to increase the overall tax burden in an effort to rebalance their budgets and increase overall levels of social and economic investment.
This is illustrated by Table 4, which demonstrates that 11 of the 17 countries are projected to reduce their deficits or increase their surplus in 2012, and table 5, which shows government revenues are expected to either remain the same or rise in 9 of the 17 countries.
Although deficit reduction is an important focus for many countries in the region in 2012, the magnitude of reduction in many (but certainly not all) is somewhat limited.
In this vein, tax changes in 2012 may be less dramatic (and certainly more planned) than those seen in other regions containing countries struggling to exit the crisis.
Because they are designed to be less aggressive, in many countries the changes perhaps drive fewer headlines but are in fact more pervasive, covering a wider range of different taxes.
Many changes are designed to less visibly widen the tax base as opposed to dramatically increasing headline tax rates.
This will make monitoring and reacting to the change a challenge.
Taxing those most able to pay: companies feel the burden
Diverging from the global trend of recent years, many of the Americas are actually experiencing upward pressure on headline corporate tax rates alongside additional base-broadening activity.
Although Canada and the United States (as well as Panama) seem to be more aligned with the underlying global trend of reducing headline corporate tax rates, many countries in the region are actually moving in the other direction.
These increases in the headline corporate tax rate seem to be in response to the general need to more actively manage deficits and the desire to tax those most able to pay.
Examples of this phenomenon can be seen in Chile, El Salvador, Nicaragua and the Dominican Republic.
In Chile, current legislation would see the corporate tax rate fall from 20% in 2011 to 17% in 2013 (as the result of the scheduled phaseout of a temporary rate increase), but some in the opposition are calling for the rate to be increased to at least 25% in order to pay for improved education.
In the Dominican Republic, similar pressure resulted in a headline corporate income tax rate increase from 27% to 29% in 2011.
Taxing those most able to pay: high-net-worth individuals (HNWIs) under the spotlight
Using a variety of different tax measures, virtually all countries in the region are targeting HNWIs with tax increases, as well as increasing their enforcement focus on this taxpayer segment.
This joint policy/enforcement focus echoes a global trend that has developed since the height of the financial crisis, with similar measures seen in France, Italy, Korea, Portugal, Spain and the United Kingdom.
Measures include the imposition of temporary “solidarity charges,” higher headline personal income tax rates, removal of relief on pension contributions, and the increase or introduction of capital gains tax.
In Argentina, there is a strong possibility that capital gains taxes will increase in 2012, and in Costa Rica proposals exist for the introduction of a 15% tax on capital gains, which are currently untaxed.
In the United States, 2011’s proposed “Buffett Tax” on wealthy individuals earning in excess of US$1 million in income certainly ignited a debate, but it has little chance of being enacted in such a politically deadlocked environment.
In Canada, the focus on HNWIs has been illustrated by the “Related Parties Initiative,” which targets HNWIs with net assets of more than CAD50 million and related entities (comprising 30 or more entities they directly or indirectly control).
In Costa Rica, the tax administration has established an aggressive enforcement policy focused on “liberal professionals” who are not declaring their taxes accurately, alongside a similarly increased focus on other taxpayers such as professional sports players and private education institutions.
In the United States, much of the focus is on new legislative mechanisms with effective dates scheduled for two and three years out, but for which active preparation is required through the course of 2012.
The most notable is the Foreign Account Tax Compliance Act (FATCA), enacted in 2010.
FATCA requires US taxpayers holding financial assets outside the United States to report those assets to the IRS, in a similar fashion to the Report of Foreign Bank and Financial Accounts (FBAR) legislation.
It also requires foreign financial institutions to report directly to the IRS certain information about financial accounts held by US taxpayers, or by foreign entities in which US taxpayers hold a substantial ownership interest. All elements of FATCA will necessitate early and robust preparation through 2012.
Taxing those most able to pay: companies riding the commodities boom
Echoing measures seen elsewhere in the world, many countries in the region are introducing new taxes on the extraction of minerals.
- Brazil, where the Congress is currently debating changes to taxation of the mining industry
- Chile, which produces nearly one-third of the world’s copper (and where student protests have ignited the debate)
- Peru (a special mining tax, ranging from 2% to 8.40%, from October 2011)
- Venezuela (13% royalty tax introduced)
This increased focus on extractive companies is also mirrored in many countries by a heightened enforcement focus on their activities.
Globalizing tax policy: an ongoing focus on taxing dividends, interest and income paid in another country
Continuing 2011’s trend, many countries in the region continue to try to expand revenue collection by imposing taxes on dividends, interest payments and other types of income generated or paid outside their borders.
In Canada, for example, recent legislative proposals concerning how foreign income should be taxed have raised questions about the tax policy underpinnings and aspirations of Canada’s system for taxing foreign business income earned by “foreign affiliates.”
These questions also raise issues regarding the significance of Tax Information Exchange Agreements (TIEAs) as indicators of whether and to what extent Canadian tax concessions respecting foreign business income consider foreign taxation of that income, as well as what makes a suitable foreign tax recognition or credit system.
In Costa Rica, a 15% withholding tax has been proposed on most payments that are made abroad.
Honduras, meanwhile, will likely see an increase in withholding tax rates where payments are made to a nonresident.
In a similar vein, in 2011, Peru began taxing any capital gains derived from the disposal of foreign corporation shares that derive 50% of their value from securities issued by a Peruvian company; these gains are deemed to be Peruvian-source income and accordingly are subject to tax in Peru.
In Colombia, modifications are expected to the capital tax regime, including the introduction of a tax on the indirect transfer of Colombian assets (which are currently not taxable), echoing similar moves seen in other countries around the world, such as China’s Circular 698 and India’s taxation of indirect transfers.
2012 will see the tax reform debate intensify, and many countries will see action
While deficit reduction can be identified as a core goal of many countries in the region, 2012 is also shaping up to be a key year of growing tax policy reform debate and action in many countries, with tax either shaping an election outcome or driving significant reform discussion and activity once an election is complete.
In our 2011 report, we predicted that “countries are more likely to enact incremental changes to their income tax base and/or to non-income taxes.
Interestingly, higher rates are not generally expected to be part of this equation for most countries in the region.”
This picture has changed quite significantly in the last 12 months and will continue to do so in 2012. There are perhaps two reasons for this.
- Countries have moved (in some cases of their own volition and in some cases through necessity) into a period of heightened austerity and watchfulness.
- Many countries have moved further through their political cycle in the last 12 months and are preparing for national elections that promise to make the economy (and, therefore, taxation) a key issue.
Looking outside the Americas, the Eurozone has already shown that the economy can be a defining issue within such elections, with four European governments — Italy, Spain, Portugal and Greece — either changing their leader or changing the ruling party altogether in 2011.
The political importance of the economy and financial performance was also illustrated in Canada, where the Conservative minority government fell in 2011 after losing a motion of no confidence.
Major elections take place in 2012 in Brazil (city mayors, municipal legislatures and a minority of senate seats), Mexico (President, 128 Senate members and 500 members to serve in the Chamber of Deputies) and the United States (President, one-third of the Senate and all members of theHouse of Representatives).
In all three countries, the results will have a definite link to tax, so the second half of the 2012 may well bring the start of major change around the region.
Mexico’s July 2012 elections will likely also result in some form of tax reform, although, assuming the polls are correct and the opposition PRI party take power, will likely be far less substantial (not to mention less controversial) than PRI’s early 2011 tax reform bill which would have eliminated the current flat-rate business tax (IETU) and increased the overall tax burden on businesses operating in Mexico.
To simplify corporate taxation, the current flat-rate business tax (IETU) would be eliminated.
However, the proposed reform would adopt certain characteristics of the IETU into the income tax code by changing the basis for recognizing income and expenses to a cash basis as well as by making salary payment relief through a credit and denying deductions for royalty payments.
The proposed reform also puts pressure on the informal economy, requiring that all transactions with a business be reported.
In the United States, meanwhile, President Obama on 25 January provided a high-level summary of the tax reform proposals he outlined in his State of the Union Address.
The corporate tax changes outlined in the Blueprint for an America Built To Last follow a theme of eliminating incentives for USbased multinational companies to move operations overseas, and encouraging “insourcing,” by which companies would move foreign operations back to the United States and create jobs.
The individual tax changes provide more specifics on the “Buffett Rule,” under which taxpayers with incomes of more than $1 million annually would pay a minimum 30% effective tax rate, and a proposal to ensure that those taxpayers do not benefit from government subsidies.
The potential increases in the tax rates on individual income, capital gains and dividends are likely to result in a push for legislative action between the November elections and the end of the calendar year.
All things considered, there is potential in the United States for 2012 to be the year during which tax stands at the center of events.
Two eyes firmly on enforcement issues
Without exception, countries in the region report that tax administrators are rapidly increasing their overall levels of tax enforcement in response to the global financial crisis and the need to increase tax revenues. This will be a key theme in 2012’s tax landscape.
In our 2011 report, we predicted that “most countries in the Americas are expected to increase their enforcement of existing tax laws; reducing fiscal deficits is a priority and tax administrators are responding by increasing their collection efforts. … Companies should expect to see tax authorities conducting more audits, requesting more documentation, imposing more penalties and applying a narrower interpretation of existing laws.”
All of these enforcement issues — and more — are borne out by countries’ 2012 outlooks. In fact, only Peru reports that the tax authorities take a “moderate” approach to enforcement, and even there (where VAT evasion is estimated to run at around 30%), 2012 will see audit coverage of the “mega taxpayer” (i.e., large multinational company) segment increase from 76% to 100%.
The only other country proving an exception to the rule of rapidly increasing enforcement is Mexico — where, since 2010, the new tax consolidation regime has been challenged in court and has led to a reduction in the tax authority’s audit intensity and related enforcement actions.
Beyond these two exceptions, all of the other countries in the region report that the enforcement landscape is becoming far more strict — and global in nature — and that enforcement action will increase in 2012 and beyond.
What is interesting is not just that the tax authorities are perceived to be aggressive per se, but that they are perceived to be more aggressive recently.
Selected observations include:
- Argentina — the enforcement approach of the Argentinean tax administration can be described as aggressive, particularly in relation to international companies in general and with certain industries in particular, such as the exporters of soya oil and other commodities.
- Brazil — large corporate taxpayers are audited at the federal level by specialized tax offices in São Paulo and Rio de Janeiro. These offices take an aggressive approach when auditing large companies, targeting issues such as tax planning and corporate restructuring, transfer pricing, controlled foreign corporation (CFC) rules and international tax.
- Canada — recognizing that companies have a more global outlook in managing their tax risk, the Canada Revenue Agency (CRA) is more inclined than previously to use its authority to obtain information, including domestic and foreign information requirements and compliance orders, as well as legislative tools, treaty networks and new TIEAs with nontreaty countries.
- Chile — the Chilean tax authority carries out intense monitoring of specific sectors, focusing on the large taxpayer segment. Currently, the administration presents an aggressive enforcement policy for large corporate taxpayers.
- Colombia — the approach of the tax administration in the case of tax audits has become increasingly aggressive in the last few years, reflecting the fact that the Government has set very high goals for tax collection via the prevention of tax evasion.
Similar examples can be found for all of the countries in the region in the appendix section of this report.
Taxing those most able to pay: an intense enforcement focus on large multinationals
In the same manner as for tax policy and legislation, tax enforcement action in the region is clearly now targeting large corporations.
Almost exclusively, countries report that tax authorities will be focusing more closely on the largest taxpayers, and that within that segment, they will focus on particular industry sectors, particular transaction types and particular tax issues.
Countries also report that they are using increased disclosure requirements and risk assessment methods in order to target their resources more efficiently.
Globalizing tax enforcement: a rapid rise in crossborder focus by Americas tax administrators
As they rapidly experience the effects of globalization, many countries report that their tax enforcement lens is increasingly focusing on cross-border tax issues.
Without exception, all of the countries reported that transfer pricing is either their leading enforcement issue or very near the top of their list.
This message was confirmed in Ernst & Young’s 2011–12 Tax risk and controversy survey, where 57% of tax administrators and 48% of the largest corporate taxpayers identified transfer pricing as their leading area of tax risk in the next 12 months.
This was mirrored by transfer pricing being the leading risk issue for all companies, securing 40% of the 541 global responses in the survey.
For tax administrators, transfer pricing polled almost three times as many responses as global restructuring, their second-highest tax risk focus area.
Input from Canada, for example, reports that transfer pricing remains the Canada Revenue Agency’s (CRA) top cross-border enforcement priority, a priority mirrored by many of Canada’s tax treaty partners, with strong emphasis on complex transactions, business restructuring, migration of intangibles, intercorporate services and intercompany financial transactions, while in the Dominican Republic a dedicated transfer pricing department was created for the first time in 2011.
Indirect taxes — including customs duties — were another area where countries predict high levels of enforcement and audit activity in 2012.
In Costa Rica and Venezuela, for example, customs is mentioned as a specific audit focus, while Guatemala, Honduras and Panama all report an increasing focus on VAT compliance enforcement.
Not surprisingly, cross-border tax structures are high on the audit focus list of many Americas tax administrators.
Reflecting the massive capital flows (both inbound and outbound) in the region, many countries report that restructurings are becoming an increasingly common tax audit trigger.
As examples, the identification and targeting of key cross-border structures and transactions will receive heightened attention from the authorities in both Colombia and Mexico.
Finally, growing focus on the aggressive use of tax losses illustrates the impact of the global financial crisis on many countries in the region, with Canada, Chile and Venezuela all confirming that losses are a high-priority focus area for their tax administrations.
Tax administrators make the best use of scarce resources: risk assessments on the rise
While many countries report an intensifying focus on the activities of large corporations and HNWIs, tax administrators also realize that they need to be more selective and effective in targeting their limited resources at the appropriate taxpayers and the appropriate issues.
Canada reports, for example, that the CRA has initiated a fundamental change in its approach to auditing large corporations, from 100% coverage to auditing based on risk profile.
The risk assessment will be based on a variety of factors, including audit history, transparency, unusual or complex transactions, aggressive tax planning, and the CRA’s assessment of the corporation’s tax governance and risk management. In 2011, the CRA intended to meet with 50 large businesses and complete its risk assessment of the roughly 1,100 large corporations (those with annual gross revenues over CAD250 million) over the next five years.
In Colombia, the tax authority has initiated a program to send taxpayers a pre-assessment of their income tax return, based on income and expense information received from different third party sources.
Taxpayers are invited to take into account this pre-assessment in their final income tax return, and these will most likely be used by the tax authorities in their tax audits.
The US requirement to disclose uncertain tax positions (UTP) went into effect for returns filed in 2011 and is an example of a disclosure regime intended to provide for more efficient risk assessment and focused enforcement.
That requirement, however, highlights the need for companies to obtain certainty through a variety of pre-filing and post-filing tools.
Along with the UTP requirement, the Compliance Assurance Process (CAP) was made permanent, as another option in the toolkit for dispute resolution and prevention.
Other countries in the Americas, however, may not have the same suite of options available to business.
Limited opportunities for relief?
One positive impact of the global financial crisis was that many more countries — whether through desire or necessity (as a result of pressure from the G20 and OECD) — entered into new tax treaties, providing an additional means of relief for companies entering into or operating in these markets.
In addition to increasing the availability of treaty relief, many countries realize that, simultaneous to increasing overall levels of tax enforcement, they need to increase the availability and quality of administrative dispute resolution (ADR) mechanisms.
That said, the growth of such mechanisms in the Americas (outside of the United States and Canada, at least) has been relatively slow.
In many countries, litigation remains the only resolution process.
For example, Argentina reports that “no ADR exists, including Advance Pricing Agreements … and there are no proposed projects in this space,” and similar messages come from both Guatemala and Panama.
Chile reports that “the use of ADR is very, very low. … Levels of prosecution are increasing and will likely continue to do so.”
Mexico, however, reports that the OECD concept of “enhanced relationships” (where companies and tax administration both agree to interact with one another in a more open and transparent manner) is on the agenda for discussion, while Brazil has been investing in the expansion of its Conselho Administrativo de Recursos Fiscais (CARF), or Administrative Council of Tax Appeals, a dispute resolution council that specializes in resolving federal taxation disputes and is composed of three sections (according to the type of federal tax in dispute) and organized in chambers and judgment panels.
For companies operating in the Latin American parts of the region, the lack of readily available dispute resolution processes is a key area to take into account.
This article was first published in the Ernst & Young Tax Policy and Controversy Outlook publication which can be accessed using the link below: