By: Alejandra Fuentes-Pieruccini y Felipe Guevara
The digitalization of the economy has generated significant changes in all areas of the economy, including tax treatment. The modification of the traditional ways of conducting commercial transactions generated a discussion on the need to change both local and international regulations, in order to tax transactions in the places where the economic benefit originates.
The issue becomes especially relevant when we see the rise of the digital economy worldwide: In the most conservative versions, the digital economy represents about 20% of global GDP, while FutureScape: Worldwide Digital Transformation 2021 Predictions reveals spectacular predictions of 65% of global GDP digitized by 2022.
Prior to the digitization of the economy, the determination of where economic benefit was generated was self-evident, as services and the sale of goods were physically performed in a jurisdiction.
It is based on the physical place of the provision of services and the sale of goods that most jurisdictions regulate the tax generating events. Therefore, large gaps have been generated between the collection of taxes in the digital economy from those that are still performed in the traditional way.
The Organization for Economic Cooperation and Development (OECD) and the G20, through the inclusive framework on Base Erosion and Profit Shifting (BEPS) generated a statement on a two-pillar approach to address the tax challenges arising from the digitalization of the economy.
Under the first pillar, multinational companies with turnover in excess of €20 billion and profitability in excess of 10% will allocate 25% of their residual profits, i.e. those in excess of 10% of their revenue to jurisdictions with which there is nexus. This proposal establishes that the jurisdictions of the final market where the goods or services are used or consumed will be considered as the source of income. The second pillar regulates two rules, the first one imposing a complementary tax on the parent entity of multinational companies when the income is subject to low taxation and the other one denying deductions or requiring a surcharge on income subject to low taxation.
The efforts generated by the OECD seek to modify the regulations of each jurisdiction in order to generate uniformity in the tax treatment of digital services. Likewise, initiatives have been generated to modify the Value Added Tax, in order to tax digital services in the jurisdiction in which the service is received. However, in Central America, no significant changes have been made to address the taxation of digital services.
In the case of Guatemala, only services rendered in Guatemala are taxed, as well as the sale of goods located in the national territory, by virtue of having an eminently territorial tax system. This generates challenges in its application, since there are no clear specific rules on what is understood as where the service is provided, and in the case of sale of digital goods, there is also no clarity on the place where the income is generated. Therefore, in the case of services provided through the Internet, there is no obligation for service providers to register with the Tax Administration in Guatemala and there is no obligation to withhold tax. El Salvador, Honduras and Nicaragua have not generated a specific regulation for the taxation of digital services.
For its part, Costa Rica, with the publication of the Law for the Strengthening of Public Finances, which came into force on July 1, 2019, established the taxation of cross-border digital services with value added tax (VAT). In other words, digital services provided by non-domiciliaries are subject to taxation. The implementation of this regulation defined the application of three alternatives, directly linked to the territoriality of the Costa Rican tax system:
The possibility for the non-domiciled service provider to register as a VAT taxpayer with no income tax effect, and to collect and pay the tax.
A list of digital service providers was created, such as Netflix or Spotify, where the payment processor is obliged to charge VAT to the consumer when processing the payment in favor of the foreign digital service provider.
In the case of VAT taxpayers, on those payments for digital services or intangible goods made to non-domiciled suppliers that are not on the list, they must be subject to reverse VAT, i.e., declare and pay the corresponding VAT.
The above reform was very much in line with Costa Rica’s accession process to the OECD, which culminated on May 25, 2021 when it was recognized as an official member. From the perspective of income tax, the regulation presents normative gaps that make it impossible to subject to taxation the income obtained by non-domiciled digital service providers, being that the authorities are waiting for what derives from the progress being made by the OECD, specifically in relation to the minimum tax contained in pillar 2.