Corporate income tax in Uruguay: is this the end of the so-called 'principle of the source'?
Bergstein Abogados, Montevideo
As a result of certain questioning from the European Union, a debate has begun in Uruguay in connection with the so-called 'principle of the source'. In accordance with such a principle, Uruguayan companies are only taxed on locally sourced income. Foreign-sourced income is, as a general rule, excluded from corporate income tax. The EU admits the validity of the above principle, though subject to certain substance requirements.
The Uruguayan executive branch has recently made public a draft bill that would keep in force the principle of the source, provided that local companies are in compliance with such substance requirements. Otherwise, certain foreign-sourced income currently excluded from the scope of corporate income tax (ie, real estate rent, dividends, interest, royalties and other passive income, including capital gains) would become taxable income.
The proposed amendment – aimed at discouraging the use of local 'empty companies' (ie, companies with no human and capital resources located within the Uruguayan territory) – will be applicable to multinational enterprises from 1 January 2023.
This article is dedicated to the analysis of the aforementioned draft bill.
As stated above, corporate income tax in Uruguay is only assessed over Uruguayan-sourced income. Foreign-sourced income is excluded from its scope. This is so as of today, with three main exceptions: (1) advertising services; (2) technical services (provided that both services are rendered in favour of Uruguayan corporate income tax payers); and (3) derivative financial investments.
The so-called 'principle of the source' is deemed to be essential to the Uruguayan tax system. However, this could change soon. The above draft bill proposes to extend the list of exceptions to such a standard. As a result, foreign capital-sourced income would be subject to taxation in Uruguay.
Having said that, the legal amendment would only apply to so-called 'multinational groups', defined as those composed of two or more entities residing in different countries/jurisdictions with consolidated financial statements. Uruguayan subsidiaries whose financial statements were not to be consolidated with those of their controlling entities, in principle, would not be affected.
From 1 January 2023, the following income will be subject to corporate income tax, even where it is sourced abroad:
1. income stemming from intellectual property rights in connection with patents and registered software;
2. immovable capital income (including that's derived from renting real estate properties);
3. dividends (including profits emerging from the participation in the stock capital of non-resident companies and in investment funds incorporated abroad);
4. interest (including that resulting from deposits with banks located abroad, loans to non-resident entities and debt instruments issued by such entities);
5. other royalties, in addition to those mentioned under number one above;
6. other movable capital income (defined as that which stems from deposits, loans and, in general, from any placement of capital or credit of any nature whatsoever); and
7. capital gains associated with the assets triggering the above income.
Such a rule would not be applicable to so-called 'qualified income' and 'qualified entities'. In other words, such qualified income and entities would remain untaxed in Uruguay.
The concept of 'qualified income' is associated with the exploitation of patents and/or registered software. Such income is determined by the application of a quotient. The numerator includes the direct expenses/costs incurred for the development of the patent or software – including those related to the services contracted with non-related parties (whether residents or non-residents) and resident-related parties – increased by 30 per cent. The denominator includes the total direct expenses/costs for the development of such a patent or software, including those included in the numerator – without the 30 per cent increase – as well as those corresponding to the concession of use or acquisition of intellectual property rights, and the services contracted with non-resident-related parties. The balance of the total income associated with the exploitation of patents and/or registered software abroad, and that characterised as qualified income, would become subject to corporate income tax in Uruguay.
The concept of 'qualified entity' is associated with all other passive income; that is, income mentioned under numbers one to seven above. Such foreign income would continue to be untaxed, provided that the Uruguayan subsidiary: (1) employs human resources whose number, credentials and remuneration are consistent with the administration of the investment assets; and (2) holds adequate premises for the performance of such activity within the Uruguayan territory (such resources/premises could be outsourced). Those local subsidiaries whose main business purpose goes beyond the mere possession of real estate properties and of participation in the capital stock of other companies would be required to meet further requirements to remain untaxed. In sum, they should: (1) make necessary strategic decisions; (2) bear risks in Uruguay; and (3) incur adequate expenses/costs.
The above concepts of 'qualified income' and 'qualified entity' would not apply to that income related to the exploitation and/or sale of trademarks. In consequence, all income resulting from such activities conducted abroad would be fully taxed.
The draft bill also includes an anti-abuse standard, under which the Uruguayan Tax Office would be entitled to disregard certain forms/structures adopted by local companies, provided that such forms/structures were to: (1) be mainly aimed at taking a tax advantage; (2) distort the purpose of the above rules; and (3) be improper in consideration of the relevant facts/circumstances.