The Tax Code is the general tax law in El Salvador, but two additional laws regulate specific types of taxes: the Income Tax Law and the Value Added Tax (VAT) Law1. Recent reforms have amended these laws - this update discusses the most important changes.
Income Tax Law Reforms
The first change to the Income Tax Law revokes the tax-exempt status of certain forms of income. Article 4, which lists non-taxable income, previously included interest from loans granted by foreign financial institutions domiciled abroad, but this has been removed.
The second significant change concerns Article 16, which provides a definition of 'income earned within El Salvador'. At present, Article 16 provides that any income from goods located or activities carried out in the national territory - even if they are received or paid for outside the country - is considered as income earned in El Salvador. Credits are considered to be located in the debtor's place of residence, while intellectual property is located in the place where it is officially registered. The proposed reform is intended to replace Article 16 completely. It aims to clarify - leaving no room for interpretation - that all income earned in El Salvador will be subject to tax. The reform makes it clear that income from services that are used in the country constitutes income earned in El Salvador for the service provider, regardless of whether the activities which generate the income are carried out abroad. Income earned in El Salvador also includes income accruing from industrial property, intellectual property and related rights, and from economic rights that authorize the exercise of certain activities in agreement with the law, if such rights are officially registered or used in El Salvador.
The concept of 'net income' set out in Article 28 is in need of a serious overhaul. The current wording provides that:
"net income will be determined by deducting from the income earned any costs and necessary expenses for its production and the preservation of the income source, and other costs determined by this law."
It further specifies that any sums incurred in relation to tax-exempt revenue activities, or which do not constitute income for the purposes of the law, are not deductible. The initial draft reforms identified at least four types of non-deductible costs and expenses. Two of these concerned: (i) costs and expenses that, although linked to income generated in El Salvador, are incurred through the purchase and use of goods or services from countries classified as tax havens by the Organization for Economic Cooperation and Development; and (ii) costs and expenses incurred in other countries, where the Salvadoran tax administration confirms with its foreign counterpart that the income has been declared within the specified term. However, these proposals were not accepted; the sole change to Article 28 provides that costs and expenses and other deductions must satisfy all requirements for deductability specified in the Income Tax Law and the Tax Code.
Unlimited donations to the government and to non-profit entities are currently tax deductible, and no formalities need be observed from a taxation viewpoint. However, this has led to abuses, and reforms to Article 32 thus propose that such donations be tax deductible up to a maximum limit of 20% of the donor's net income in the corresponding tax period. The proposals also clarify that in the case of a donation of services or in-kind donation, the value subject to deduction will be the cost of the relevant goods or services incurred by the donor. Finally, the reforms regulate the documents issued by non-profit entities, requiring that these be numbered and authorized by the tax administration.
Not all the proposals seek to increase tax control. Proposed changes to Article 33 would allow individual salary earners, regardless of income, to deduct a total of 5% of the total VAT paid in a given fiscal year in the form of a fiscal credit.
VAT Law Reforms
The first proposed reform includes the payment of interest on loans and other types of financial instruments within the concept of a tax-generating activity, as regulated under Article 16 of the VAT Law. This leaves no doubt that such interest will be subject to VAT.
Article 17 concerns operations that are considered to be a taxable service. It is proposed that Article 17 be modified in order to include expressly the licence, sub-licence or any another method of authorizing the use or enjoyment of trademarks, patents, industrial procedures or formulas and similar services.
Another change affects Article 65, which regulates the requirement to deduct a fiscal credit transferred in a fiscal debit invoice, and lists the credits that may not be deducted. The reform proposes that the credits which may be deducted be listed in Article 65, while a new Article 65-A will contain a detailed list of the credits that can no longer be deducted.
The final amendment concerns companies that provide cargo services in El Salvador in order to complete a service initially provided outside the country. Article 74 provides that the following activities are taxable at a special rate of 0%:
"any export operations involving the transfer of movable goods destined for local use and consumption, and the provision of services carried out in the country, to users that do not have a domicile or residence herein, and services that are exclusively destined for use abroad."
The reform clarifies that services which are provided from within El Salvador to users who do not have a domicile or residence in El Salvador, in order to continue or complete services initiated abroad, are similarly exempt from VAT.
Endnotes
(1) The official name of the Value Added Tax Law is the Movables Transference and Provision of Service Tax Law.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
