Special Taxation Regimes for Taxpayers with Lower Capacity: Theory and Strategies in Tax Policy and Administration in Latin America

Special Taxation Regimes for Taxpayers with Lower Capacity: Theory and Strategies in Tax Policy and Administration in Latin America

© 2024, Inter-American Center o Tax Administrations – (CIAT)

ISBN: 978-9962-722-60-1

Copyright

The opinions expressed, and the arguments used in this publication do not necessarily represent the official viewpoint of the Inter-American Center of Tax Administrations (CIAT), its executive board, or the countries it represents. www.ciat.org

CONTENT

GLOSSARY

PROLOGUE

TITLE I. THEORY OF SPECIAL REGIMES

Chapter I. SELF-EMPLOYED TAXPAYERS

Objectives

1. Simplification

2. Formality

3. Social inclusion

4. Supplier control

Chapter II. MICRO AND SMALL ENTERPRISES

Objectives

1. Promotion

2. Simplification of formal obligations

3. Tax burden reduction

3.a. Presumptive simplified regimes

3.b. Preferential Regimes

3.b.1. Reduction of the tax rate on Corporate Income Tax and Social Security Contributions

3.b.2. Tax benefits

Chapter III. ESSENTIAL ASPECTS

1. Subjects

2. Parameters

a) Gross income

b) Net income

c) Purchase level

d) Economic activity

e) Assets or capital

f) Self-management or persons involved in the activity

g) Street vending or permitted economic units

h) Maximum unit selling price

i) Rental value of the premises

j) Electricity consumption

k) Surface area affected by the activity

3. Tax calculation (Presumptive technique)

a) Percentage over gross receipts or purchases

b) Fixed fee

c) Presumptive income

d) Presumptive value added

e) Substitution of the taxable person

f) Assets

g) Physical magnitudes

h) Agreement between the tax administration and taxpayers

i) Presumptive techniques applied

Chapter IV. GENERAL CHARACTERISTICS

1. Current regimes

2. Number of regimes (Unit or multiplicity)

3. Benefits granted

a) Simplification of formal obligations

b) Reduction of the tax burden

c) Inclusion of social security resources

d) Substitution of local taxes

4. Preferential regimes: benefits granted

5. Trends in simplified schemes

TITLE II. TAX POLICY AND ADMINISTRATION STRATEGIES

Chapter I. BEST PRACTICES

1. Simplicity in assessment and control.

2. Perception of risk and perception of benefit

3. Formalisation

4. Number of regimes (uniqueness or multiplicity)

5. Very small and small individual contributors

6. Micro and small enterprises: comprehensive policies

7. Economic activities

8. Emigration to a higher regime

9. Management of tax administration

10. Specific control unit

11. Issuance of electronic tax receipts

Chapter II. UNWANTED EFFECTS

1. Fiscal dwarfism

2. Gross income fraud

3. Billing fraud

4. Symbolic fixed fee

5. Disguised dependency relationship

6. The politicization of special regimes

7. Wrong design of the special regime

8. Other undesirable effects

Chapter III. SUMMARY

A. Best practices

B. Undesired effects

C. General summary

REFERENCES

GLOSSARY

PROLOGUE

This study focuses on the taxation of special regimes for taxpayers with lower tax capacity in Latin American countries.

It can be argued that, given the economic and social context, these countries were compelled to be creative and innovative in their tax policy regarding so-called small taxpayers.

The region is characterized by a predominantly low-income taxpayer base, with large sectors involved in the so-called informal economy, resulting in a high level of informality.

That context also provided an opportunity for larger taxpayers in the economic chain (industry, commerce, services) to take advantage of this situation and engage, either wholly or partially, in the so-called underground economy to maximize their income, thereby eroding tax revenues.

Tax administrations with limited capacity in terms of both human and material resources, especially technological resources, focused their target on taxpayers with higher tax capacity, where the additional potential tax to be collected through a tax audit was greater.

This adverse cost-benefit relationship led to this sector of taxpayers often being isolated from controls, creating what I have termed the fiscal island of informality, which in many cases became a space distant from taxation.

This led to two distinct universes within the tax system: one comprised the sector that complied with its obligations, while the other consisted of a sector where there was a tacit fiscal tolerance of underground activity.

Gradually, it became evident that these small taxpayers were supplied by a chain of suppliers or service providers with higher tax capacity. Due to the absence of logical conflicts of interest in the tax system (for example, in VAT the computation of input tax credit, in income tax the deduction of costs), and not being required to issue invoices or tax receipts, they also took advantage to develop all or part of their activities without registering, generating a significant level of evasion in the general tax regime.

In this context, dense economic trade knots were created, with transactions not only involving goods lacking fiscal records but also originating from smuggling and illicit activities.

Another factor driving fiscal misconduct was the loss of fiscal discipline due to the social contagion resulting from non-compliance and the lack of effective action by tax administrations.

Initially, tax experts from central countries and international organizations did not give the theoretical and pragmatic importance that the issue deserved, as they did not share the same economic and social context and therefore the underlying problem.

The present topic was tangentially analyzed, and most of the time, authors were limited to studying only the special regime applied in the country under analysis, without leveraging the extensive regional experience. This occurred due to the lack of comparative studies that could point out the strengths and weaknesses of these regimes.

Subsequently, a new approach emerged, credited to two tax experts, Richard Miller Bird y Milka Casanegra de Jantscher (1992)¹, With an essentially pragmatic vision, they departed from the traditional theory of developed countries and proposed heterodox but efficient courses of action for both tax policy and administration in emerging countries.

They argued that both taxation and policy were the art of the possible, and that was what tax policy makers in emerging countries should focus on. They emphasized that public finance texts overlooked the fundamental role played by tax administration in restoring macroeconomic balance and promoting equity and efficiency.

Hence, their work filled a gap in the theory by linking tax policy with tax administration reform, aiming to find new methods that lead to improving taxpayer compliance.

Among the tax topics that inexplicably had not been addressed by doctrine, despite their relevance, they pointed out, among others, the regimes for small taxpayers.

In their work, they argued that in developing countries, tax administration is tax policy, meaning that, in Latin American countries, the definition of a successful tax policy must consider the actual capacity of the tax administration.

Otherwise, the inefficient implementation of that policy in practice will not only result in the failure to achieve the objectives of tax policy but also, in many situations, the opposite effect of what is intended.

In this line of thought, Shome (2000)² argued that ...the mark of an advanced tax system is seen, on one hand, in the degree to which there is maximum correspondence between tax administration and the original policy objective, and on the other hand, in the extent to which the feasibility of implementation is considered when conceiving a tax.

During the 1970s and 1980s, tax legislation generally applied a sales threshold as a parameter for exempting small taxpayers from VAT and a minimum exemption threshold in the Income Tax.

Obviously, the lack of invoicing or under-invoicing improperly allowed many taxpayers with considerable tax capacity to qualify for exemption, thereby extending non-compliance to significant sectors of economic agents.

For small taxpayers, whether they were eligible for exemption or the general regime, their comfort zone was informality, where they obviously had the greatest economic benefit.

It was in this context that what I term first-generation regimes began to be promoted, which were simplified regimes specifically for VAT, achieved through the application of various presumptive techniques.

The lack of success of these schemes ultimately stemmed from flaws in their design and the pursuit of misguided objectives.

After decades, and understanding the causes of their weaknesses, second-generation regimes began to be implemented, which included an integration of the substituted taxes, with the essential objective being simplification.

As a culmination of this evolution, what I’ve labeled as third generation regimes emerged. These regimes integrate social security resources (pension or health) with the aim of achieving social inclusion and promoting formal employment for micro and small businesses.

Regarding the taxpayers of these regimes, there was also an evolution. Initially, the focus was on single taxpayers (individuals), and in a second stage, attention was also directed towards micro and small businesses.

It is worth noting that the strategies for individual small taxpayers differ from those for micro and small businesses, as they have different objectives that must be taken into consideration by tax policy makers.

This has led to the application of new tax strategies according to the taxpayer, and as a result, the formulation of new regimes.

An aspect of fiscal sociology to consider is that small taxpayers, due to their high quantitative representation, organized themselves and became a significant political consideration for governments. This limited the adjustment of regimes by government authorities.

All this copious practice with dissimilar results allows for generating a critical analysis of both best practices and the unintended effects that their application has led to in the tax systems of countries in the region.

The central point is that tax policy makers, often under considerable pressure and facing logical urgencies due to tight deadlines, must develop proposals without having access to a comprehensive analysis of the issues involved, in order to make the best decisions possible.

Therefore, this study aims to provide a comprehensive contribution based on the experience of the last 50 years of its application in the countries of the area, highlighting from its main characteristics to the strategies that have been implemented and their results.

The objective of this research is not only to target tax policy makers and tax administration managers but also academics and research centers. The aim is to provide them with more elements for the evaluation of special regimes, further enriching the debate they often entail.

The current document methodologically consists of two sections. The first section covers the theory of these regimes, including their essential aspects such as objectives, characteristics, taxpayers, object, tax calculation (presumptive technique), general characteristics like unity or multiplicity, substituted taxes and social security resources, and trends in their application.

While the second section has an eminently pragmatic objective regarding the application of these regimes in recent decades, consisting of conducting a critical analysis of best practices, as well as the unintended side effects they have brought to the Latin American tax system.

¹ Bird, Richar Miller and Jantscher Milka Casanegra de (1992) Improving Tax Administration in Developing Countries, FMI.

https://www.elibrary.imf.org/display/book/9781557753175/9781557753175.xml

La Administración Tributaria en los países del CIAT, Bird Richard and Casanegra de Jantscher, Instituto de Estudios Fiscales (1992), Madrid.

² "La tributación en América Latina: tendencias estructurales e impacto en la administración, La política fiscal en América Latina: una selección de temas y experiencias de fines y comienzos de siglo, Shome, P. (2000): Seminar and Conference Series, Nº 3, LC/L.1456-P, Santiago de Chile, The Economic Commission for Latin America and the Caribbean (ECLAC). Taxation in Latin America: Structural Trends and Impact of Administration", 1999, IMF, Washington.

In taxation, there is an extensive body of doctrine or tax literature regarding the so-called classic or orthodox taxes.

From professors at leading universities to taxation experts and even international research centers, a solid theory has been developed regarding Taxes on Income, Taxes on Wealth, Taxes on general consumption, and Taxes on specific goods and services.

However, because special regimes for small taxpayers are frequently applied in peripheral countries (with Latin America³ and Sub-saharian⁴ Africa being notable examples), they have not received the same level of theoretical interest from central countries. Apart from some generic research on their application by certain international organizations, there hasn’t been as much focus on their theoretical study.

This theoretical void has resulted in the establishment of regimes in countries without prior consideration through comparative benchmarking evaluations to utilize best practices and mitigate unintended consequences. Consequently, in many instances, regretfully, failed experiences have been replicated,