strategically managing indirect taxes in latin america...strategically managing indirect taxes in...

Strategically managing indirect taxes in Latin America

ContentsI. Introduction 2

II. Brazil and Mexico — the giants of Latin America 14

III. VAT/GST 26

IV. Global trade 38

V. Excise and other indirect taxes 48

VI.Regional management of indirect taxes

52

VII. Bringing it all together 62

1Strategically managing indirect taxes in Latin America |

Welcome to LatAmIn recent years we have seen a dramatic shift in taxation away from government reliance on direct taxes, such as corporate tax, toward an increased dependence on indirect taxes, which are assessed on consumption and individual transactions.

According to the Consumption Tax Trends 2016 report published by the Organization for Economic Co-operation and Development (OECD),* indirect taxes now account for approximately 31% of all tax revenue collected by OECD member country governments, and value-added tax/goods and services tax (VAT/GST) is the third most important type of global tax.

The portion of Latin America tax revenues collected from indirect taxes, such as VAT/GST, customs duties, excise and other operational taxes, is among the highest in the world with Argentina, Brazil, Costa Rica, Mexico, Uruguay and Venezuela all earning close to or greater than 50% of their tax revenue from this group of indirect taxes. That means companies are incurring huge tax bills in Latin America (LatAm) countries from indirect taxes.

The LatAm region is leading the world in modernizing the electronic system platforms in which the different tax authorities interact with taxpayers. This transformation involves not only improvements in the way tax information is reported by taxpayers, but also a more sophisticated method of immediate communication with the tax authorities. In recent years, the LatAm region tax authorities have driven a shift toward electronic invoicing and electronic reporting of tax information, which creates greater visibility than ever before into a company’s tax position.

Many world governments have concluded that taxing consumption is a more equitable approach to generating tax revenue as consumers pay based on their ability to spend and the tax base grows with the economy. These types of taxes are also seen to be less disruptive or distorting to overall economic and consumer behavior. As the proportion of tax revenue generated from indirect taxes continues to grow exponentially, so has attention from the tax authorities. We fully expect to see an increase in audits and controversies surrounding indirect taxes as intense revenue collection pressures continue to grow.

Consequently, the level of scrutiny placed on indirect tax compliance is heightened, and we see executives, tax staff, audit committee members and other stakeholders becoming ever more mindful of the reputational risks associated with getting their indirect tax positions wrong. In LatAm it could be argued that they are even more susceptible to potential tax risks as companies have not deployed sufficient resources and efforts to proactively manage the tax burden and achieve compliance.

Companies recognizing the trend of increased attention need to respond in-kind by redoubling their efforts to comply with a multitude of indirect tax regulations.

This can be extremely challenging with the rapid pace of regulatory change in many countries across the region — making it difficult to know what rules and local practices must be complied with.

Our experience shows many companies operating across LatAm have not yet placed a corresponding level of emphasis on indirect tax management. This oversight could lead to increased levels of potential risks and costs. As we will expand on throughout this report, it is no easy task to strategically manage a company’s indirect tax burden in the LatAm region. Unfortunately, there is no one-size-fits-all management approach that can be deployed across such a diverse group of countries and taxes. It will take concerted effort and dedication to develop an approach that fits your organization.

We will provide our thoughts about the struggles and successes companies will face along the journey of managing their indirect taxes in this part of the world.

Based on our experience, this journey is not a onetime setup but is part of an evolutionary process of understanding, assessing and then proactively managing your LatAm indirect tax footprint.

We hope you enjoy this report and are able to gain valuable insight from our in-depth knowledge and experience into this important area of taxation. We are confident that through our assistance on indirect tax matters you will be able to proactively identify and address risks and opportunities, reduce costs, recognize cash-flow benefits, improve overall indirect tax operational efficiencies and enhance accuracy of compliance.

* OECD, Consumption Tax Trends 2016: VAT/GST and excise rates, trends and policy issues, OECD Publishing, 2016 (accessed via oecd.org, 21 February 2017).

Robert Smith Americas Global Trade and VAT Leader

2 | Strategically managing indirect taxes in Latin America

IntroductionGiven the increasing focus on expanding global business, companies are looking to the LatAm region as an engine for growth more than ever before. However, managing businesses across the diverse group of countries is not an easy task. In order to have a successful operation in this region, companies must be keenly aware of the indirect tax implications and costs of operating across LatAm. EY’s global tax risk survey* has identified indirect taxes as the #2 overall tax risk behind only transfer pricing, and this is even more prevalent in the LatAm region.

The indirect tax regimes in LatAm are some of the most complex in the world — with Brazil arguably having the world’s most difficult tax regime in which companies incur disproportionally high indirect tax costs compared to other countries around the globe. Failure to understand and plan for indirect tax costs in LatAm can jeopardize the best-designed strategic business plans.

Are you aware of the indirect tax risks and costs of operating across LatAm, and what steps, if any, are you taking to proactively manage these?

* EY Tax risk and controversy survey, EYGM Limited 2014.

LatAm macroeconomic outlook

Population 2015: 544 million

GDP Real 2015: USD5.3 trillion

Per Capita Real GDP 2015: USD9,716

LatAm’s share of world economy (% of world, US$)


Each LatAm country’s indirect tax regime is in a different state of technical maturity and development. Some are more sophisticated and aligned with internationally recognized principles, such as those of Argentina, Mexico, Chile and Colombia, whereas Brazil has one of the most complicated tax regimes in the world with many local adaptations and nuances. The regulatory framework in developed regimes is fairly stable with limited updates to the underlying regulations and few dramatic fluctuations in the interpretation of technical matters. On the other hand, in most LatAm countries, we see a constant flow of regulatory changes to revise their governing framework, improve their systems and legislate modifications to the rules along the way as well as interpretations of the meaning and practical applications of each new rule within a compressed timeline. For example, Brazil is well-known for issuing almost 30 new indirect tax rules each day and requiring companies to keep abreast of these changes or risk noncompliance.

Companies must be able to understand and adapt to the local environment of each regime in LatAm to succeed in managing their indirect tax matters. This requires a knowledge of the technical and practical application requirements from the tax authorities.

Source: Oxford Economics, February 2017

8.2

7.4

2011 2014 20172012 2015 20182013 2016 2019 2020

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7.4

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7.9

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As the long-term global trend toward increased indirect taxation is likely to continue and influence tax policies in LatAm, businesses operating in the region need to determine whether they have the right mix of corporate income tax and indirect tax management resources.

Before proceeding further, it is important to define the coverage of indirect taxes as recognized by EY and used throughout this report. The OECD and EY define consumption taxes similarly. Under OECD category 5100, consumption taxes are defined as follows:

Taxes on the production, sale, transfer, leasing and delivery of goods and rendering services into the following two subcategories:

• General taxes on goods and services (5110) — includes VAT/GST (5111), sales taxes (5112), and other general taxes on goods and services (5113)

• Taxes on specific goods and services (5120) — consisting primarily of excise taxes (5121), customs and import duties (5123), taxes on export and taxes on specific services (e.g., taxes on insurances premiums and finance services) in (5126)

We have realigned the OECD categorizations into the following major indirect tax groups, which are explained in more detail throughout the remainder of this report.

GDP (constant prices and exchange rate)

GDP (PPP exchange rate, real)

LatAm’s economic forecast


Customs duties

• Tariffs levied on the importation of goods into LatAm countries are usually based upon the cost, insurance and freight value. We have placed customs in the middle of the types of indirect taxes since trade is such an important element of economic activity in LatAm, and many of the related indirect taxes are collected by customs authorities at the time of importation.

• Economic projections continue to depict uneven short-term growth throughout the region.

• According to the International Monetary Fund (IMF), growth prospects over the next five years will likely remain subdued, particularly for those countries in LatAm facing lower commodity prices and weak investment.

• Growth is projected to pick up in 2017 at a very modest pace ranging between 1% to 3% annually until 2020.

According to the OECD, consumption taxes now account for approximately 31% of all revenue collected by governments across OECD countries. In LatAm, we will clearly demonstrate that the indirect tax burden can be as high as 50%–80% in a number of countries.

Customs

VAT/GST

Excise taxes

Otherindirect andoperational

taxes

Different types of taxes

Other indirect and operational taxes

• Turnover tax (industry and commerce)

• Financial transaction taxes

• Municipal taxes

• Stamp taxes

VAT/GST

• Taxes on consumption and importation of goods and services that usually have an input and output invoice credit system. Output tax is charged on supply of goods or services while input tax is paid to suppliers for purchases, and these are credited against each other with the net amount payable to the tax authorities. There can be multiple levels (federal, state and local) and different groups of combined taxes, such as in Brazil.

Excise taxes

• Excise tax is levied on certain groups of imported and locally manufactured products, such as tobacco, automobiles, oil, natural resources, alcohol and luxury products. These taxes are typically charged on the declared value for imported goods or ex-factory price for locally manufactured goods. The taxes may also be assessed on a fixed amount or combination of ad valorem and specific amount.

2011 2014 20172012 2015 20182013 2016 2019 2020

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5.0 5.1 5.3 5.3 5.3 5.3 5.4 5.6 5.85.2

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2.63.23.2

GDP Real YoY, %GDP Real YoY, %

Source: Oxford Economics, February 2017


Comparing LatAm indirect tax profiles Country Type of tax RateArgentina VAT rates — standard 21%

VAT rates — reduced 10.5%

VAT rates — other 27%, 0% and exempt

IIBB* rates (average):

Industrial 1% to 4%

Commerce and services 3.5% to 5%

Commission and intermediation 4.9% to 8%

Tax on bank accounts 0.6% on every credit and debit in bank accounts

Municipal taxes 0%–3% in general, based on sales which are attributable to the municipality tax base and could vary depending on the activity and jurisdiction

Stamp tax 1% of the total value of the contract or instrument and could vary depending on the jurisdiction and activity

Average customs duty rate 13%

Aruba RT* rates — standard 1.5%

RT* rates — other Exempt

HT* rates — standard 1% through 7 July 2015; 2% as of 8 July 2015

HT* rates — other Exempt

Health tax 2%

Turnover tax 1.5% and exempt on export of goods and services

Bolivia VAT rate 13% (nominal rate); 14.94% (effective rate)

Excise tax (Impuesto al Consumo Especifico, ICE) Specific excise tax: ranging from BOB0,42 to BOB13,42 per liter; percentage excise tax: ranging from 1% to 10%

Average customs duty rate 11.6%

Brazil ICMS* 0% to 35% (for supplies in the same state)

4%, 7% or 12% (for supplies made to a taxable person in a different state)

IPI* 0% to 365% (depending on the IPI tariff table classification for the goods)

ISS* 0% to 5% (depending on municipality and nature of service)

PIS-PASEP* 0.65% (for taxpayers taxed under the deemed corporate income tax method of calculation, under the cumulative system)

1.65% (for taxpayers taxed under the annual actual income tax method, under the noncumulative system)

COFINS* 3% (for taxpayers taxed under the deemed corporate income tax method of calculation, under the cumulative system)

7.6% (for taxpayers taxed under the annual actual income tax method, under the noncumulative system)


Chile VAT rates — standard 19%

VAT rates — other Exempt and additional taxes (ranging from 15% to 50%)

Additional tax on sumptuary products Additional tax rate ranges from 15% to 50%

Additional tax on alcoholic beverages Additional tax rate ranges from 10% to 31.5%

Additional tax on tobacco products Additional tax rate ranges from 52.6% to 59.7%


Colombia VAT rates — standard 19%

VAT rates — reduced 5%

VAT rates — other Zero-rated (exempt)

Excise tax (consumption tax) 4%, 8% and 16%

Financial tax (tax on financial transactions) 0.004%


Costa Rica VAT rates — standard 13%

VAT rates — reduced 5% and 10%

VAT rates — other Exempt and zero-rated

Excise tax Ranges from 10% to 50%


EY has compiled tables of the indirect taxes for each LatAm country to compare and illustrate how important they are to each tax authority. In the following tables below and on page 8 and 9, you can see the system, rates and material percentage of overall indirect taxes collected:

*refers to federal, state and municipal value added taxes, social contributions, withholding VAT and various other similar taxes


Curaçao Turnover tax standard 6%

Turnover tax other 9%, 7% and exempt

Transfer tax 4%

Dominican Republic

ITBIS** rates 18%, 13%, 0% and exempt


Ecuador VAT rates — standard 14%

VAT rates — other 0% and exempt

Special consumption tax (ICE) Ranges from 10% to 300%

Capital outflow tax (ISD) 2%


EI Salvador VAT rates — standard 13%

VAT rates — other Exempt and zero-rated


Guatemala VAT rates — standard 12%

VAT rates — reduced 5% on gross sales for small taxpayers with annual turnover of less than GTQ150,000 (approximately USD19,585) (no input tax recovery)

VAT rates — other Exempt, zero-rated, and a fixed amount on used vehicles


Honduras VAT rates — standard 15%

VAT rates — other 18% and exempt


Mexico VAT rates — standard 16%

VAT rates — other Zero-rated and exempt

Special excise tax (IEPS) Rate depends on service or item: from 3% to 160%


Nicaragua VAT rates — standard 15%


Selective consumption taxes — ISC Ranges from 9% to 42% depending on the product

Stamp taxes — ITF (tax imposed on certain legal documents which have effect in the country)

Fixed rates and ad valorem rates


Panama VAT rates — standard 7%

VAT rates — other 10%, 15% and exempt


Paraguay VAT rates — standard 10%


VAT rates — other Exempt

Selective consumption tax Ranges from 5% to 50%

Peru VAT rates — standard 18%



Puerto Rico SUT state standard rate 10.5%

SUT municipal rate 1%

SUT special rate 4%

Uruguay VAT rates — standard 22%




Venezuela VAT rates — standard 12%

VAT rates — other Maximum 16.5%, minimum 8%; additional (luxury consumption tax) maximum 20%, minimum 15%; zero-rated and exempt


** taxes related to the transfer of industrial goods and services


Country VAT Duties Excise tax Corporate income tax (CIT) Total tax revenue VAT x Total (%) Duties total (%) Excise tax total (%) CIT x total (%) VAT taxes considered CIT taxes considered

Argentina $27,788,316,920.00 $2,206,696,577.00 $1,965,448,415.00 $11,755,662,241.00 $43,716,124,153.00 63.57% 5.05% 4.50% 26.89% Impuesto al Valor Agregado Ganancias Ganancia minima presunta

Bolivia $1,517,615,172.00 $470,177,846.00 $167,982,508.00 $1,745,008,249.00 $3,900,783,775.00 38.91% 12.05% 4.31% 44.73% Impuesto al Valor Agregado IUE

Brazil $209,472,512,820.00 $12,466,849,198.00 $15,742,452,713.00 $58,920,771,209.00 $296,602,585,940.00 70.62% 4.20% 5.31% 19.87% PIS/PASEPS/COFINS/State VAT IRPJ CSLL

Chile $20,606,328,600.00 $506,060,227.00 $3,710,683,413.00 $18,080,006,857.00 $42,903,079,097.00 48% 1.18% 8.65% 42.14% Impuesto al valor agregado Impuestos a la renta

Colombia $10,372,760,469.00 $1,776,792,360.00 $1,837,571,053.00 $14,497,912,818.00 $28,485,036,700.00 36.41% 6.24% 6.45% 50.90% Impuesto al Valor Agregado (actividad interna & externa) Renta y Complementarios

Costa Rica $2,392,041,601.00 $320,537,399.31 $1,432,040,834.00 $2,233,118,665.00 $6,377,738,499.31 37.51% 5.03% 22.45% 35.01% Impuesto sobre ventas de bienes y servicios Impuesto a los ingresos y utilidades

Ecuador $6,500,436,000.00 $1,130,913,800.00 $839,644,000.00 $4,833,000,000.00 $13,303,993,800.00 49% 8.50% 6.31% 36.33% Impuesto al Valor Agregado Renta y Complementarios

Mexico $33,606,848,610.00 $2,095,402,778 $16,836,070,675.00 $61,879,650,000.00 $114,417,972,063.00 29.37% 1.83% 14.71% 54.08% Impuesto al Valor Agregado Impuesto Sobre la Renta

Nicaragua $703,848,232.00 $78,703,771.00 $332,078,260.00 $726,668,770.00 $1,841,299,033.00 38.23% 4.27% 18.03% 39.47% Impuesto al Valor Agregado (a las importaciones y domestico) Impuesto sobre la Renta

Panama $2,413,000,000.00 $390,672,436.00 $377,584,226.00 $2,496,000,000.00 $5,677,256,662.00 42.50% 6.88% 6.65% 43.96%ITBMS — Importación

ITBMS — Ventas Importación Consumo de Combustible

Renta Inmuebles Avisos de Operación de Empresas

Seguro Educativo

Peru $9,230,414,731.00 $542,494,763.00 $1,679,823,035.00 $10,568,823,394.00 $22,021,555,923.00 41.92% 2.46% 7.63% 47.99% Impuesto General a las Ventasion Impuesto a la Renta

Uruguay $4,828,765,423.00 $506,298,106.00 $1,030,921,078.00 $3,018,388,646.00 $9,384,373,253.00 51.46% 5.40% 10.99% 32.16% Impuestos al consumo Impuestos a la Renta

Venezuela $70,274,270,715.00 $9,875,727,363.00 $11,976,327,065.00 $23,775,347,976.00 $115,901,673,119.00 60.63% 8.52% 10.33% 20.51% Impuesto al Valor Agregado ISLR (Petroleo)

LatAm — tax revenue comparison in 2015 in USD

LatAm countries have some of the highest indirect tax rates around the world.

• The OECD average VAT/GST rate is 19%, but a number of LatAm countries have higher rates.

• The average customs duty rate on a global basis is approximately 3%, but many LatAm countries are two, three or even four times higher than this average.

• Excise tax rates in LatAm are comparatively high, and countries such as Mexico collect almost 15% of overall tax revenue.

LatAm indirect tax observations

• Almost every LatAm country collects its highest percentage of overall tax revenue from indirect taxes — well above the OECD average.

• Argentina, Brazil, Uruguay and Venezuela all collect more than 50% of tax revenue from indirect taxes with Mexico following close behind.

• Brazil’s percentage is likely the world’s highest with almost 80% coming from indirect taxes.


Country VAT Duties Excise tax Corporate income tax (CIT) Total tax revenue VAT x Total (%) Duties total (%) Excise tax total (%) CIT x total (%) VAT taxes considered CIT taxes considered

Argentina $27,788,316,920.00 $2,206,696,577.00 $1,965,448,415.00 $11,755,662,241.00 $43,716,124,153.00 63.57% 5.05% 4.50% 26.89% Impuesto al Valor Agregado Ganancias Ganancia minima presunta

Bolivia $1,517,615,172.00 $470,177,846.00 $167,982,508.00 $1,745,008,249.00 $3,900,783,775.00 38.91% 12.05% 4.31% 44.73% Impuesto al Valor Agregado IUE

Brazil $209,472,512,820.00 $12,466,849,198.00 $15,742,452,713.00 $58,920,771,209.00 $296,602,585,940.00 70.62% 4.20% 5.31% 19.87% PIS/PASEPS/COFINS/State VAT IRPJ CSLL

Chile $20,606,328,600.00 $506,060,227.00 $3,710,683,413.00 $18,080,006,857.00 $42,903,079,097.00 48% 1.18% 8.65% 42.14% Impuesto al valor agregado Impuestos a la renta

Colombia $10,372,760,469.00 $1,776,792,360.00 $1,837,571,053.00 $14,497,912,818.00 $28,485,036,700.00 36.41% 6.24% 6.45% 50.90% Impuesto al Valor Agregado (actividad interna & externa) Renta y Complementarios

Costa Rica $2,392,041,601.00 $320,537,399.31 $1,432,040,834.00 $2,233,118,665.00 $6,377,738,499.31 37.51% 5.03% 22.45% 35.01% Impuesto sobre ventas de bienes y servicios Impuesto a los ingresos y utilidades

Ecuador $6,500,436,000.00 $1,130,913,800.00 $839,644,000.00 $4,833,000,000.00 $13,303,993,800.00 49% 8.50% 6.31% 36.33% Impuesto al Valor Agregado Renta y Complementarios

Mexico $33,606,848,610.00 $2,095,402,778 $16,836,070,675.00 $61,879,650,000.00 $114,417,972,063.00 29.37% 1.83% 14.71% 54.08% Impuesto al Valor Agregado Impuesto Sobre la Renta

Nicaragua $703,848,232.00 $78,703,771.00 $332,078,260.00 $726,668,770.00 $1,841,299,033.00 38.23% 4.27% 18.03% 39.47% Impuesto al Valor Agregado (a las importaciones y domestico) Impuesto sobre la Renta

Panama $2,413,000,000.00 $390,672,436.00 $377,584,226.00 $2,496,000,000.00 $5,677,256,662.00 42.50% 6.88% 6.65% 43.96%ITBMS — Importación

ITBMS — Ventas Importación Consumo de Combustible

Renta Inmuebles Avisos de Operación de Empresas

Seguro Educativo

Peru $9,230,414,731.00 $542,494,763.00 $1,679,823,035.00 $10,568,823,394.00 $22,021,555,923.00 41.92% 2.46% 7.63% 47.99% Impuesto General a las Ventasion Impuesto a la Renta

Uruguay $4,828,765,423.00 $506,298,106.00 $1,030,921,078.00 $3,018,388,646.00 $9,384,373,253.00 51.46% 5.40% 10.99% 32.16% Impuestos al consumo Impuestos a la Renta

Venezuela $70,274,270,715.00 $9,875,727,363.00 $11,976,327,065.00 $23,775,347,976.00 $115,901,673,119.00 60.63% 8.52% 10.33% 20.51% Impuesto al Valor Agregado ISLR (Petroleo)

Vene

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2015 Consumption taxes as a percentage of total taxation in LatAm

Consumption taxes as a % of tax revenue

0%

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Chile

Mex

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Pana

ma

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Uru

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Colo

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Boliv

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Nic

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Ecua

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Cost

a Ri

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Peru

50%

10%

60%

30%

20%

70%

80%

40%


The comparison with the OECD member countries’ average of 31% clearly shows that LatAm countries collect more tax revenue from indirect taxes than in most other parts of the world. In fact, most LatAm countries are substantially higher than the OECD average and even as high as 80% in the case of Brazil. Why would this be the case? The rates are not drastically higher than other countries, but there are less exemptions and more cascading tax. Consequently, LatAm indirect taxes are not as neutral as purer regimes seen around the world especially when compared with the European systems.

Tax authorities see consumption taxes as a faster and easier way to collect taxes from a broader base of taxpayers. Accordingly, a tax system based on taxing consumption should be able to more efficiently capture a broader base of transactions.

In general, the tax systems in many LatAm countries are used to protect or encourage local industry. The indirect tax systems operate very independently from each other with different regulatory frameworks as opposed to regions like the European Union (EU) that leverage a common framework and guiding principles. High rates of import and excise taxes prevail in LatAm and are used to protect local economies.

With the exception of some semi-regional treaties, such as Mercosur, CARICOM, Andean Pact, and the Central American Common Market, and some individual treaties between specific countries, there is limited integration of trade in the LatAm region.

The different LatAm tax regimes in place and the steady pace of new regulations make the following questions difficult to answer: do you know how much in indirect taxes

you are paying in LatAm? Are you in compliance with all of the complex indirect tax regulations across the region? How are you managing this important area of tax? In the past, it was easier for companies to avoid addressing these issues because LatAm may have accounted for a smaller portion of their entire global business. This is no longer the case as the LatAm region includes some of the biggest and fastest growing economies in the world. Companies must be prepared to respond to the increased scrutiny coming from both internal and external sources.

Internally, companies are paying closer attention to their indirect tax profiles. Finance and tax departments are starting to recognize that indirect taxes under management are a material item that must be appropriately addressed. Stakeholders are starting to realize that these taxes are not just pass-through balance sheet items but can have a direct impact on profitability, cash flow, company reputation and in general, the ability to perform business in the region. Consequently, audit committees and management are starting to question which internal department or staff should be accountable for managing indirect taxes across the region.

In some organizations, the finance department has historically been held responsible for indirect tax compliance, as part of the transactional tax function. However, with no tax specialization, the finance department cannot effectively determine, anticipate or address risks and opportunities. Other organizations struggle with a lack of internal resources to manage the indirect tax function in some countries and are not able to easily find resources with experience and knowledge across the broad region. Language barriers can also be an important issue to consider.


On the other hand, tax authorities are under extreme pressure to enforce compliance and to increase tax revenue. Consequently, they are taking a more aggressive approach on technical issues, implementing new electronic reporting systems that create and transparency into a company’s indirect tax data in almost real time. We anticipate that greater electronic reporting will rapidly expand throughout the whole region. Companies must be prepared to meet the growing electronic demands from the tax authorities.

With this increased focus from both internal stakeholders and external government authorities, we think it is important for companies to view indirect taxes from a number of angles to more efficiently address risks and progress toward strategic management through an indirect tax framework.

This indirect tax framework is built upon the recognition that the following three aspects of indirect taxes must be managed.

OperationalTransaction processing, data capture, accounting treatment and indirect tax procedures are all important elements of capturing indirect tax information. How systems have been set up to capture indirect tax information and how they process the indirect tax elements at the transactional level are essential to successful indirect tax management. Further, a functional operational system will help identify what accounting treatments are being applied on individual transactions and determine whether such transactions are being processed correctly and deriving accurate tax outcomes. The operational aspect will also help companies address how indirect tax data is being rolled up into accounts that flow through to the financial statements and whether their systems are able to accurately report tax data on a real-time basis. Finally, it can help determine what procedures and internal controls are in place to facilitate accurate processing of transactions and data.

ComplianceTimely and accurate completion of a company’s indirect tax compliance obligations is important in LatAm. Indirect tax returns must be submitted at periodic intervals (e.g., biweekly, monthly, quarterly or annually) while customs declarations must be correct on each and every cross-border shipment.

In some countries, multiple returns may need to be completed and filed within very tight deadlines after the end of a reporting period. Companies must identify the sources of relevant data for preparing returns and how

and by whom the declarations/returns will be prepared. Further, they must make certain that the correct data and procedures are being used to calculate and report the correct amount of tax payable.

StrategicExperienced resources are needed to gain a full understanding of the business and how its transactions should be treated and processed in the systems. Using technology, data analytics, or detailed systems and process reviews to uncover risks, identify potential opportunities and streamline procedures will result in more accurate, consistent and efficient indirect tax processes. Continuous improvement to systems, processes and controls is an important element of strategically managing your indirect taxes.

Companies should undertake proactive planning to effectively and legally reduce their indirect tax costs. They should also be asking how this is being accomplished within their organization and by whom.

From our experience helping clients in LatAm, there are significant gaps between the indirect tax operational, compliance and strategic activities undertaken in the region. Most companies have no choice but to focus on executing the operational and compliance activities since these are necessary to run the day-to-day business. Notwithstanding this, even the operational and compliance aspects, which should naturally be closely aligned, seem to be disconnected, causing inefficiencies and errors in processing and reporting. They may also raise red flags with the authorities. At the same time, there are also gaps between the operational and compliance activities and how these are used for strategic management purposes to improve indirect tax performance.

To date, we have not seen many companies in LatAm that are able to elevate the management of their indirect taxes to a strategic level — partly due to lack of knowledge and disconnects between the operational and compliance aspects but the lack of regional visibility also contributes heavily. Those seeking to manage their LatAm indirect tax burden must gain a detailed understanding of each aspect of the indirect tax framework and where they should be connected. These activities will force companies to consider new and innovative approaches for managing the operational, compliance and strategic aspects of their indirect taxes around the region. Through such proactive efforts, it is possible to close the gaps and more closely connect the elements of the indirect tax management framework to achieve your objectives.

| Strategically managing indirect taxes in Latin America12

LatAm indirect tax highlights

Costa RicaPlans to implement VAT to replace GST at a rate of 13% by the end of 2017, rising to 15% in 2017

Colombia• Standard VAT rate increased as of January 2017 from 16% to

19%. Some goods and services keep the preferential rate of 5%.

• New customs law released in March 2016 to standardize and modernize logistics and customs technology.

SurinamePlans to introduce a VAT system have been postponed until further notice.

EcuadorIn April 2016, VAT rate was increased from 12% to 14%, in order to finance the reconstruction efforts after devastating earthquake.

ChileJanuary 2016: VAT applies to sale of immovable property.

Brazil• ICMS (state VAT): simplification of reporting obligations for

ICMS purposes within the 27 states. Current pilot project under development in five states.

• ISS (municipal service tax): national implementation of the electronic invoice for services (NFS-e). Currently, just some municipalities require taxpayers to issue electronic invoices for ISS purposes. The measure intends to make this a requirement in all municipalities.

• Simplification of procedures to refund and offset federal taxes. This should be implemented as of December 17 for federal indirect taxes.

UruguayDecree extends additional VAT reduction of 2% for transactions paid through debit cards or electronic instruments valued at less than 4,000 indexed units (approximately USD485) to invoices issued as of 1 January 2017.

PeruTax reform proposals modify the regulations related to the special VAT refund regimes, which are intended to promote and facilitate investments in Peru.

Mexico• Electronic audits mechanism began operating in September 2016.

• New export invoicing and documentary support for valuation requirements represent challenges for companies.

• NAFTA renegotiations may be undertaken with the new US administration.

Argentina• Tax changes enacted, including a VAT collection system

for nonresidents. The substitute taxpayers will pay the corresponding VAT (general rate 21%) and use the amounts paid as input VAT to offset of their own output VAT. When it is not possible to withhold the tax, the new legislation states that the substitute taxpayer will be responsible for paying the tax.

• DJAI (anticipated sworn statement) procedure was eliminated and replaced by the simplified integrated system of import monitoring.

• New prior automatic and non-automatic import license system has been introduced.


We continue to be surprised at the limited time and resources that companies have historically dedicated to manage LatAm indirect taxes. Nevertheless, we are seeing a greater emphasis placed on managing indirect taxes on a LatAm region-wide basis in today’s tax environment. An investment in internal or external resources to manage LatAm indirect taxes should result in a much greater return as costs and risks are reduced through their proactive efforts to enhance indirect tax performance. We would encourage companies to build up stronger internal functions and organizational support structures to manage the region-wide indirect tax burden, and tangible benefits will surely follow.

Understanding the gaps in indirect tax management

Gaps between strategic and operational

Limited visibility of local entity indirect tax footprint, processes and data

Limited use of operational and transactional data analysis for improvements

Little standardized accounting and operational processes leading to inefficient performance

Multiple systems and internal departments performing parts of end-to-end indirect tax processes in isolation

Gaps between strategic and compliance

Limited use of compliance returns/data to discover potential risks and opportunities

Compliance processes that could be used to enhance performance, save costs and reduce risks are not entirely considered

Lack of development of new ways to perform indirect tax compliance to leverage standardization, centralization, etc.

Lack of use of data analytics tools

Gaps between compliance and operational

Multiple systems processing accounting entries and transactional details not always reconciled to return summary data

Variances between accounting data and operational support documentation

Operational processes completed by different departments from those completing returns

Strategic

Operational

Compliance

“Our first challenge has been getting to know all of the technical and practical requirements of the authorities in each country so we can have a clear view of how a taxpayer can fulfill their compliance obligations. However, we have been spending most of our time resolving historic issues and stabilizing the operational and compliance processes for our LatAm businesses before we can get to the strategic management activities. We have requested and need additional indirect tax resources in order to move to strategic efforts.”

“Strategic optimization efforts that save money for the organization are the ‘sweetener’ that buys you creditability and a seat at the table to reinforce the need for compliance. If you can show the actual value of the savings created by the indirect tax function, it is easier to build a business case for additional resources to manage the overall function. Otherwise, it can be difficult to build a world-class indirect tax function only on compliance activities. You need to be strategic.”


5.6 5.65.7

5.64.7

4.5 4.85.2 5.5 5.8

2.6 2.5 2.5 2.5

1.8 1.82.0 2.1 2.2 2.2

1.2 1.2 1.3 1.3

1.2 1.01.0 1.1

1.2 1.2

-5.0

-2.0

1.0

4.0

7.0

10.0

13.0

16.0

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

LATAM Brazil Mexico

LATAM GDP (% of world) Brazil GDP (% of world) Mexico GDP (% of world)

Brazil and Mexico contribute more than 60% of LatAm gross domestic product (GDP).

Nominal GDP* (USD trillion) and real GDP growth (%)

GDP (% share of world, 2015):LatAm: 7.0%Brazil: 3.1%Mexico: 1.6%

Brazil and Mexico — the giants of Latin America

Source: Oxford Economics, 2017; *constant prices and exchange rate, USD


BrazilBrazil is the seventh largest economy in the world and accounts for approximately 45% of South America’s entire GDP. Powered by more than 200 million people and an abundance of natural resources, Brazil has built a diversified industrial base from food and beverages to airplanes and computers.

Brazil has been the largest coffee producer for more than 150 years and produces ethanol, iron ore, steel, orange juice, soybeans, corned beef, textiles, footwear, electrical equipment and automobiles, along with other products.

Brazil’s direct and indirect tax policies are seen by many foreign companies as providing incentives and protections designed to strengthen local industry. For example, the average import customs duty in Brazil is 13.5% — more than four times higher than the global average — which puts imported goods at a significant cost disadvantage. Many of Brazil’s tax reliefs have implemented local content requirements, forcing entire industry sectors to localize their production and supply chains to efficiently access the enormous Brazilian market.

Indirect taxes in Brazil are so material to business operations that they must be closely monitored and managed holistically in order to be successful in the local market. How are you managing these taxes in Brazil?


As previously mentioned, Brazil’s indirect tax system is one of the most, if not the most, complicated systems in the world today. The following six main indirect taxes are incurred by companies operating in Brazil:

How do these tax rates actually translate into costs incurred by businesses operating in Brazil? We created a common business fact pattern to demonstrate how these taxes are material to your operations in Brazil.

Description Federal social contributions

Federal VAT State VAT in 27 states

Municipal VAT in 5,570 municipalities

Customs duty

Taxable event

Revenues or imports Manufactured products

Movement of goods and supply of transportation or communication services

Supply of services listed in the law

Importation of products

Rates Standard rate: 9.25% Other regimes: 0%, 3.65%–13.10%

Rates range from 0% to 300%, according to the tariff code

Rates vary according to the state of origin and destination, import content, type of customer and type of product, usually range from 4% to 19%

Rates range from 2%–5%

Rates range from 0%–35%

Credits Noncumulative system: credits can be calculated with restrictions

Cumulative system: no credits available

Credits are limited to products used as inputs

Credits are limited to products and services related to the company’s core business

No credits allowed No credits allowed

PIS COFINS IPI ICMS ISS II

Indirect taxes of considerable importance to taxpayers

Brazil observation:

The indirect tax costs on imports and local operations can be as high as almost 60%. No wonder indirect taxes are so important to a successful business in Brazil. You cannot afford to get it wrong here.

What’s the impact of indirect taxes on sales and imports?

Espirito Santo

Rio de JaneiroImpact on local operation

Product value (Cost + margin) 100

Gross up 137.46

ICMS 18% 24.74

PIS/COFINS 9.25% 12.71

IPI 10% 13.75

Total value 151.20

Impact on imports

Product value 100

Import duty 8% 8.00

IPI 10% 10.80

PIS/COFINS 11.75% 11.75

ICMS 18% 28.66

Total value 159.21

It’s getting more and more complex every yearA study shows that considering the 26 years after the last revision of the Brazilian Constitution (1988), tax authorities have issued an average of 30 new rules per day.

Total of 290,932 fiscal rules Ranking of taxes paid

Sources:Brazilian Institute of Tax PlanningRated by Globalization Services at GartnerDoing Business World Bank from 2013 Footnote: Comparison between 188 Countries tax

Time to be compliant with ancillary obligations (in hrs/year)

Compared with other Latin American countries, Brazil is the most complex ...

31%

59%

Municipal

State

Federal

10%

Peru

Ecuador

Colombia

Chile

Argentina

Brazil 159

153

38

104

91

73

Peru

Ecuador

Colombia

Chile

Argentina

Brazil 2,600

405

291

203

654

293


Localization complexity ranking

Brazil Argentina Colombia Venezuela Peru Chile

Complexity level

Frequency of legal changes

Difficulties in law’s interpretation texts

Complexity level

Very high complexity

High complexity

Medium complexity

Low complexity

Interpretation of law

Very difficult

Difficult

Medium

Easy

Frequency of changes

Very dynamic (more than 6 per year)

Dynamic (more than 2 per year)

Medium (1 or 2 per year)

Stable (less than 1 per year)

With so many indirect taxes applied on different types of transactions, at the federal and state levels and where credits may not be allowed across the different tax types, it is apparent the indirect tax regime is complex. But how complicated is it really? The World Bank conducted a study showing just how difficult it is for companies to maintain compliance with the Brazil indirect tax regime and the following table summarizes those findings:

Brazil ranks the highest in complexity in every category, including frequency of regulatory changes, practical interpretation of the laws and rules, the most hours spent by staff in compliance activities and, finally, in the amount of indirect taxes paid. This report clearly demonstrates the challenge that companies face in order to efficiently and strategically manage their indirect tax obligations in Brazil.

Finally, any discussion on Brazil’s indirect taxes would not be complete without mentioning that the tax authority is leading the world in transforming the way taxpayers must interact with the government and provide tax data in electronic formats increasingly on a real-time basis. The Brazilian tax authority’s thirst for tax data and greater insight and visibility into a taxpayer’s transactional data has created an environment in which companies must directly connect their systems with the tax authority to provide data and seek approvals before sales or shipments can occur. The level to which the tax authority is embedded into a Brazilian taxpayer’s daily operations is unprecedented and the envy of governments around the world.


The Public Digital Bookkeeping System (SPED) includes digital accounting bookkeeping (ECD), digital tax bookkeeping (EFD) and electronic invoicing (NF-e), which came into effect in 2008 and continues to expand its coverage into more detailed transactional level data. There is an integrated initiative by the federal, state and municipal tax authorities to promote a more transparent relationship between taxpayers and the tax authority in order to rationalize, standardize and consolidate compliance obligations to avoid tax evasion and prevent unfair competition.

As can be seen by the diagram below, the Brazilian tax authority, through the SPED initiative, is able to capture electronic tax data for all of a company’s accounts, tax transactions and electronic invoices. VAT returns are also capturing detailed transactional tax data. This level of visibility into every transaction allows the tax authority greater access to identify red flags, perform risk analysis and even conduct remote e-audits.

Siscomex

Electronic information on

imports and exports

ECD EFDElectronic invoice

(NF-e)

SPED (Public Digital

Bookkeeping System)Other VAT returns

GIA

SintegrNFC-eEFD/ICMS/IPI

DCTFMDF-e

E-CredacNF-eEFD

IN 86NFS-e

PERDCOMPCT-e

Detailed information

on transaction level

We fully expect to see the Brazilian tax authority continue its efforts toward greater digital tax visibility and require companies to provide ever greater access to real-time data. Companies must understand this trend and be prepared to proactively work within their organizations to satisfy these detailed requirements and may one day soon be required to fully integrate their internal systems with the tax authority.

Companies have their hands full trying to manage their indirect tax burden in Brazil. The indirect tax costs are the highest in the world and noncompliance can result in stiff penalties and fines. Due to the complex indirect tax regime, companies must leverage the detailed knowledge of experienced resources in order to manage their indirect tax function in Brazil.


MexicoMexico is the second largest economy in Latin America and has long been a strategic country in the global supply chain of multinational companies due to NAFTA and other preferential programs designed to facilitate trade. Heavily reliant on export-oriented factories for production and employment, the US is its largest trading partner.

Mexico’s main economic revenue comes from crude oil extraction, remittances sent by Mexicans working abroad, tourism and intense industrial, mining and agricultural activity.

Mexico is also recognized as a global leader in the automotive manufacturing sector. In 2014, Mexico ranked as the seventh largest producer of automotive vehicles at an international level and as the first largest producer of automotive vehicles in LatAm, exceeding Brazilian production by more than 200,000 units.*

Information released by the Trump administration regarding potential renegotiations for NAFTA, the application of US import duties on Mexican products to fund building a border wall, and immigration concerns have companies preoccupied, and simultaneously worried, about the future of Mexico in the supply chain. Mexico trade issues are increasingly grabbing the attention of senior executives.

“Every time President Trump sends a tweet or makes a statement regarding Mexico trade issues, I get a direct call from my CFO asking how this impacts our company. These discussions have raised Mexico and trade matters to the highest levels within our organization. We didn’t always have such interest or unfettered access to leadership on trade issues.”

* Mexican Ministry of Economy at the following website: http://www.gob.mx/promexico/acciones-y-programas/automotriz


Mexico: current environment

0

10

20

30

40

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

USD

bill

ion

Historic energysector liberalization,

fundamentalshift for the

hydrocarbons sector

Automotive and manufacturing continue to be

Mexico’s main driver

Nine stategovernment elections

in June 2016

Exchange rate will continue to show

volatility

Foreign direct investments (FDI)

The Bajio and northern regions continue to lead

FDI index

Oil prices arestill low butstabilizing

Labor costamong the most

competitive worldwide

Federal budgetcuts through 2017

It is important to look at the current economic environment in Mexico and overlay potential policy changes related to trade with Mexican operations as they have the ability to significantly impact the country’s economic outlook and Mexico’s strategic position as a popular manufacturing base. Programs such as NAFTA, Maquiladora and Manufacturing and Export Services Industry (IMMEX) may be revised to decrease the benefits companies have historically enjoyed. We have summarized some general economic information to set the scene of what is happening in Mexico at this time.

With the continued budgetary cuts and spending pressure, it should be no surprise that we have seen increased focus on the collection of tax revenue in Mexico. This is especially relevant for indirect taxes, which account for nearly 50% of overall tax revenue generated in the country; VAT accounted for almost 30% of collected tax revenue while almost 15% is derived from excise taxes. Customs duties in Mexico are less than 2% of tax revenue due to the many preferential duty programs that defer or alleviate the imposition of taxes on goods crossing the border into Mexico — many of which are further manufactured and exported to the US or other countries.

The numbers in Mexico tell the story of how the authorities have, in a few short years, revolutionized the tax world to bring taxpayers into the digital age.


100% of new taxpayers register online

5.4 million companies and individuals issue electronic invoices every day

20.6 million e-invoices are issued daily

8.9 million customs declarations are received every year

292,813 companies have communication with the tax authority through the digital tax mail

Second half of 2016 —beginning of e-audits and automated refunds

To improve revenue collection and identify and mitigate tax risks and evasion, the Mexican tax authority has also taken a proactive approach, closely mirroring Brazil, requiring taxpayers to electronically submit all relevant accounting and tax data. This has given unprecedented visibility into a company’s detailed transactions and daily operations that was just not possible when all such data was paper-based.

The Mexican tax authority has been working on the backbone of the system to gather, sort and analyze this data. This has taken a number of years but is quickly making progress. What should we expect in the future? A regime similar to Brazil in which taxpayers will need to connect their systems to the tax authority and provide real-time access to transactional level data? If this happens, companies must be prepared to verify that their tax and accounting data is accurate at the time it is entered into the operational systems instead of waiting until later to make corrections when submitting periodic returns.


The following diagrams outline the types of data the Mexican tax authorities require to be submitted to analyze your tax position. Do you know what the tax authorities in Mexico are doing with your data? If not, then it is important to understand the steps they are taking to better prepare for questions and risks they may identify as part of their internal findings.

2004 2009 2013 2016 and beyond

Benchmarking between companies

Business rules to detect discrepancies

Predictive models (i.e., network analysis)

• Analysis in real time• Analysis of 100% data• Electronic audits

Electronic requests

Electronic accounting record

Tax return

Customs declarations

Tax refunds

Starting in July 2016, the Servicio de Administración Tributaria (SAT) will validate if the tax ID of the client, reported in the customs declaration and the e-invoices of exports, exists in the US.

Third parties related to the company

Agreement to exchange information with other national agencies

Agreement to exchange information with other international agencies

Audit history

Electronic invoicing

Company addresses


Mexican VAT refundsThe accumulation of VAT credits and the need to claim VAT refunds are two of the major indirect tax issues encountered by many Mexican taxpayers. The refund procedure is highly scrutinized by the tax authority, and absolute compliance is necessary if your company wishes to obtain a timely refund without triggering an audit. Errors or inconsistencies will result in delayed processing of the refund or of it being rejected entirely. Certain sectors, companies or business models regularly generate VAT balances that can tie up essential cash flow and need to be closely monitored. The following diagram outlines the electronic VAT refund filing process:

The above process and scrubbing the relevant data to be submitted with the refund application will greatly enhance your ability for quicker approval and processing of your refund. Otherwise, we have seen many situations in which companies are stuck waiting for months or even years before they receive their VAT refund in their bank account.

Usage of technology and analytical solutions has become an essential part of the relationship between the Mexican tax authorities and taxpayers. In this sense, the use of electronic invoicing, e-accounting, online filing of tax returns and payments, tax mail, electronic signature and electronic audits are tools that the tax authorities are currently using to analyze information almost in real time. The new digital tax world requires taxpayers to implement monitoring schemes to detect irregularities in real time and also to have traceability of their information in order to respond in a timely basis to the requirements from the tax authorities.

With the intense global focus on business in Mexico, the management of your indirect tax profile is more important than ever before. Are you ready?

Yes

Yes

No

No

refund

Electronicfiling F3241

180 days to conclude

90 days to conclude

Verification tothird parties

Additional information

First requirement within 20 days after

filing

Information requirement

Second requirement10 days following

compliance offirst requirement

Up to 40 days following filing Respond

within10 days

Respondwithin

20 days

Audit

VAT


VAT/GSTRecognized as one of the world’s most efficient and popular taxes, VAT/GST is now found in more than 170 countries and affects more than four billion people worldwide. According to the OECD, VAT/GST is the third most important source of global tax revenue for governments and accounts for approximately 20% of total tax collected. We will show this is much higher in most countries around the region. That means that companies and consumers in LatAm are paying a significant amount of VAT/GST in the course of their daily business operations. Do you know how much VAT your company is paying?


Government revenue generated from VAT/GST grows in proportion to consumer spending increases on taxable items. The overarching objective of a VAT/GST is to create a levy on final household consumption, but the tax is collected and remitted by businesses that supply goods and services at each stage in the supply chain. Many companies complain about their role as unpaid tax collectors responsible for accurately administering a tax that, in theory, should not be borne by them but assessed on the final consumer. The staged taxing approach also presents situations in which a business is stuck with VAT/GST costs that could not be recovered or passed on to the end consumer for one reason or another. This is particularly true of LatAm countries where the VAT/GST regimes are well-known for being less neutral than most and result in trapped VAT/GST that is not a pass-through, but becomes an actual cost or cash flow drain to the business. While not the intentional design of a pure VAT/GST regime, many LatAm countries still have specific rules or practical procedures that block the collection, refund or credit on tax amounts that otherwise should be refunded or passed on to the end consumer.

LatAm VAT/GST observations

• Every country collects a higher percentage of tax revenue from VAT than the OECD average of 21%.

• Most country VAT rates are below the OECD average rate, however, the revenue collected is higher. This is because the VAT/GST regimes are not entirely neutral as compared to other countries and result in significant trapped VAT/GST costs to the business.

• Eight countries collect more than 40% of their tax revenue from VAT. Consequently, the authorities are keenly focused on revenue collection and audits.

• Brazil collects approximately 70% of tax revenue from VAT.

21%

13%

18%

19%

13%

19%

14%19%

16% 15%

7%

18%

22%

12%

0%

10%

20%

30%

40%

50%

60%

70%

Arg

entin

a

Bol

ivia

Bra

zil

Colo

mbi

a

Cost

a R

ica

Chile

Ecua

dor

OEC

D a

vera

ge

Mex

ico

Nic

arag

ua

Pana

ma

Peru

Uru

guay

Ven

ezue

la

VAT as a percentage of total taxation in LatAm

VAT/GST as a % of total taxation VAT/GST/other rate

OECD average % of total taxation OECD average VAT/GST rate


There are certain fundamental principles of a typical VAT/GST system that are recognized by countries around the world. These may include the following: the offsetting of input and output tax, neutrality on international transactions, zero rating or exemption of certain goods and services and the efficient recovery of input VAT that seeks to avoid the tax being incurred by intermediate businesses. Unfortunately, many of the LatAm countries do not fully adopt these underlying principles, and we see businesses absorbing a larger portion of VAT/GST costs. This is due to factors, such as inefficient input recovery procedures, limits or restrictions on VAT/GST that can be refunded and other such sticking costs. It is not uncommon to be surprised by the local interpretation of certain rules that seem in conflict with how an international VAT/GST system was originally designed.

Why would there be major differences in the local application of an internationally recognized taxing regime like VAT/GST by LatAm tax authorities? The OECD states that “Countries operate VAT systems with their own exemptions and special arrangements but also with differences in approaches regarding the place of taxation for cross-border transactions. In addition, there are a number of variations in the application of value-added taxes, and other consumption taxes, such as different interpretations of the same or similar concepts, different approaches to time of supply and its interaction with places of supply; treatment of bundled supplies.” Simply put, each country has the legal right to determine how to apply a taxing system in its jurisdiction, and this has given rise to the variations we see across the LatAm region. On top of that, the jurisdictions themselves range widely on their technical knowledge and application of the internationally recognized principles — which can create further confusion on how and why each LatAm country’s indirect tax system is so different.


VAT/GST under managementAgainst surmounting evidence to the contrary, many professionals still believe that VAT/GST is simply a neutral, pass through balance sheet item and therefore not a cost to the business. There is also a common misperception that the netted VAT/GST account balances, or net payable, may be small enough to fall below determined materiality thresholds, thus not requiring proactive management. Those with VAT/GST experience in LatAm are acutely aware that this is not the case and that a substantial amount of costs and cash flow is tied up in these accounts.

VAT/GST under management

What is it? High-level calculation

Total input VAT/GST — total amount paid to supplier on

purchases or imports that form the amount to be credited

against output VAT

+

Total output VAT/GST — the total amount charged to

customers or deemed payable on taxable revenue, sales or

other such activities

+

Total avoided VAT/GST — amount that would have been payable, but avoided through a special regime or preferential program. Noncompliance with

the regime may trigger a liability for which no one

has planned

=

Total VAT/GST under management

High-level VAT/GST under management calculation:

• Take regional/country revenues from annual report

• Multiply by average regional or country rate = output tax

• Take cost of sales and SGA (selling, general and administrative expenses)

• Take out employee costs

• Allocate cost of sales and SGA to each region/country

• Multiply by average regional VAT or country rate = input tax

• Add % to allow for intercompany transactions

• Result = a high-level estimate of the total VAT/GST that needs to be managed on an annual basis

The variations in the LatAm regimes, frequency of regulatory developments and local interpretations by the authorities can trigger a perception that compliance with VAT/GST is a moving target in the LatAm region. This increases the need for companies to more closely monitor and manage their indirect tax activities through an understanding of the unique local differences. Failure to take into account the local characteristics of a system by mistakenly assuming they are the same could be costly.

We recommend that companies look at their VAT/GST accounts from a fresh perspective. Instead of only referencing the net VAT/GST payable, which is based upon balancing inputs and output, we feel it is more accurate to look at the total VAT/GST under management to better reflect the amount of cash tax being managed. When looking at VAT/GST in this manner, the tax takes on an entirely different risk profile. The amount of VAT/GST being handled by the organization is enormous and can even approach or exceed 30% of total sales, even more in Brazil, and multiples of the entity profits or other tax costs.

See the following table for an illustration of how to estimate your VAT/GST under management. Do you know how much you are managing? If not, try to calculate it for management and you will likely be surprised at the outcome.

Isn’t VAT just a pass-through tax? In theory, maybe, but in many LatAm countries this is not the case. There are long outstanding VAT credits waiting to be refunded, federal and state taxes that are not creditable against each other and other “sticking” VAT, which can be costly for the business.


LatAm is leading the revolution in electronic invoicing and capture of indirect tax data At first this may seem counterintuitive, but the developing countries of LatAm are leading the world in the evolving digital tax world. The authorities in Brazil and Mexico, as explained earlier, followed rapidly by Argentina, Chile, Peru and others are quenching their increasing thirst for indirect tax data by becoming digital. Quickly disappearing are the days when a company had superior tax systems as the LatAm governments have invested and built powerful platforms to manage the growing volume of big tax data. E-invoicing, the electronic completion and submission of invoices for VAT/GST purposes, allows the authorities greater visibility into the detailed transactions behind a company’s operations. With this visibility, tax authorities can match purchase and sales transactions between parties, reduce the risk of VAT/GST fraud, complete e-audits of transactions and eliminate the need to wait until a summarized VAT/GST return is completed before looking into the details. Electronic capture of accounting and customs data has quickly followed suit.

The following heat map and chart clearly illustrate the world-leading move toward digital tax in the LatAm region.

High e-invoicing regulatory adoption

• E-invoicing is mandatory for companies meeting certain federal standards.

• Minimum requirements for meeting this benchmark are dropping every year, such as lower revenue figures.

• Strict legislation across countries dictates specifics of what must be reported; legislation does not vary widely by country.

Medium e-invoicing regulatory adoption

• E-invoicing is optional.

• Taxpayers should comply with local and federal regulations, but these vary by country in terms of strictness.

• Invoices may be issued electronically.

Low e-invoicing regulatory adoption

• E-invoicing is not adopted.

• In some countries, legislation has been introduced but not actually adopted.

Note: Countries excluded from analysis include French-speaking countries typically excluded from LatAm classifications.

Source: EY tax resources

Latin America regulatory heat map Perspective

E-invoicing is mandatoryE-invoicing is optionalE-invoicing is not adoptedExcluded from analysis


E-invoicing adoption and enforcement are prevalent in the majority of countries, with increased regulation and enforcement expected

Country Adoption Commentary

Argentina High• E-invoicing is mandatory for companies performing certain activities or operations (e.g.,

exporters) and optional for other businesses.• In addition, large taxpayers are subject to mandatory electronic invoicing.

Bolivia High • Effective 5 January 2015, only invoices using the new virtual system are valid for tax purposes, such as documenting VAT credits.

Brazil High• Nfe, CT-e and NFS-e documents are used for various matters; they serve as invoices, and NFe

and CT-e documents have to accompany each shipment of goods.• E-invoicing is mandatory.

Chile High

• On 31 January 2014, Law No. 20.727 was passed with rules and requirements regarding electronic invoicing.

• In general terms, the law makes the use of electronic invoices mandatory — along with other tax documents, such as debit notes, credit notes, purchase invoices.

• Implementation of electronic invoicing began when companies that had annual income from sales and services during the previous calendar year in excess of approximately USD3,800,000 were required to adopt the system by November 2014.

• VAT input tax credit arises in the period when the buyer or service recipient grants the acknowledgment receipt for the invoice.

Colombia Medium

• Electronic invoicing was introduced in the tax legislation with the Decree 1929 of 2007 but it was never adopted.

• Based on that legislation, currently, in Colombia, some taxpayers have in place a mechanism for sending electronic copies of invoices as pdf or txt files to their customers that should comply with the same requirements as the paper invoices when printed or stored, but this does not constitute an obligatory electronic invoicing system. With the Decree 2242 of 2015, the Colombian Government enacted again the discussion about electronic invoicing. However, this obligation will only start as of 31 December 2017.

Costa Rica Medium • It is possible to issue invoices electronically, but taxpayers should comply with the requirements stated in Directive of the Tax Administration Num. 02-09 dated 9 January 2009.

Dominican Republic Medium• Invoices may be issued electronically.• Electronic invoices with their corresponding NCF are valid for fiscal purposes.

Ecuador High • E-invoicing is mandatory for certain companies.

Guatemala Medium • Electronic invoicing is possible and an authorization from the tax authorities is required.

Mexico High • E-invoicing has been mandatory (CFDI) since 2014.

Panama Low • Panama does not currently have an e-invoicing system in place; it will be implemented in 2017.

Paraguay Low • It is not possible to issue invoices electronically, although the Government has been in discussions about implementing it (following the same model implemented by Uruguay).

Peru High • Electronic invoicing is mandatory for certain taxpayers.

Uruguay High • Invoices may be issued electronically but some taxpayers may receive a mandatory notification to register and issue e-invoices (e-Factura).

Venezuela Medium• In Venezuela, the use of e-invoices is voluntary. • Potential implementation timelines remain uncertain.

Sources: Country-specific websites, EY tax resources

The authorities, through the electronic capture of transaction-level tax data, are armed and prepared better than ever before to challenge the accuracy of your VAT/GST transactions and tax position. How are you responding to this challenge, and will you be ready? One peripheral benefit to this digital tax trend is that the information and data needed to complete returns is more readily available, and more efficient VAT/GST compliance procedures should be designed. As we will see in the next discussion, compliance in LatAm is still a mixed bag.


Sources: Country-specific websites, EY tax resources

VAT/GST complianceManaging VAT/GST compliance across an area as wide and diverse as the LatAm region can be challenging. There are a multitude of variations in local country requirements and differences in the technical treatment for the same transaction, and VAT/GST returns are in widely different formats and requirements.

For instance, in jurisdictions like Brazil, where VAT is levied at the federal, state and municipal levels, indirect tax professionals face unique challenges in planning, standardizing and strategically managing their compliance portfolio when compared with other countries in the region and around the world. Adding another layer of complexity, the complications of programming multiple levels of taxes into enterprise resource planning (ERP) systems requires significant time and expertise.

Another important topic in the LatAm region is the application of different types of withholding requirements applicable on the same transactions. For example, a single vendor invoice in Colombia may require the withholding of four types of taxes (e.g., income tax, CREE, VAT and turnover tax withholdings), which are intricately intertwined with the VAT/GST compliance obligations. It can be difficult to separate the compliance with both direct and indirect taxes when this is the case.

VAT substitution regimes also apply in the LatAm region, in countries such as Brazil (ICMS ST), Argentina and Peru. Through these regimes, the governments require sellers to include additional VAT on their invoices to anticipate the VAT that will be triggered by subsequent sellers in the supply chain. This is not common in other parts of the

world and thus requires special procedures to satisfy the practical compliance obligations.

Throughout the LatAm region, the level of specialization of the tax authorities varies considerably. Countries such as Brazil, Argentina, Chile and Mexico have developed sophisticated electronic invoicing systems that require taxpayers to report their accounting, sales and financial information in almost real time. Other countries still rely on manual information gathered from the periodic submission of VAT/GST returns to understand the company’s overall tax position, but they likely will be closing the digital gap in the future. Consequently, companies will need to design separate or special compliance procedures to mirror the local requirements and match the sophistication level of the tax authorities.

Jurisdiction Frequency of returns

Annual time to comply with tax

administration (hours)

Argentina Monthly 216

Brazil Monthly 1,374–2,600

Colombia Bimonthly 66

Costa Rica Monthly 108

Guatemala Monthly 156

Mexico Monthly 100

Uruguay Monthly 108

VAT/GST returns comparison of the administrative burden in some jurisdictions in LatAm

Data and process flow in an ERP environmentData and process flow in an ERP environment

VAT returnprocess

Master datamaintenance

Core transactionsprocesses

Post-transactionaladjustments

Financialreporting

Taxreporting/audits

General ledger

Financialreporting

Adjustments

Customer data

Product data

Vendor data

Tax codes

Salesprocessing

Purchasingprocessing

Tax engine

Ord

er e

ntry

Ord

er e

ntry


Due to many of the factors outlined above, VAT/GST return preparation in LatAm takes significant amounts of time and effort in order to satisfy the varied compliance obligations. In fact, VAT/GST return preparation time is significantly higher in these countries when compared with corporate income taxes, other taxes and especially when compared with time to comply with EU VAT/GST returns. This significant time requirement means that companies must have established procedures, managed by knowledgeable technical resources who have the experience in the LatAm region to accurately complete these tasks by the short deadlines.

Record Gather Analyze Report

• Transactional processing in various ERP or IT systems

• Accounting entries for VAT/GST account codes and transactions

• Manual adjustments to VAT/GST accounts

• Posting of other additional VAT/GST considerations for accounting and compliance purposes

• Identify systems where transactions are processed

• Download relevant transaction-level data from internal/external systems

• Gather the VAT/GST summarized data, such as account balances, etc.

• Organize and summarize data for further use in return preparation

• Review VAT/GST data and remove incorrect or useless data

• Undertake processes, either manual or using technology/systems, to utilize VAT/GST data to calculate balances and figures for return

• Prepare draft VAT/GST return compiled from base data

• Management review of VAT/GST return before finalization

• Finalize VAT/GST return based upon management review comments

• Submit VAT/GST return either electronically, in paper form or even in person at tax office

• Maintain and retain copies of underlying data and completed VAT/GST return

• Use completed return for comparison purposes in preparation of next period’s VAT/GST returns

Processes would need to be completed from the end of the period to the filing deadline of the next period, which could be only two weeks after the end of the period. How can a company prepare accurate and complete returns in such a short period of time?

VAT/GST compliance processes


Americas — time spent to comply

Corporate income tax time Consumption tax time Average corporate income tax time Average consumption tax time

0%

10%

ArgentinaBolivia

BrazilChile

ColombiaEcuador

HondurasMexico

NicaraguaPanama

ParaguayPeru

Uruguay

Venezuela

20%

30%

40%

50%

60%

70%

80%

90% % of time spent per compliance domain per country

LatAm — comparison with EU

ArgentinaBolivia

BrazilChile

ColombiaEcuador

HondurasMexico

NicaraguaPanama

ParaguayPeru

Uruguay

Venezuela

3.4

6.8

19.4

1.90.9

3.4

1.42.5

1.0

3.52.0 2.2

1.5

5.4

0.0

5.0

10.0

15.0

20.0

25.0% of times the time spent on consumption tax exceeds the EU average

Source: The World Bank/International Finance Corporation

Source: The World Bank/International Finance Corporation


Jurisdiction Types of return Frequency

Number of days available before the due date (actual date might vary based on specific entity)

Argentina

VAT return Monthly 7

Turnover tax return (Provincial filing) Monthly 7

Sales and purchase listing Monthly 7

Withholding tax return (WHT) — SICORE + SIRE Monthly 7

Collection agent return — monthly (turnover) — three provinces Monthly 7

Brazil

ICMS and GIA (balance based on the tax book) Monthly 5

SPED fiscal (ICMS and IPI return) Monthly 2

IPI (balance based on the tax book) Monthly 6

PIS/COFINS (prepare statement) Monthly 6

EFD Contribuições Monthly 4

ISS return Monthly 5

WHT (PIS/COFINS/IRRF/INSS) Monthly 6

DCTF Monthly 2

ISS WHT Monthly 5

Chile


F1886 owner´s withdrawals and credit Annually 15

F1802 employees according to branch or head office Annually 15

F1912 Annually 6

F1884 Annually 11

F1879 Annually 13

F1835 Annually 11

F1847 Annually 14

F1926 Annually 14

F1925 Annually 14

F1803 Annually 15

Colombia

VAT return Bimonthly 6

Industry and commerce (ICA) and withholding (ICA) Bimonthly 14

CREE self-holding return Monthly 6

Withholding tax return Monthly 6

EcuadorVAT return Monthly 7

Tax on payment to foreign entities (ISD) Annually 7

Mexico


Informative returns (DIOT) Monthly 25

VAT withholding tax return Monthly 25

Peru



Withholding tax return Monthly 4

Venezuela

Value added tax Monthly 10


Anti-drugs contribution Annually 14

Science, technology and innovation contribution Annually 20

VAT withholding tax return Monthly 10

Industry and commerce patent Annually 24


We expect to see more and more tax authorities emphasize that a taxpayer’s systems, processes and internal controls must be configured in a way to result in compliant processing — especially when these countries require that the ERP data is transmitted in real time to the authority’s system. The days of processing inaccurate data, making revisions later and fixing transactions as part of periodic return preparation are long gone. VAT/GST compliance in LatAm is rapidly becoming an exercise in real-time, forward-looking processing versus the old method of looking at historical data to compile a return.

In the future, we fully anticipate that the tax authorities will continue to push the burden of enhanced systems processing accuracy back to taxpayers and earlier in the transactional processing than ever before. Given how the operational processes feed directly into the accuracy of the real-time submitted data and the periodic VAT/GST returns, companies must be addressing this aspect as a matter of immediate focus or risk transmitting inaccurate data that can result in audits coupled with stiff fines and penalties. The tax authorities will very quickly flag transactions in which the real-time data varies from the reconciled data later submitted in the periodic returns. Adjustments to this data will be seen as potential errors to be followed up on by the tax authority.

In the hands of experienced professionals who know what to test and how to interpret the results, the ability to analyze the data creates visibility into your entire VAT/GST profile that cannot be gained any other way. Accordingly, we strongly recommend that you begin to perform analysis on your VAT/GST transactional data, and you will likely be surprised at how useful the outcomes can be — especially in countries such as Brazil and Mexico where the tax burdens are high and there are significant buckets of trapped costs and cash flow.

We can help you to obtain, gather and analyze your data into useful results and more valuable outputs that can be easily understood by management. This can help you address the operational, compliance and strategic aspects of managing your VAT/GST footprint and create a strong business case for closer monitoring. It is clear that in LatAm a majority of companies have not been able to align the operational, compliance and strategic objectives of managing VAT/GST due to limited resources, less focus on the region and the variations of the tax regimes. However, we recommend that companies need to focus on aligning these important aspects in the following ways:

By working to align and link the objectives of the operational, compliance and strategic activities, the LatAm indirect tax professional will gain greater insight and ability to manage the overall VAT/GST processes in a more efficient and value-added way. The benefits and efforts will be readily apparent and tangible to the local operations.

Bridging the gaps between VAT/GST management

Operational activities Compliance activities Strategic activities

Improved use ofsystems

Formal processes Automated returns

Data analytics Opportunities andrisk reviews

VAT managementreport

EY can help to bridge the gap betweenoperational and

compliance.

EY can help to bridge the gap between compliance and

strategy.

RecordAccountingfor VAT

IT systemsData Gather Analyze Report Visibility of

VAT position Management confidence

Strategic planning

Bridging the gaps between VAT/GST management


Global tradeTrade issues have dominated US news due to President Donald Trump’s position on free trade and the various free trade agreements (FTAs) in which the US was a signatory or negotiating. This increased scrutiny on global trade issues is raising the level of interest senior company executives are placing on how customs and trade matters impact their businesses. Particular focus is needed on LatAm countries involved in the North American Free Trade Agreement (NAFTA) and Trans-Pacific Partnership (TPP).

One company executive mentioned that “my phone was on fire with questions from senior executives immediately after Trump won the election and every time he comments on trade issues ever since taking over the presidency …” Countries such as Brazil and Mexico play a critical role in the global supply chain of multinationals, and it will be a daunting task if significant regulatory changes, upon which strategic business plans were previously concluded, require material changes to a company’s manufacturing, distribution and supply chain design in order to adapt to the new environment.

Average customs duty rates in the LatAm region, higher than 13% in Brazil and Argentina, are two, three and even four times the global average. This level of import duty costs can protect local businesses and be seen to be a barrier to competition from overseas companies. Clearly trade is an important factor in running a successful LatAm business operation, and today’s level of uncertainty over the future presents both concerns and opportunities. How are you managing trade matters across the LatAm region?

Strategically managing indirect taxes in Latin America | 39


Every time a physical good crosses a country border, or even a customs territory within the same country, the transaction must be reported to the local customs authority. Accordingly, customs falls right in the middle of the supply chain, and companies must be in compliance with trade regulations or risk the consequences of noncompliant activities.

LatAm countries rely on trade for economic progress and continued growth. Trade within the region has increased dramatically over the last 10+ years as the countries have recognized the power and synergies of trading with partners on not only a global basis but also within the same geographic area. To fuel the expansion and supply chain growth, the amounts of tangible goods flowing into and out of the region has reached staggering proportions. Considering the major economic trading partners of LatAm countries, the following chart clearly shows how important trade is to the region:

Country or region

Average customs duty rate

#1 trading partner

#2 trading partner

#3 trading partner

Argentina 13% Brazil EU China

Bolivia 11.6% Brazil Argentina US

Brazil 13.5% EU China US

Chile 6% China EU US

Colombia 5.8% US EU China

Costa Rica 5.6% US EU Hong Kong (China)

Dominican Republic

7.3% US Haiti EU

Ecuador 11.9% US EU Chile

El Salvador 6% US Honduras Guatemala

Guatemala 5.6% US El Salvador Honduras

Honduras 5.7% US EU El Salvador

Mexico 8.57% US EU Canada

Nicaragua 5.7% US Mexico Venezuela

Panama 12.1% EU US Canada

Peru 3.4% US China EU

Uruguay 10.5% Brazil EU Russia

Venezuela 12.9% EU China US

On a global basis, we have seen a steady reduction in customs duty rates and a gradual dismantling of non-tariff barriers. However, the LatAm region has not followed this trend and still has some of the highest average customs duty rates around the world. Non-tariff barriers are also increasing at an alarming rate.

While there are technical standards set by international bodies, such as the World Trade Organization (WTO) and the World Customs Organization, these rules are complex and have usually been written by developed countries with robust legal systems. Developing countries, many of which are in LatAm, are unfamiliar with or in the process of learning the aspects of the technical rules and officials at the working level can struggle with their application. Accordingly, companies need to be prepared to utilize different approaches and strategies for dealing with customs in each country and must be aware of the local variances in the regulatory environment.

Importers into LatAm countries will most likely have to comply with certain non-tariff restrictions. The most common type of non-tariff restrictions are permits that need to be presented to the customs authority during the customs clearance process but can also be import quotas, labeling requirements, etc. In Argentina, depending on the type of goods, permanent imports are subject to approval through prior automatic or non-automatic import licenses. In Mexico, most imported products need to comply with labeling requirements according to Mexican Official Standards (Normas Oficiales Mexicanas) prior to importation. Several LatAm countries require sanitary permits, issued by local government agencies, when importing products from the food or beverage industries. Being aware of the applicable non-tariff restrictions and establishing an efficient process to obtain all required approvals in advance of goods landing at a customs border is important to avoid delays in clearance and compliance issues during or after the import process.

The LatAm region countries have some of the highest import taxes and customs duties around the world. Every country has an average import duty rate exceeding the global average, but countries like Brazil have even more than four times that average (see the chart on page 41).

Source: Compiled from 2014 trade information obtained online at: http://bit.ly/1dvLueH. Average duty rates obtained from the Perfiles arancelarios en el mundo 2015 report published jointly by the World Trade Organization, the United Nations Conference on Trade and Development and the International Trade Center.


Since customs duties are an absolute cost (i.e., not creditable and in some countries duty drawback or refunds are not allowed according to legislation), they account for a significant tax burden on the cross-border movement of goods into the LatAm region. Accordingly, customs duties are still frequently part of the debate about how truly open a local LatAm economy is to global trade and foreign competition.

All trade in LatAm requires the movement of tangible goods across country borders, and unlike the EU or other jurisdictions, there are no customs unions that offer a single customs gateway. Even the Mercosur, Andean Community and the Central American regional blocs,

while able to negotiate and operate as a type of trading bloc sharing common duty structures, do not offer a single customs regime, and every country still has its own rules and way of controlling the customs borders.

Since the LatAm region is composed of many diverse countries, this increases the amount of cross-border activity, and transporting goods even short distances could result in additional customs reporting requirements. Similar to most indirect taxes, companies must employ an approach that takes into consideration both strategic and compliance aspects of the indirect tax management framework if desiring to better manage their customs and trade activities.

El S

alva

dor

Peru

0%

Vene

zuel

a

Pana

ma

Para

guay

Hon

dura

s

Mex

ico

Cost

a Ri

ca

Braz

il

Chile

Puer

to R

ico

Ecua

dor

Arg

entin

a

Aru

ba

Nic

arag

ua

Uru

guay

Colo

mbi

a

Boliv

ia

Dom

inic

an

Repu

blic

Guat

emal

a

10.0%

2.0%

12.0%

6.0%

4.0%

14.0%

16.0%

8.0%

Average customs duty rates in LatAm

Average WTO customs duty rate is approximately 3%.

Every country has an average duty rate higher than the global average.


StrategicCross-border business is expanding rapidly in LatAm, both as a manufacturing base and as an expansion strategy as consumer demand and buying power across the region increases. The key to bottom-line success is understanding and taking advantage of the myriad of FTAs available in the region as numerous companies have experienced.

Map of Latin American free trade agreementsNote: This map only illustrates bilateral preferential agreements. It does not illustrate multilateral preferential agreements, such as CARICOM, Mercosur, Mercosur-India, EU-Colombia and Peru, EU-Central America and NAFTA.

NAFTA

Canada Canada – Honduras Canada – Panama Canada – Colombia Canada – Peru Canada – Costa Rica Canada – Chile

United States of America (US) US – Panama US – Colombia US – Peru US – Chile US – Korea US – Oman US – Bahrain US – Morocco US – Australia US – Singapore

CAFTA (US, Dominican Rep, Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua)

Mexico Mexico – Panama Mexico - Colombia Mexico – Peru Mexico – Bolivia Mexico – Uruguay Mexico – Chile Mexico – Japan Mexico – European Free Trade

Association Mexico – European Union Mexico - Israel

Mexico – Central America (Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua)

■ NAFTA

Canada ■ Canada–Honduras ■ Canada–Panama ■ Canada–Colombia ■ Canada–Peru ■ Canada–Costa Rica ■ Canada–Chile

US ■ US–Panama ■ US–Colombia ■ US–Peru ■ US–Chile ■ US–Korea ■ US–Oman ■ US–Bahrain ■ US–Morocco ■ US–Australia ■ US–Singapore

North America

Regional integration has continued since the enactment of NAFTA during 1994. The new US administration has indicated its intentions to renegotiate NAFTA or even completely withdraw from the agreement. While no concrete proposals for potential amendments have been put forward yet, companies should be prepared to react to any significant changes. In the meantime, Mexico and Canada have continued to expand their FTA network, Canada entered into an FTA with the EU in 2016, and Mexico continues to move forward with trade negotiations (even considering TPP countries without the US) as well as modernizing current agreements (i.e., Mexico-EU FTA).

■ CAFTA (US, Dominican Republic, Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua)

Mexico ■ Mexico–Panama ■ Mexico-Colombia ■ Mexico–Peru ■ Mexico–Bolivia ■ Mexico–Uruguay ■ Mexico–Chile ■ Mexico–Japan ■ Mexico–European Free Trade

Association ■ Mexico–EU ■ Mexico-Israel

■ Mexico–Central America (Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua)

There are now hundreds of FTAs around the world, of which LatAm countries currently participate in 73, with five additional FTAs announced. Countries such as Chile, Colombia, Mexico and Peru have aggressively expanded their involvement in global agreements. FTAs eliminate or reduce tariffs on goods that originate in a certain country as defined by the parties on a bilateral (e.g., US-Peru FTA) or regional (e.g., NAFTA, Dominican Republic-Central America-US FTA) or multilateral (TPP) basis. See the following maps for an illustration of the global reach of FTAs in which LatAm countries are signatories. The map provides a clear picture of how North America’s FTA network (in particular Mexico) covers most of the continent and abroad, while Central America has focused on regional integration and more recently embarked on larger initiatives. South America’s FTA network has remained limited, with a few country exceptions (e.g., Chile, Colombia and Peru) that are aggressively pursuing trade deals with the rest of the world.

FTAs are a critical strategic factor in designing our supply chain. At one point, we were saving over USD250m a year from FTA benefits. We use FTAs in LatAm whenever and wherever we can to gain a competitive advantage.

We have been doing business in Mexico for over 15 years and our entire business strategy was built around NAFTA and customs benefits. Due to these benefits, we currently save over USD300m a year in costs, which allows us a seat at the table with our executive teams.


CARICOM – Costa Rica

CARICOM – Dominican Republic

CARIFORUM – European Union

Northern Triangle (El Salvador, Guatemala, Honduras) – Colombia

Central American Common Market (Guatemala, Honduras, Nicaragua, Costa Rica, El Salvador)

Central America – Panama

Central America – Chile

Central America – Dominican Republic

Central America – European Free Trade Association

Central America – European Union

Costa Rica – China Costa Rica – Singapore

El Salvador, Honduras – Taiwan

Guatemala – Taiwan

Nicaragua – Taiwan

Pacific Alliance (Mexico, Chile, Colombia, Peru)

Panama Panama – European Free Trade

Association Panama – Singapore Panama - Taiwan

■ CARICOM–Costa Rica

■ CARICOM–Dominican Republic

■ CARIFORUM–EU

■ Northern Triangle (El Salvador, Guatemala, Honduras)–Colombia

■ Central American Common Market (Guatemala, Honduras, Nicaragua, Costa Rica, El Salvador)

■ Central America–Panama

■ Central America–Chile

■ Central America–Dominican Republic

■ Central America–European Free Trade Association

Central America

Andean Community (Ecuador, Peru, Bolivia, Colombia)

MERCOSUR (Argentina, Brazil, Paraguay, Uruguay, Venezuela)

MERCOSUR MERCOSUR - Bolivia MERCOSUR – Israel

Chile Chile – Colombia Chile - MERCOSUR Chile – Peru Chile – Panama Chile – Thailand Chile – Hong Kong (China) Chile – Vietnam Chile – Malaysia Chile – Turkey Chile – Australia Chile – Japan Chile – China Chile – New Zealand, Singapore and

Brunei Darussalam Chile – European Union Chile – European Free Trade

Association Chile – Republic of Korea

Colombia Colombia – Republic of Korea Colombia – European Union Colombia – European Free Trade

Association

Peru Peru – Costa Rica Peru - MERCOSUR Peru – Panama Peru – European Union Peru – Japan Peru – South Korea Peru – European Free Trade

Association Peru – China Peru – Singapore Peru – Thailand

■ Andean Community (Ecuador, Peru, Bolivia, Colombia)

■ Mercosur (Argentina, Brazil, Paraguay, Uruguay, Venezuela)

Mercosur ■ Mercosur-Bolivia ■ Mercosur–Israel

Chile ■ Chile–Colombia ■ Chile-Mercosur ■ Chile–Peru ■ Chile–Panama ■ Chile–Thailand ■ Chile–Hong Kong (China) ■ Chile–Vietnam ■ Chile–Malaysia ■ Chile–Turkey ■ Chile–Australia ■ Chile–Japan ■ Chile–China ■ Chile–New Zealand, Singapore and

Brunei Darussalam

South America

■ Central America–EU

■ Costa Rica–China ■ Costa Rica–Singapore

■ El Salvador, Honduras–Taiwan

■ Guatemala–Taiwan

■ Nicaragua–Taiwan

■ Pacific Alliance (Mexico, Chile, Colombia, Peru)

Panama ■ Panama–European Free Trade

Association ■ Panama–Singapore ■ Panama-Taiwan

Interestingly, Central American countries, including Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua, have taken steps to increase their integration through the establishment of a single, uniform customs declaration that will be applied across all countries as well as through the consolidation of FTAs as a single bloc. The implementation of the Mexico-Central America FTA is one such example.

Several South American countries, including Chile, Colombia and Peru, have been aggressively expanding their FTA networks through agreements with the EU, China and participation in regional initiatives, such as the Pacific Alliance. In contrast, the Mercosur countries, including Argentina, Brazil, Paraguay, Uruguay and Venezuela (which was suspended from Mercosur in 2016), have a limited network of FTAs as well as stricter origin requirements that limit potential savings opportunities.

■ Chile–EU ■ Chile–European Free Trade

Association ■ Chile–Republic of Korea

Colombia ■ Colombia–Republic of Korea ■ Colombia–EU ■ Colombia–European Free Trade

Association

Peru ■ Peru–Costa Rica ■ Peru-Mercosur ■ Peru–Panama ■ Peru–European Union ■ Peru–Japan ■ Peru–South Korea ■ Peru–European Free Trade

Association ■ Peru–China ■ Peru–Singapore ■ Peru–Thailand

“A multinational company with a heavy footprint in North America stated that they are ‘heavily preoccupied’ with the current US administration because they are closely linked with Mexico and any increase in duties and changes in policies leading to reduced incentives and investment is seen as worrisome.”

| Strategically managing indirect taxes in Latin America44

With such high duty rates, it is essential that companies manage their cross-border transactions in LatAm. Conducting strategic duty savings reviews to identify opportunities and build an FTA optimization strategy (inbound-outbound duty analysis) is important to obtain a clear understanding of potential FTA duty savings that would be based on country of production, sourcing and destination markets.

The actual savings benefits for certain products traded between qualifying countries can be significant, with many of the customs duty rates being eliminated entirely to 0% or subject to material reductions. Through data analytics it is possible to map product trade flows and identify significant FTA savings opportunities.

For example, consider the following:

• More than USD1 million in savings on imports into Argentina were identified under various FTAs with Brazil, Chile, Mexico and Uruguay through the use of the company’s own trade data. The company was then able to implement compliance processes and realize bottom-line savings from this proactive effort.

• Under the Brazil-Mexico FTA, savings of more than USD10 million each year were identified, and benefits were almost immediately realized through cooperation with suppliers and the importing entity.

While these examples are neither the largest nor the smallest FTA benefits identified through analysis of trade flow data, they illustrate a snapshot of the types of recurring savings that are available for companies that take advantage of existing FTAs. Astute companies moving toward strategic management of trade matters are modeling their supply chain decisions around where and how to recognize FTA benefits directly to the bottom line.

We are still surprised to see many companies operating in LatAm that are not fully enjoying the cost savings and benefits coming from available FTAs. Is your company availing itself of all the available FTA and customs preferential programs? If you are not sure, it is worth exploring.

Alternative use of temporary import programs, which may provide duty deferral or reduction benefits, has also been identified through our data analytics process, resulting in additional savings for importers.

It is through the strategic management of the customs and trade activities that such FTA and other savings opportunities can be uncovered, quantified and then explored. We suggest that companies obtain their customs data from every possible source and subsequently seek to improve the level at which they are strategically managing the customs and trade transactions of the business through detailed data analytics.


Case study — do you know what your customs broker is declaring on your behalf?A company manufacturing products in the Dominican Republic was surprised to learn that the original data it provided to its customs broker was not used when the actual import declarations were filed with the local customs authority. The customs broker had created separate summary invoices that had been translated into Spanish to comply with local requirements, but the invoices were not provided to the company, and some data elements had been incorrectly typed into the summary invoices. Errors included declaring incorrect quantities of imported products as well as differences in the customs value, which could have led to significant fines and penalties if identified by the authorities. The company was able to identify these issues during an internal audit and voluntarily revise the affected import declarations as well as establish a process to supervise the customs broker’s summary invoice drafts.

The manufacturing process for the automotive industry in Mexico can benefit from customs planning as follows:

• Use of FTAs: extensive FTA network that allows for duty-free import of components (e.g., Mexico–Central America, NAFTA, Mexico–Colombia, EU–Mexico FTA) and preferential duty rates in destination markets for finished goods originating in Mexico

• Special programs: allow for deferral or waiver of duties. Most also include VAT waivers, but special requirements may need to be met in certain cases (e.g., VAT certification in Mexico for IMMEX or maquila companies)

• Domestic transfers: after the manufacturing process is completed, automotive parts can be domestically transferred to other suppliers for subsequent assembly

Finished automotive parts are typically exported all over the world. Mexico’s extensive FTA network would allow the finished good to be subject to duty preferences in many importing countries

Components imported into Mexico from around the world (e.g., US, Latin America, Europe)

Inbound-outbound customs planning

ComplianceWhile strategic customs planning has become an essential element for companies doing business in LatAm, aggressive enforcement by customs authorities, with a heavy focus on audits and revenue generation, is also on the rise. Accordingly, compliance with customs regulations and proper interaction with the customs authorities should remain a top priority. In this regard, companies must clearly understand and keep track of all information being submitted to the authorities.

What are you declaring to customs?Our experience has shown that many companies think they know what information and data has been declared to the local customs authority but are surprised to learn that this may not be the case. The actual data finally submitted to the customs authority could be entirely different than data extracted from internal IT systems and provided to their broker. This can be problematic during an audit, investigation or when trying to support a certain position with customs. A key takeaway when managing your customs obligations is that the customs authorities are likely to have better data than you. It is important that you have the most accurate and up-to-date


information to be in a position to defend any challenges from the customs authorities. We see many companies that rely heavily on their brokers/agents to lodge accurate declarations on their behalf without the appropriate levels of oversight or review. This is not recommended. The brokers/agents themselves make errors and use simplified ways of reporting data that can put the company at risk. Companies also employ multiple brokers that are supposed to be declaring products the same way, irrespective of location. However, our experience shows that gaps and differences exist even among your brokers/agents, and these inconsistencies can become your problem as the importer of record, not the broker/agent, as you have the ultimate legal responsibility for the accuracy of declared data.

Knowing what is being declared on your behalf is one of the most important parts of managing your customs activities, especially since brokers in the LatAm region may have different standards toward compliance levels compared to the level your company would strive to obtain. It is imperative to periodically test the broker/agent processes deployed on your behalf and make revisions if they do not satisfy your compliance standards. This is even more critical when multiple brokers/agents are employed by the organization to clear goods

in the same country. You must work to identify the inconsistencies and risks that can arise from brokers/agents taking various approaches and reporting different positions on the same goods.

Use of data analyticsIt is extremely difficult to manage what you don’t know, and this is very relevant for customs transactions in LatAm. Customs data may not be captured within the internal IT systems or retained in the ERP or hard copy declarations may not have been received. The differences in declared data can only be uncovered when comparing the actual customs declarations with the source data the company thought was being declared.

This can be a surprisingly difficult task since there are multiple sources of the truth and getting to the bottom of how the data was processed may not be entirely transparent or traceable.

The most reliable source of trade data would be directly from the local customs authority where the declaration was lodged since this is what it legally recognizes as the truth. In some LatAm countries, such as Brazil, Chile, Mexico and Peru, for example, it is possible for an importer to submit a formal application directly to customs requesting the declared data from the customs


Performing data analytics on trade dataPerforming data analytics on trade dataData analytics on your Customs data

External trade data sources

Internal trade data sources

Customsbroker data

ERP system Shipping system

Customsbroker data

Mapping yourglobal trade

Duty paid analysis

HS code analysis

Risk analysis

Transactional analysis

Reporting analysis

Stronger processes and controls

Improved accuracy ofreporting

Improved cash flow

Systems improvements

Reduced costs

Chile

Colombia

Brazil

Mexico

Peru

Data gathering Consolidation and analytics Improvements

Latin American customs authorities in other countries, such as, Argentina, Bolivia and Ecuador do not provide date

system. While this is technically an option, many companies hesitate to utilize this mechanism for fear that it may raise a red flags with customs and increase the likelihood of being selected for an audit or investigation.

Outside of obtaining data directly from local customs, the broker/agent should have the next most reliable data set as it is traditionally the entity that transmitted the data directly into the customs’ system. We are still shocked that many brokers/agents do not provide source data back to their customers in the normal course of their business responsibilities. We highly recommend that companies formalize the responsibility for brokers/agents working on their behalf to provide the underlying declared data as soon as possible. This can help prevent you from being at a disadvantage for not having access to your own trade data at a critical time.

There is nothing more frustrating than being in the middle of an audit with an aggressive customs authority, particularly when you are not aware of the data that is being used against you. This can be a dangerous position, and the company can be surprised at the differences in data actually declared to customs compared to expectations. Don’t let this happen to you.

To start strategically managing your trade function, you need access to data (either from customs, the broker/ agent, internal ERP systems data, logistics data, etc.) upon which analysis at the transactional level can be conducted. With this data, the company’s customs and trade footprint can be mapped and risk and opportunity

assessments undertaken. Once you begin to analyze the data, it is interesting to see what is uncovered. EY employs a process to analyze trade data similar to the illustration above.

Once the data has been gathered, either directly from the customs authority or from other sources, then a number of different tests and analyses can be performed to create a greater level of visibility into the trade operations but also to target areas for improvement.

In fact, the types of analysis could also benefit other parts of the business, such as purchasing, procurement, logistics, sales, supply chain and others, where this level of data could be helpful in making business decisions.

Through the application of analytics on trade data, risks and opportunities can be more readily identified and resolved. This type of activity has not been widely adopted by customs practitioners based in LatAm to date since access to data continues to be an ongoing struggle. Our experience has shown that once the customs data has been obtained, the types of analysis that can be performed are almost endless and can drive enormous value. Instead of only testing transactions on a limited group of randomly selected samples, businesses are now able to review the entire universe of import/export declarations against a number of established tests and criteria to more readily uncover opportunities and risks.


Excise and other indirect taxesTaxes on certain specifically defined groups of products have been around well before consumption taxes like VAT/GST became as popular as they are today. “There has been a discernible trend in recent decades to ascribe these taxes characteristics other than simply revenue raising. A number of excise duties have been adjusted with a view to discouraging certain behaviors considered harmful for health and environmental reasons.”*

The importance of excise and other indirect taxes in LatAm reflects EY’s observation of the increasing popularity and growth of new excise taxes with increasingly higher rates. These taxes are being introduced on different transactions and a narrow set of goods and services but also growing as a significant source of revenue — Mexico collects almost 15% of its overall taxes solely from excise taxes.

Those companies affected by the excise and other indirect taxes must understand the impact and manage accordingly or risk noncompliance, resulting in significant financial and reputational exposure.

* OECD, Consumption Tax Trends 2016.


Excise taxesExcise duties are levied on the transfer and importation of goods specified by the law and on the rendering of specific services, at a single or multistage depending on the country. Mexico collects almost 15% of its tax revenue from these taxes.

Commonly, taxable persons include producers, importers and suppliers of tobacco, alcoholic beverages, wine, non- alcoholic beverages, syrup, extracts, cellular and satellite phone services, vehicles and motors, luxury objects, recreation and sports craft, and spaceships.

Excise duties are levied at ad valorem or specific rates varying according to the price of goods or services imported or produced/distributed locally.

Other indirect taxes Turnover taxesThis tax is levied on gross receipts and accrued during the tax period (i.e., the calendar year/month) and derived from the development of the activity subject to tax according to the respective local legislation. In certain cases, some legislations provide for taxation on a cash basis (e.g., for taxpayers for whom bookkeeping is not compulsory). Argentina is well-known for its turnover taxes.

Special rules are also provided for the computation of the taxable base for taxpayers, such as banks, insurance companies, foreign exchange transactions, news agencies.


Financial transaction taxesThis tax is levied on the total of the credits and debits (i.e., deposits and withdrawals) in current bank accounts. It is assessed and collected by the financial entities where the current bank accounts are registered. The individuals or entities holding the current bank accounts bear the tax, as it is deducted from the bank account.

In general, the tax base is the gross amount of credits and debits, excluding additional expenses relating to these transactions.

Municipal taxesThis tax is levied on gross receipts accruing during the tax period (i.e., the calendar year) and derived from the development of the activity subject to tax according to the specific city or municipal law.

Stamp taxesStamp duty is a local tax levied on contracts that are either signed or have effect in specific jurisdictions, e.g., city, municipal or state/provincial, depending on the country. The taxable base for the stamp duty is the economic value of the transaction as foreseen in each local rule. If no value clearly arises from the instrument itself, the parties must estimate such value upon payment; certain provinces even request that the value be indicated in the instrument itself.

The stamp duty is payable in the jurisdiction in which the instrument is executed, but it may also be applicable in the jurisdiction in which the transaction has effect.

Case studyA company required to stamp its products with a partial excise tax payment described how the inventory management of the original paper stamps was lacking controls, and as a result some of the stamps were commonly stolen and later resold on the street to be attached to counterfeited goods illegally entering the country. What could have originally been seen as a minor issue became an important reputational risk to the organization.


Regional management of indirect taxesNow that we’ve covered a detailed explanation of the types of indirect taxes, let’s turn our attention to how a company can take on the daunting task of strategically managing the entire indirect tax portfolio across the LatAm region.

As seen by the EY webcast survey results and explained in this section, many companies are currently not able to elevate their indirect tax function to performing strategic level activities as they primarily focus on setting a stable foundation of compliance and processes with a limited pool of experienced indirect tax staff resources.

Strategically managing indirect taxes in Latin America | 53


Companies often wrestle with the idea of how to more effectively execute and efficiently manage their indirect taxes across the LatAm region. Accordingly, we see indirect tax functions of various sizes, strength and effectiveness. World-class organizations have already designed management structures with a regionally integrated approach while others continue to operate with local management on a country-by-country basis to be close to the business and have limited interaction with global/regional resources.

Very few businesses are proactive in their management style, and a majority are still responding in a reactive manner to manage compliance with the myriad of regulations applicable in all the countries of the region at all jurisdictional levels.

The indirect tax functions in LatAm are still in the early days of development and appear to be handled more in isolation on a country-by-country basis, rather than in a comprehensive regional approach. One of the main reasons for this is the significant differences of the tax regimes between countries. Although this may be a true challenge, there are still many aspects of the indirect tax function that can be standardized and managed in a consistent regional fashion.

EY recently surveyed more than 500 company respondents on whether they are proactively managing their indirect tax data in Mexico.

Over 74% responded that they do not perform detailed analysis on their indirect tax data to identify risks or uncover savings opportunities.

EY recently surveyed more than 400 companies during a Brazil webcast on how they are managing their indirect taxes in Brazil.

Only 1/3 are taking a strategic value-add approach while more than another 1/3 are working reactively in “fire fighting” mode.

Although more than 60% of companies we interviewed mentioned that regional teams have some involvement in the management of indirect taxes, our actual on-the-ground experience indicates that the visibility and involvement are limited.

We are frequently asked how a company should manage its indirect taxes, establish a function and even make recommendations about the characteristics necessary to hire potential candidates. Unfortunately, there is no straightforward one-size-fits-all answer to those questions, as they relate to the organization’s management structure, culture, style and specific needs.

The three questions we repeatedly hear from companies about managing their indirect tax function are:

1. What should be managed? There are many different types of indirect taxes, and it is reasonable to ask whether they can be all managed by one person or role, or whether the responsibilities should be divided among different functions. Additionally, the operational, compliance and strategic aspects all need to be managed, but how can all of these objectives be accomplished by the function?

How is your organization currently managing indirect taxes in Brazil?

Do you obtain and proactively analyze your indirect tax data in Mexico?

Strategically managing (e.g., integrated approach with other areas of the business, such as procurement and supply chain)

Proactively managing (e.g., verify future changes in the tax law and be prepared in advance)

Reactively managing (e.g., gather information and calculate/report tax amounts)

33%

30%

37%

We regularly obtain the data and perform detailed analysis.

We obtain the data but do not currently perform detailed analysis.

We do not obtain or perform analysis on our data but would like to learn and understand how we can.

We currently do not obtain or analyze our indirect tax data.

26%

28%

27%

19%


“We decided to combine our indirect tax function structure to take on the responsibility for customs, VAT, excise and other taxes into one department as we saw commonality among many of the indirect tax issues arising from the same transaction or trade flow and felt we would be able to serve the organization better through this approach.”

EY observation:

At EY, we are seeing a growing trend of companies seeking to manage their global indirect tax matters through the design of this type of organizational structure. Numerous companies have seen synergies and grouped tax and trade together. In addition, many are now trying to more closely link trade and VAT/GST closer due to the commonalities in cross-border transactions.

Company observation:

Our first challenge managing indirect taxes in LatAm was getting to know all of the tax authority requirements — the rules as well as the actual local practices, which often vary from the letter of the law. We needed to obtain a clear view of how the taxpayer can fulfill their tax obligations in each LatAm country but this is really tough. The effort requires experienced resources to manage the right activities.

2. Who should be managing? There are many different departments responsible for portions of the indirect tax end-to-end processes. Typically, finance, tax or supply chain has taken the lead in looking after indirect taxes, while other departments maintain peripheral responsibility for transacting parts of the process. It is also important to consider the linkages between the countries, local business units and regional responsibilities to understand who needs to be involved when and where. Should local, regional and/or global resources be responsible for management? How should a company organize and leverage a more centralized function that works closely with local resources?

3. How should the function be managed? There are various ways to manage indirect taxes, such as through the use of technology or through designing formal processes. The level of proactivity and the trade-off between operational and compliance activities with escalating the function to more strategic matters is discussed.

What should be managed?We have covered four major groups of indirect taxes and while there is some commonality and overlap between each, there is also a wide variation in the technical and practical matters that must be addressed by the responsible staff. This increases the difficulty in combining the indirect tax management function into a single role

or person. However, if possible and reasonable for the company’s organizational structure, there are benefits in employing and training a resource to holistically see across the broad indirect tax categories. Since many of the indirect taxes are also linked to trade activities, we have clearly seen a trend of combining tax and trade roles or having trade roles report into tax functions.

Where it is not feasible to combine the management function into one role, there should be clear direction and incentive for the staff to be grouped together or working very closely toward similar goals. Treating the management function of certain indirect taxes differently (e.g., customs, VAT/GST or excise) risks not being able to provide holistic guidance to internal initiatives or coming up with recommendations that are good for one type of tax but creates issues for another. We have seen this problem arise many times in LatAm, where a proposed supply chain transaction or business structure appears to be feasible from an income tax perspective but is later discovered to have created a significant VAT/GST or customs issue that should have been addressed during the idea formulation and vetting process.


The indirect tax function should be managing the operational, compliance and strategic aspects to varying degrees and should have knowledge and overall responsibility for each. If the indirect tax manager does not understand the processes or IT systems used for operational activities or lacks knowledge on the compliance aspects of how returns are generated, then he or she will not be very successful in his or her role. The indirect tax function needs to be more detail-oriented than many others simply because the taxes are assessed at the individual transactional level. It is critical that the indirect tax staff have detailed working knowledge of how the business operates, all the transactions and how they are processed from a regional but also a local perspective.

Actual processing of the operational and compliance level work is frequently delegated to other internal departments, such as tax or finance, or other local resources for day-to-day execution. This delegation should not absolve the indirect tax manager from exerting his or her sphere of influence or responsibility to determine that these are carried out in an effective and efficient manner. Rather, the indirect tax manager should be deeply knowledgeable in each of these areas, reviewing the processes employed and seeking to enhance the overall indirect tax performance.

All too often the indirect tax function gets pulled into working on the detailed operational and compliance activities and is not able to elevate its contribution to more value-adding activities, which come from strategic positioning. When the indirect tax function is involved in strategic matters, it is in a position to influence the operational and compliance activities for the better. Companies should seek to find ways to set certain strategic objectives for the indirect tax function, while at the same time pushing them to control (through a minimum level of oversight or visibility) the in-country processes.

Finally, management should certainly focus on risks but must not overlook savings or planning opportunities.

Too much emphasis on cost savings, at the expense of identifying and addressing risks, and vice versa is not an optimal balance for this role. We have seen

“Strategic optimization and realization of savings is the sweetener that buys the indirect tax function creditability and a seat at the table. If you can bring cost savings, then leadership will be more open to adding resources and enhancing compliance.”

some companies entirely focused on savings and cost reductions, but at a time in the continuum of indirect tax management in which the operational and compliance foundational processes are not efficient. We have also seen companies so focused on a risk management agenda that they are missing savings opportunities legitimately available for the taking. This can be harmful for the indirect tax function as one of the strongest ways to gather support is to identify and bring cash savings to the business units.

A balance between risks and opportunities needs to be struck for the function to be successful.

Who should be managing?Interestingly, many companies currently do not have a dedicated indirect tax manager position for the LatAm region or such an organizational role in the local business units. Instead, there seems to be a reliance on other tax, finance or accounting department resources to share nominal responsibility for indirect tax management activities, which are then performed on a part-time basis. The part-time staff are typically involved only on a reactive basis when a tax issue is encountered that must be resolved. This usually means that the day-to-day operational and compliance activities are being accomplished but little strategic thought is given as to how to improve overall indirect tax performance.

We do not recommend assigning the responsibility to manage indirect taxes to other staff who already have a full plate in their daily roles and who hesitate to fully take on indirect tax management as it is seen as just another task. As mentioned many times throughout this report, the size of the indirect taxes under management, together with the possible tax and reputational risk, means there should be more dedicated indirect tax resources.

The management of the indirect tax function may need to be divided up to cover the operational, compliance and strategic aspects but also to take into consideration the regional and local needs. The indirect tax manager will need to be able to monitor the operational and compliance activities often carried out by other departments and have the authority to effect necessary changes. On top of that, a reporting structure (either direct, dotted lines or through close cooperation) should be discussed so that a regional manager can also reach into the local business units to exert influence on how


the indirect tax business operations are conducted in-country. Thus, the indirect tax function must be able to maneuver through the web of internal organizational and operating structures between local, regional and global units to integrate and closely cooperate with the various internal departments that have a part in processing the operational and compliance activities.

Many different departments play a part in the indirect tax end-to-end processes. Accounts receivable will process collection activities. Logistics will be intimately involved in the physical cross-border movement of goods and the import/export transactions. Sales personnel will decide pricing and must understand how indirect taxes impact profit and loss. Tax and finance typically share responsibility for operational processing of VAT/ GST or other indirect tax returns that are submitted to the tax authority. The accounting department will need to be involved in transactional processing and related accounting entries to verify the financial accounts reflect an accurate picture of indirect tax assets and expenses.

With so many departments each having responsibility for only a small portion of the end-to-end indirect tax processes, it is essential that indirect tax function is able to monitor the indirect tax processing activities from beginning to end.

Oversight through the entire end-to-end indirect tax processes will require close cooperation and interaction with the other internal functions that are responsible for parts of the processes. Such an indirect tax manager role typically does not involve completing returns or submitting declarations themselves but commonly involves oversight for the functions responsible for indirect tax operations and compliance to confirm that people who perform the day-to-day operations are aware of what is expected and know where and when to raise questions. Therefore, to be fully effective, the indirect tax manager must closely cooperate with the various internal stakeholders, such as the business units, finance, IT logistics, sales and legal, to coordinate and monitor these activities. How aligned and connected is your indirect tax staff to other critical parts of the organization?

Given that there are many developing markets in LatAm and with the projected growth levels, companies may benefit from reviewing the roles and reallocating precious experienced resources to more directly manage areas of indirect tax risk in LatAm and developing markets. In fact, we frequently see a glaring mismatch between

a company’s indirect tax risks and the experienced resources employed to manage them. When reviewing the indirect tax function, we have commonly seen situations in which more experienced resources are allocated to the developed markets, which through historic efforts should already have reduced risk to acceptable levels, while very few resources are dedicated to managing the developing markets where risks, costs and complexity are higher.

There are many ways an internationally experienced resource can contribute and add value to managing indirect taxes in developing markets outside its home country — but this must be complemented with local knowledge to be most effective.

10

8

6

4

2

0Developed

Allocated resources Risk level

More stable Developing

Imbalance between risk and resources indirect tax management

Many questions about how and where a regional indirect tax resource should be based and how it can leverage working with local resources to cover the whole process are important. Should Brazil or Mexico be managed separately due to their size? Does Mexico fit into LatAm or part of North America? Caution may need to be taken when placing a regional resource in a complex country such as Brazil or Mexico since the local issues can become all-consuming and can increases the difficulty of spending time in smaller countries.


How should the function be managed?Effective management of indirect taxes across the LatAm region will require a balance of the following four main building blocks in varying measure: (1) experienced resources, (2) IT systems and technology, (3) formal procedures imbedding internal controls and (4) access to experienced professional advisors. Heavy focus on one area will require a correlating reliance on the others to compensate managing the function.

The management scale in LatAm is currently tipped heavily in favor of using less experienced resources and limited staffing to simply execute on the operational and compliance activities. Less focus has been placed on the effective use of IT systems, technology, processes and engagement of external advisors to improve the overall indirect tax performance — but this balance will certainly change over time, as priorities are realigned to match the trend in which the tax authorities are demanding collection of more and more electronic tax data — which should make for an easier transition to more reliance on systems and automation to complete required tasks.

In the future as companies mature in their understanding of the importance of indirect tax management, we expect to see a balanced strategy with more effective use of IT systems, technology and implementation of formal processes, which can exponentially enhance indirect

tax performance. Since these methods reduce the need for human involvement, which is limited in the LatAm resource-constrained environment, they can be more effective in processing large volumes of transactions accurately and improve compliance.

However, certain solutions will need to be tailored to the unique attributes of the indirect tax systems in LatAm.

Advances in technology and process capabilities are providing better opportunities that were not available even just a few years ago. These new capabilities allow companies to strike a better balance between efficiency, control and value in managing indirect taxes. As companies increasingly undergo financial transformation (which may include ERP systems implementations, rationalization projects, changes in tax or finance management, and the adoption of a global compliance and reporting framework), it provides a rare opportunity to elevate its important role in the organization.

The function must also be managed in a proactive, instead of a reactive, manner to be effective and achieve value-adding objectives. If the company is able to make progress on the structure around what is to be managed and by whom, then we would expect to see the level of proactivity increase as well.

Finally, we suggest that the indirect tax function must find a way to elevate its area of focus from day to-day operational and compliance matters to also include value-adding strategic activities. Despite very real obstacles, we believe companies can significantly improve their indirect tax performance in all phases of the tax life cycle (tax planning, tax accounting, tax compliance and tax controversy) through better strategic management of their indirect tax function.

It will be necessary to adopt a host of strategies that make better use of resources, for example through outsourcing, centralization, standardization of processes and documentation as well as through technology and diagnostic tools. However, this is an evolutionary process and will take time to move along a continuum with the goal of becoming a world-class indirect tax function with a structure that facilitates change and empowers those accountable. Where do you currently sit on the continuum (See the diagram on page 59).

For the function to progress along the continuum, it is essential that indirect tax managers give more high-value and strategic advice to the businesses, while retaining intimate knowledge of and monitoring the operational and compliance activities undertaken locally. Market-leading

Systems and technology

Processes

Experts and advisorsResources

Balancing indirect tax management


companies are using a range of practices to improve the strategic management of the indirect tax function in LatAm, including:

• Establishing an effective indirect tax function with dedicated roles and resources with the authority to effect change at a number of levels, including regional, country and local, where appropriate. Large and complex countries such as Brazil and Mexico with a high volume of transactions can provide a natural location for a regional manager.

• Changing the role of the indirect tax function from the performance of necessary but lower value operational activities (e.g., completing returns) to performing higher value activities (e.g., performing analytics on core data) and managing the end-to-end indirect tax reporting process with the objective of uncovering risks, identifying savings opportunities and improving process efficiencies.

• Forging closer relationships between a wide range of corporate departments (such as tax, legal, finance, logistics, IT and local business units) to confirm indirect tax management is high on the corporate agenda.

• Achieving a balance between leveraging regional experience and technical knowledge with local expertise and practical understanding of local business and tax requirements.

• Leveraging innovative technology tools to standardize and automate processes (such as accounts payable and accounts receivable) in order to increase accuracy and reduce the time taken to complete returns, diagnose

problems, and identify and test planning opportunities. As the function develops, we anticipate a much greater use of tools and technology to more effectively manage the function but also reduce the heavy reliance on staff.

• Centralizing to the extent possible, of some indirect tax operational, compliance and strategic activities via the use of mechanisms, such as shared service centers or centers of excellence.

• Establishing and maintaining good working relationships with the tax administrations, especially in those countries where indirect taxes are a known hot issue and where the appropriate levels of in-house control over compliance can reduce audits, penalties and overall company risk rating.

• Outsourcing or co-sourcing compliance, operational or opportunities with third-party providers and advisors in order to generate efficiencies and take advantage of local expertise.

The transition from the current state to a leading class indirect tax function that strategically manages matters on a proactive basis with experienced resources utilizing advanced systems and technology and development of formal processes and connecting the operational, compliance, and strategic pillars locally and across the LatAm region will not happen overnight. We have experience helping companies through this journey and have seen dramatic improvements to costs, operational efficiencies and cash flow as a result. Are you ready to embark on the journey of strategically evolving your indirect tax management function?

Low risk, high automation

Formal indirect tax management: structure-experienced resources connect operational, compliance and strategic aspects; they are proactive and connected to business and other departments and perform regional oversight and local reporting.

Compliance and advisory specialists: they place greater focus on different aspects of tax management, are more proactive, perform local and some regional reporting and have some budget.

Compliance specialist: this includes junior or inexperienced staff who are low in the reporting chain and perform reactively; there is local reporting but no budget.

No function: responsibility is nominally delegated to finance/tax departments on a part-time basis, which perform firefighting tasks only and have no budget.

Leading class

High risk, high automation

Local country role Local country/regional role Business unit/global roles

The indirect tax management continuum


Considerations and challenges for managing indirect taxes across LatAm

Complex organizational structures …Each company has a different internal organizational and legal entity structure in place to operate around the world. With many different subsidiaries, branches, business units and legal entities in countries around LatAm, the reporting matrix for local and regional indirect tax responsibilities can be difficult to align. The business may have a large presence in a few countries but some or no presence in others where issues will still need to be managed. In addition, the internal organizational structure across these local entities and regional management layers may drive where the indirect tax function resides (e.g., finance, tax, legal, logistics).

Finally, while many of the indirect taxes overlap, to some extent, the responsibility for different taxes, such as VAT/GST, customs and consumption taxes, exists in different departments.

Should the company combine the management into a single indirect tax role or share responsibility and align activities between multiple roles? Where should a regional resource be based and can he or she really manage a larger geographic region or will he or she need a more localized approach?

Significant and frequent regulatory developments …As previously mentioned, there are many different types of indirect taxes across the region; each with their own set of rules and peculiar local characteristics. In many countries across the LatAm region, the indirect tax regimes are undergoing significant regulatory changes, as seen by the number of rules issued by Brazil each year. It can be extremely challenging for local and regional staff to stay on top of, or even ahead of, how these impact a company’s compliance with all of the indirect taxes.

The difficulty of having and maintaining reliable, detailed, up-to-date knowledge of local legislation for every country in which a business operates can create a barrier to compliance.


Limited systems visibility into the underlying transactions and data ...Due to the size and volume of transactions processed automatically in the IT systems, it is important to assess whether indirect tax transactional outcomes are accurate. This is even more important in LatAm where the authorities are demanding real-time data and implementing direct connections with the ERP. Our experience shows that the systems transactional data is not always clearly visible and the entries affecting the accounts are buried. Too often we find responsible staff have not dug deep enough to challenge the detailed transactional treatment and still rely on the indirect tax results for statutory, financial and return reporting purposes. In that environment, companies must create greater levels of visibility into the indirect tax transactions under management.

Lack of experienced indirect tax resources in LatAm …Unfortunately, many LatAM businesses are still in the early stages of understanding and trying to manage indirect taxes on a localized or region-wide basis. A majority of companies still have not established a separate role for a dedicated indirect tax manager (albeit some have a regional customs role) who has responsibility and oversight for the entire function. Consequently there is a limited pool of resources with in-depth experience available for companies to recruit, train and maintain who have wide regional exposure to complex indirect tax matters.

In other locations around the world, commonly in Europe, there are specific indirect tax manager roles filled by staff that have been managing indirect taxes for more than a decade or two. This is not the case for most companies in LatAm.

“We cannot have experienced indirect tax resources in every LatAm country. From the center, we take on the responsibility of helping smaller countries come into our governance orbit while they retain the overall management function. This approach helps them to improve compliance and establish procedures while at the same time providing ongoing advice on technical issues because we have an understanding and visibility into their business activities.”


Bringing it all togetherCompanies are no longer in a position to ignore the LatAm indirect tax risks and opportunities due to the heightened level of internal and external scrutiny in today’s world of taxation.

Governments have recognized that a significant and growing proportion of their tax revenue is generated from indirect taxes and are introducing world-leading systems to capture electronic indirect tax data on an almost real-time basis. Increasing trends in proactive enforcement together with internal recognition that the related indirect tax costs are not small are forcing companies to rethink how they view their indirect taxes. Add to the mix some of the world’s heaviest indirect tax burdens encountered by companies operating across LatAm and it has never been more important to focus on managing indirect tax matters with a comprehensive and strategic approach. How is your organization managing this overall indirect tax portfolio?


LatAm countries have a wide range of different indirect taxes that can create operational hurdles and result in significant costs if not appropriately managed. The various taxing regimes, even though in the same region, complicate matters even more as they are all in different states of maturity and development. At the same time, there are numerous similarities that can be leveraged for those taking a regionally coordinated approach to managing indirect taxes.

We have seen many indirect tax issues replicating around the region to which a coordinated and strategic approach would leverage the following efficiently:

• Accumulation of VAT credits and the need to expedite processing of VAT refunds

• Revisions to supply chain, trade flows and restructuring of legal entities, which will typically involve every category of indirect taxes

• The use of ERP and systems to manage indirect tax data — especially in countries such as Brazil and Mexico and others that already require submission of electronic data, which could be leveraged to other countries

• Export manufacturing regimes and customs preferential programs to avoid or mitigate customs duty, VAT and excise tax costs

• Cross-border transactions of goods and services, which can trigger the imposition of multiple indirect tax obligations

• Mergers, acquisitions, spin-offs and other transaction-related activities, which all have indirect tax implications

• VAT/GST compliance that can possibly be regionally coordinated or even outsourced to leverage established processes

• Controversy and audits from the authorities covering multiple indirect taxes on the same transactions using the same tax basis or similar technical issues raised in multiple countries requiring a consistent approach and response

• Numerous other areas of indirect tax that replicate around the region and can be strategically managed through a more organized approach with regional/global resources

As companies begin to better manage the operational, compliance and strategic areas of their indirect tax function, they will see continuous improvements to their overall operations. This work requires a certain level of technical expertise but also needs to have clear ownership and accountability to achieve the desired objectives. We suggest considering the following approach to bridge the gaps within the indirect management framework and more closely align the operational, compliance and strategic aspects of your business.


Closing the gaps in indirect tax management

Closing the gaps in indirect tax management

Current state Work to be done Future state

Prioritize key focus areas1.

2.

3.

4.

5.

Gather and organize data to build your indirecttax profile, understand amount undermanagement, and raise level and visibility withinthe organizationConduct a thorough review of systems andprocesses to enhance indirect tax performanceImprove compliance through increased use of ITsystems, automation, standardization andpossibly centralization effortsPerform data analytics to identify trends, risksand opportunities to reduce costsEstablish an organizational structure withappropriate levels of responsibility andaccountability that can elevate activities tostrategic levels

Gaps

Gaps

Gaps

Strategic

Compliance

Operational

Strategic

ComplianceData

Data

Operational

We have surrounded the operational, compliance and strategic aspects of the indirect tax management framework with data in the graphic above because this is a constant in all parts of indirect tax operations and is important to strategically managing the indirect tax function. It is interesting to note that a company will have more detailed VAT/GST data than the tax administrations (except in countries such as Brazil, Argentina and Mexico where the electronic invoicing systems are giving

more visibility to the tax authorities), while the customs authorities are likely to have better data than the company. For many of the other indirect taxes we have covered in this report, the data is spread across many internal systems or housed in other locations. If a company is able to get behind the transactional-level data to perform detailed analysis and provide consistency across the different aspects, then we believe that significant benefits may be achieved.


Where to start?A reasonable approach to starting this indirect tax management journey can begin with a review of important countries or legal entities where your company has the most operations in a complex indirect tax environment and with the highest risk profile. The availability of electronic tax data coupled with the indirect tax costs typically experienced in these jurisdictions warrants a strategic focus that could then be more readily leveraged to smaller and less complex countries. Subsequently, the company can begin to review and manage operations in other countries with lower risk profiles.

Consider this — in countries such as Brazil, where the access to actual data is most available (even directly from the authorities) — the internal and external systems are more developed; the flows of affected goods and service transactions may be known but have yet to be fully explored. Review of these areas and countries could result

in a deeper understanding of the indirect tax profile and end-to-end processes, which can more easily be leveraged to other less developed locations. Therefore, companies should seriously consider starting the evolution of strategically managing their LatAm indirect taxes from countries such as Argentina, Brazil, Chile, Mexico and Colombia, which have also developed tax systems and/or electronic invoicing requirements and proceeding with a risk-based approach for determining the way forward.

We recommend a company start to manage LatAm indirect taxes by using the following five-step approach, or some variation thereof, and believe this will enable a dramatic improvement to the function as a result. However, do not become discouraged in the beginning if this effort uncovers unknown risks or significant deficiencies in your indirect tax function. That is part of the process and will set you on the right track to enhancing your function, because you can’t really manage what you don’t know.


In conclusion, gaining effective control of your LatAm indirect taxes is an evolutionary process that will take time and effort. The current starting point for many companies today is a limited understanding of indirect taxes around the region, lack of visibility into the detailed transactions that underpin the indirect tax position, little automation to create efficiencies and no definition of who is directly responsible for managing each part of the indirect tax function. This is a common situation because there are very few experienced resources who are fully dedicated to understanding the indirect tax matters faced by business in the various LatAm countries.

All companies will be at different points of maturity in the process of building an indirect tax management function in LatAm, but it is important to start now to keep the momentum moving forward. We see an evolving state of indirect tax management with dedicated indirect tax roles and responsibilities manned by staff who operate in a centralized, or regional manner and apply a consistent reporting framework to manage the operational, compliance and strategic aspects of the business. We fully expect to see in the coming years more indirect tax managers in Brazil, Mexico or regional headquarter

locations who will take on the proactive management of the various country and region indirect tax matters while working closely with local resources charged with executing the day-to-day operational tasks. However, this will require time and a strategic vision to build and deploy this type of management structure.

Whether you need assistance in improving the indirect tax performance at the operational level, want to enhance your compliance efforts or get a jump on your strategic activities across LatAm, EY can help. We know how to provide advice on closing the gaps between the operational, compliance and strategic objectives while managing the diverse indirect tax category groupings of customs, VAT/GST, excise and all of the other indirect taxes around the region. Our EY indirect tax professionals have in-depth practical experience locally, regionally and globally coupled with strong technical knowledge to provide insight and valuable advice to meet all of your indirect tax needs.

We hope you’ve enjoyed this report and look forward to hearing about your continuous journey building a world-class indirect tax function across the LatAm region.

Five steps to improving indirect tax managementFive steps to improving indirect tax management

Dashboard, transaction mapping, total indirect tax under management

Automated returns and VATmanagement reports

Define your indirect tax organization,accountability and responsibilities

Formal processes

Opportunities and risk reviews

Data analytics

1. Build your indirect tax profile

2. Gain thorough understandingof systems and processes

3. Improve indirect taxcompliance

4. Perform data analytics

5. Establish an effectiveorganizational structure

EY | Assurance | Tax | Transactions | AdvisoryAbout EYEY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

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This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice.

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EY contactsRobert S. Smith EY Americas Global Trade and VAT Leader Irvine, CA, USA +1 949 437 0533 [email protected]

Sergio Fontenelle Indirect Tax Leader South America Sao Paulo, Brazil + 55 11 2573 3169 [email protected]

Rocio Mejia Indirect Tax Leader Mexico and Central America Mexico City, Mexico +52 55 5283 8672 [email protected]

Armando F. Beteta Executive Director, Ernst & Young LLP Global Trade Latin America Business Center Dallas, TX, USA +1 214 969 8596 [email protected]

Enrique Agresott-Garcia Senior Manager, Ernst & Young LLP VAT Practice Miami, FL, USA +1 305 415 1742 [email protected]

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