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Latin America (LATAM) is emerging as a significant market for foreign digital service providers. This growth is driven by increased internet usage, a rising middle class, and widespread digital technology adoption. The demand for digital services such as video streaming and online education is rapidly increasing. By the end of 2024, revenues in the electronic services market are projected to reach $10.36 billion, and the digital media market alone could generate $11.87 billion.
However, entering the LATAM market presents specific challenges, especially regarding the Value Added Tax (VAT) on cross-border digital services. Governments in the region have begun enforcing VAT on these services to ensure they collect revenue from this growing sector. For foreign sellers looking to enter the LATAM market, it is vital to understand and comply with these tax regulations for successful entry and continued operations.
The enforcement of VAT on digital services provided by foreign sellers in LATAM began in the mid-2010s. Before these regulations, many foreign digital service providers operated without paying taxes in several LATAM countries, putting them at an advantage over local businesses. To address this issue and increase tax revenues, countries in the region introduced VAT rules. Colombia and Argentina were among the first to apply VAT on digital services provided by foreign companies as early as 2017, followed by Chile, Uruguay, Costa Rica, and Mexico.
Divergent Approaches to VAT Collection in LATAM
While LATAM countries are often viewed as a unified region, their approaches to VAT collection on digital services vary significantly. Some countries require foreign sellers to register for VAT and adhere to local tax laws, while others use payment intermediaries to withhold taxes during transactions. Over time, a hybrid model that combines both approaches has become the most common method for ensuring VAT compliance.
Registration Obligation for Foreign Sellers
In this approach, foreign digital service providers must register for VAT in the country where they offer services, collect VAT, and remit it to the local tax administration. This model is similar to the VAT systems in other regions, like the European Union.
For example, Mexico’s VAT regime for cross-border digital services, effective from June 2020, requires foreign companies providing digital services to Mexican customers to register with the Mexican tax authority. Foreign sellers must charge VAT on their services, file monthly VAT returns, and remit the collected tax to the Mexican government. They have 30 days from the date they first provide services in Mexico to register. As of January 2024, there were 201 foreign companies registered in Mexico.
To complete the registration, foreign companies must appoint a legal representative in Mexico and provide various documents, such as:
An apostilled, and translated power of attorney, company bylaws and foreign tax registration number.
Proof of a tax address in Mexico, such as a lease agreement or utility bills.
Identification of the appointed legal representative.
Mexico is known for having very burdensome tax registration obligations. Recently, the tax administration has added new registration requirements, including:
Company bylaws must explicitly state that services are provided through a “technological platform.”
An affidavit from the legal representative detailing the services offered, the website used, and the company’s main business location.
If a Mexican customer buys services from an unregistered foreign company, the customer must account for VAT. The Mexican tax administration publishes a list of registered foreign service providers to help consumers verify compliance.
Tax Withholding by Intermediaries
In this method, intermediaries like payment processors or financial institutions are responsible for collecting VAT, removing the need for foreign sellers to register or file VAT returns in the country. Instead, VAT is automatically withheld at the time of payment and sent to the tax authority.
Argentina was one of the first countries in LATAM to adopt this system for cross-border digital services. When an Argentine consumer pays for a digital service from a foreign company, the payment processor withholds the VAT and sends it directly to the Argentine tax authorities. The supplier does not handle VAT, and the consumer is treated as the taxpayer for VAT purposes. If VAT is not withheld by the intermediary, the Argentine customer must pay the VAT directly to the tax administration.
The withholding system benefits the government by collecting VAT without managing compliance from numerous foreign companies, while foreign companies avoid potentially complex VAT registration processes. However, issues such as incorrect VAT withholding and increased responsibilities for intermediaries may arise, especially if they do not fully understand the transactions they are processing.
Hybrid Approach
Many LATAM countries use a hybrid approach to collect VAT on digital services. This method combines elements of both direct registration and tax withholding, allowing for more effective VAT collection while providing flexibility for different scenarios.
In Colombia, foreign businesses offering digital services to Colombian consumers can either register for VAT or use a VAT withholding system. The Colombian tax administration provides a list of withholding agents. If a foreign provider chooses to use this system, it must inform the tax administration of their decision. The withholding mechanism also applies to foreign service providers identified as non-compliant with their Colombian VAT obligations.
Ecuador and Costa Rica use a similar withholding system. Foreign sellers can register for VAT, but if they do not, intermediaries like credit card companies will withhold VAT during payment. In Chile, foreign companies are expected to register and charge VAT, but from August 2022, if a foreign supplier has not registered, intermediaries must withhold VAT on payments to non-compliant suppliers.
Peru is currently setting up a hybrid model, effective from October 2024. Non-resident providers of digital services to Peruvian consumers must register for VAT and act as withholding agents. These providers need to file a monthly tax return and remit the VAT collected. If a foreign company does not comply, it will be included in the list of non-compliant entities and payment processors will withhold the tax.
Tax Compliance Considerations for Foreign Sellers
Navigating tax compliance in LATAM involves understanding various approaches to VAT collection, each with its advantages and challenges. The tax registration approach requires foreign digital service providers to register for VAT in the countries where they offer services, providing a straightforward way to collect VAT but imposing a significant compliance burden on foreign sellers. Conversely, the tax withholding approach simplifies compliance for foreign sellers as they do not have to interact directly with local tax authorities. However, this system can lead to errors and disputes if intermediaries incorrectly calculate VAT. The hybrid approach offers more flexibility but adds complexity, requiring foreign sellers to decide whether to register locally or rely on intermediaries for VAT withholding, depending on their business model and the regulations of each country.
Foreign companies registering for VAT in LATAM must ascertain whether their digital services are taxable and, if so, determine the applicable VAT rate. While most digital services are subject to the standard rate, exceptions exist. For instance, Colombia does not tax cloud computing services, while Mexico exempts digital publications. VAT rates in LATAM countries generally range lower than in the European Union but are higher than in the United States. They span from 13% in Costa Rica to 19% in both Colombia and Chile. Notably, Ecuador has increased its VAT rate from 12% to 15%, effective from April 1, 2024, until the end of the year.
Another critical consideration is whether VAT must be collected on all sales or only on B2C transactions. The rules vary by country: Mexico, Ecuador, and Costa Rica require foreign digital service providers to collect VAT on both B2B and B2C transactions. In contrast, Colombia and Chile limit the tax collection obligation to B2C transactions only.
Future Developments
As Latin America’s digital economy grows, VAT rules for cross-border digital services are expected to evolve. One key development is Brazil’s ongoing tax reform, which aims to modernize and simplify its complex tax system. Brazil’s proposed reform plans to consolidate multiple taxes into a dual VAT applied uniformly to goods and services, impacting digital service providers significantly.
Other countries, like Bolivia and Panama, may also update their VAT systems for digital services. While these countries have announced plans to introduce tax collection requirements for foreign digital service providers, these have not yet been implemented. For foreign sellers, staying informed about these developments is crucial. As Latin American markets continue to attract international businesses, understanding VAT regulations and being prepared for changes will be essential for compliance and seizing opportunities in this dynamic region.
The opinions expressed in this article are those of the author and do not necessarily reflect the views of any organizations with which the author is affiliated.
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Publish date : 2024-08-18 05:16:00
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