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New Tax Legislation Creates Controversy and Upset In El Salvador 

by Dr. Diego Martin

Published: September, 2014

Submission: September, 2014


The approval of amendments to the Tax Code and the creation of new taxes have caused upset and criticism among business sectors in El Salvador, accusations that they will affect competitiveness and a better economic performance, and lead to an increased cost of living. The new tax measures with which the government intends to attract about $20 million more during the rest of this year, and an even higher amount for next year, have been challenged as unconstitutional by part of the business sector, as well as by individual “amparo” remedies filed by seven financial entities; but while such remedies are resolved, these measures, effective from the first day of September, remain in force.

The tax measures approved in July by Congress, where the FMLN government does not have majority, also affect the printed media, by means of amendments made to the Printing Law.

In order to elaborate on these new tax measures and their effects in El Salvador, weinterviewed Dr. Diego Martin, from Consortium - El Salvador, an expert in tax matters.

New taxes and amendments to the Tax Code have been approved. How do they affect entrepreneurs and the Salvadorans?

Actually only a new law has been enacted. It is a Tax on Financial Operations, which creates two different taxes in this new legal text. The other amendments are directed to reinforce the Tax Code with tools related to the subject of transfer prices, suspension of the statute of limitations for collection of taxes and expiration of the term of oversight by tax authorities, also establishing again a process to define the minimum payment of Income Tax, which is not a new tax. It has also repealed an Income Tax exemption in the Printing Law thus affecting the companies that print newspapers and other materials, save for the book industry. However, this repeal was made as part of the amendment to the Income Tax Law and not directly in the Printing Law.

The only new taxes created are those regulated in the Law of the Tax on Financial Operations. Although the name of the law indicates one tax, it is actually divided into two different taxes: first, a tax on checks and financial transfers, and second, a tax on liquidity control. The first tax is levied on transfers made by means of checks or electronic transfers exceeding one thousand dollars, and the liquidity control tax has been established to control the liquidity of merchants, entrepreneurs, taxpayers or not, as a tool to be used by the Tax authorities to seek and control individuals with informal activities and expand the taxation base, which is in fact the main objective of the second tax.

Did the implementation of this Law take the banks by surprise?

It was not a surprise, because these are provisions that have been discussed for months; but they were not prepared, in view of the fact that the Law was enacted suddenly and in a very fast manner, establishing an extremely short time for its entry into force and implementation.

According to publications of ABANSA, some associations and the financial system, banks have stated that they did not have the information technology tools to manage the tax, adding that if they were not given sufficient time to get prepared, they would have to keep control of these taxes manually, thus delaying terribly any financial transfers and the banking activity. However, they have the obligation to enforce the law and pay such taxes starting from the first of September, just giving them a term slightly longer than 30 days counted from enactment of the Law.

Would the banks be expected to have adequate technology to collect these taxes?

The law has to be enforced by them from the first of September, whether they have the technology required to do so or not. They will be forced to find resources or a procedure to document such actions, but they are required already to withhold taxes on all said financial transfers and liquidity control. In fact, we have learned from several of our clients that they are already collecting the taxes, doing it at times apparently in the wrong manner or for higher amounts, but this is a natural result of the fact that their systems were not prepared for this action.

In order to facilitate work a little, banks themselves have asked their customers to open separate bank accounts or to transform their accounts into specific accounts for any of their activities that are tax exempted under the Law, such as payment of salaries, payment of imports of goods and services to suppliers abroad, Social Security payments or payment of basic services. The idea is that by opening such accounts, there would not be any taxes wrongly withheld, because they would be tax exempted activities. However, the wave of requests to banks has delayed their answer to customers. As a result, many of them do not have yet any “specialized accounts”, reason for which they would be charged taxes even on exempted activities. Again, this is natural because the banks did not have time to prepare their systems due to the expedite manner in which this law has entered into force.

Some entities have asked to extend the term for entrance into force of this law, even ARENA, haven’t they?

ARENA did not support from the beginning the enactment of these laws, and the one that requested such extension was the private sector, through its different associations and groups, such as ABANSA, ANEP and the Chamber of Commerce. However, this request was not heard by the legislative body which would have been the one to extend such term for entrance into force of the Law.

Does the Government have majority in Congress?

No, the FMLN does not have majority. It would need 43 Congress seats for it. However, different political forces, with the exception of Arena, can join their votes and have majority for enactment of these laws. This is the way in which this law was enacted and is now in effect because the President approved it and ordered its enforcement following a very expedite procedure.

Has the private sector expressed any disagreement?

Of course, there is disagreement for several reasons, such as the fact that there is no compete regulation, the laws have not been fully regulated yet, and need the appropriate regulations, and that in a situation as critical as the one affecting the Salvadoran economy, the enactment of laws that create new taxes is not welcomed. This is normal in any country; it is a normal answer, expected from the private sector, because this affects all of us, because we all will end up paying the costs of these taxes, which generate a “waterfall” effect.

Is the Government objective to collect more resources?

Let’s remember that the State do not have any other way to collect resources other than taxes, because there has been a privatization process during the last 20 years, in which the company has been divesting itself of the public companies it had. First, it privatized banks, then communication, followed by electricity, etc. In this sense, the State has been losing various sources of funds, and now it has no source other than taxes. If it needs resources, it could resort to international financing or public debt, or else local debt through the issuance of bonds or other securities to be issued in order to cover public spending, or else to create or increase taxes. These are actually the only two options it has, because there are only a few State companies left which may generate other revenues, and those it has now are not profitable.

Entrepreneurs claim that this new burden affects competitiveness. What is your opinion about it?

Taxes affect the pocket of those that ultimately cover them. With regard to the competitiveness of El Salvador with regard to other countries, the reality is that this tax exists in other countries, and it is not exclusive of El Salvador. However, history has shown that it is not a tool that is necessarily effective as intended by the State to attract more resources. It makes operations more expensive and difficult because these are taxes that do not generate a tax credit, save for the tax on liquidity control. As a result, the tax becomes an expense which cannot be deducted according to the same Law, producing a waterfall effect in the economy. Finally, this tax is being paid by all of us. The businesses pass their costs, whether deductible or not, to the population.

Summarizing, was a new tax created? Is it a tax reform?

It is not a comprehensive tax reform, but amendments to certain laws and the enactment of this Law of the Tax on Financial Operations that I would rather call a legislative patch, by means of which the State is attempting to receive more revenues that would allow it to cover the high spending it has now, in particular due to the policy of Social Security benefits it wants to provide through different subsidiesand financial aid to the low-income population.

The purpose of the creation of these taxes is apparently a noble reason: financing of this support to social programs. However, the private sector has claimed that the State is not doing anything to reduce its spending in other items and is not managing public finances in an orderly manner or reducing unnecessary expenditures.

What has been the reaction of the media that print their newspapers?

I have not noticed any major reaction of the media, in particular the newspapers, to the elimination of the income tax exemption granted in the Printing Law. There has been in general a criticism that this type of actions attack freedom of press, but the largest newspapers in the country have not made any statements, and to the best of my knowledge, they have not filed any “amparo” remedies. Anyway, this tax has not affected them yet, although it is already in effect. Income Tax is declared and paid after the end of the fiscal year, on December 31. I think that in view of the fact that various actions to declare unconstitutionality and some “amparo” remedies have been filed, they are waiting for the resulting resolutions.

On the other hand, I have heard comments that the law is not retroactive, and that the companies that were already certain concessions granted by the laws, such as an Income Tax exemption, cannot be affected. However, this is an opinion expressed in the private sector. It is obvious that the State would not make such an interpretation. So far, the written media, which are the only ones that do not pay income taxes, have not made any statement, and the State justifies payment by them because the radio and TV media do pay income taxes.

The objective of the Tax authorities is that these media should pay these taxes, but so far they have not expressed their position or made any critical statement. The elimination of an Income Tax exemption in the Printing Law was made, in my opinion, with a lot of haste and not in the most adequate manner, because the amendment was made directly to the Income Tax Law and not to the Printing Law. These are things still analyzed from a legal perspective, with regard to functionality and application. There is still a lot to be analyzed. Although there was a discussion of several months between the State and the private sector, the laws were enacted suddenly and quickly, leaving as a result many gaps and gray areas.

Any final comment?

For now, the laws are in force and the population has to comply with them, while they are not amended or changed, or until the Supreme Court of Justice, through the Constitutional Court, issues a resolution suspending the effects thereof. Therefore, in the meanwhile, the Tax Reform, if we may call it by that name, is in full force. We will see in the following days any direct effects it may have on the economy, in particular this Law of the Tax on Financial Operations.


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