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Tax Planning for U.S. Companies with Latin American Operations

Pass-through structures

Many South Florida-based companies conduct business operations throughout Latin America. Typically, these operations are conducted though wholly-owned foreign subsidiaries. With the corporate tax rates in these jurisdictions approaching the highest U.S. federal income tax rates (for example, the corporate income tax rate is 35% in Argentina, 34% in Brazil, and 30% in Mexico), many U.S.-based multinationals simply elect to treat their Latin American subsidiaries as “pass-through” entities for U.S. federal income tax purposes.

This can be accomplished by filing a Form 8832 (otherwise known as a “check-the-box” election) with the IRS, so long as the foreign subsidiary is not a “per se” corporation and therefore ineligible to file such an election. While this structure prevents any foreign-source income earned by these entities from being deferred from U.S. federal income tax, it does allow the U.S. parent to claim a foreign tax credit for the high corporate income taxes incurred in the local jurisdictions.

Deferral Structures

Instead of the U.S. parent treating the Latin American subsidiaries as pass-through entities for U.S. federal income tax purposes, an alternative structure may be to reduce the foreign corporate income taxes paid in these jurisdictions through intercompany lending and licensing arrangements. Assuming this can be accomplished without triggering high rates of foreign withholding tax, and the interest and royalty payments made from the Latin American subsidiaries can be deferred from U.S. federal income tax (for example, they may be exempt from the U.S. controlled foreign corporation rules under the Section 954(c)(6) look-through rule), the overall effective income tax rate may be lower when compared to the overall effective income tax rate paid under a pass-through structure. This is especially true if the profits eventually can be repatriated to the United States at qualified dividend rates (currently 20%).

Given that the only income tax treaties concluded by the United States with Latin American jurisdictions are those with Mexico and Venezuela (the proposed treaty with Chile is not expected to be effective any time soon), it usually does not make sense to lend money or license intellectual property to the subsidiaries in Latin America through a U.S. company. Not only would this likely result in high foreign withholding tax rates (unless the U.S.-Mexico or U.S.-Venezuela treaties were taken advantage of) but the interest and royalty payments would be subject to current U.S. federal income tax.

Benefits of Using Spanish ETVEs

Historically the jurisdiction that is most commonly used as a holding company for Latin American companies has been Spain. The Spanish holding company (otherwise known as an ETVE) exempts from corporate income tax most dividends received from non-tax haven jurisdictions, has no withholding tax on outgoing dividends to non-tax haven jurisdictions, and Spain has more income tax treaties with countries in Latin America than any other jurisdiction in the world.

While Spanish ETVE’s are most often used as a holding company, they also can be very tax efficient when used to finance operations in Latin America with debt, as well as license intellectual property to Latin America, through a branch located in a non-tax haven jurisdiction, such as Uruguay, Ireland, or Malta.  The reason why such a structure would work well is that, even though the loan or license agreement is entered into between the branch and the Latin American subsidiary, the interest and royalty payments made are eligible for the reduced withholding tax rates available under the treaties in effect between Spain and the Latin American jurisdiction.

Branch Exemptions

Furthermore, just like Spanish ETVEs exempt dividends received from subsidiaries located in non-tax haven jurisdictions, they also exempt from corporate income tax active income earned by a branch located in a non-haven jurisdiction. For this purpose, a branch engaging in intercompany lending and licensing arrangements would be considered to be deriving active income that is eligible for the branch exemption.  Finally, the branch locations mentioned above (Uruguay, Ireland, and Malta) may not be considered tax havens for this purpose, even though they may incur little, if any, local income tax on the receipt of the interest or royalty payments (for example, Uruguay has a territorial tax system and therefore exempts from local income tax income derived from sources outside of Uruguay).

To Defer or Not to Defer

Accordingly, if properly set up, this structure produces a deduction at the high-tax operating company level in Latin America without incurring significant withholding taxes, and results in income that is exempt from corporate income tax in Spain and possibly at the location of the branch. Finally, if the beneficial owners of the Spanish ETVE are U.S. individual taxpayers, profits eventually can be repatriated at qualified dividend rates.  Given these results, a South Florida-based company with operations with Latin America should seriously consider whether to defer or not to defer its profits earned in Latin America.