6th September, 2011.


It is a distinct pleasure, and honour, to be invited back to talk at the 21st Oxford Offshore Symposium at Jesus College.  And because I am more familiar with Chuck Berry than a Blackberry, this prepared paper does not include a power point presentation because the points I wish to make are for your ears and not your eyes.  Whether they have any power I will leave to your judgement.

I have provided supplementary notes to this lecture and my subsequent one on Thursday regarding regulation that will provide additional background information which I hope will be helpful.

I should start by saying that the collection of countries comprising Latin America is distinct.  So one can’t apply a common model like the Russian inventor tried to.  He went to the patent office with a new mechanical shaving apparatus and when asked to describe its operation replied:  “It is very simple.  You drop a coin in the box and put your face in the oval aperture.  Then two mechanical blades come up and shave you according to a standard template”.  The puzzled patent officer retorts:  “but every man’s face is different”.  The inventor smiles knowingly and replies:  “that is certainly true, but only until the first shave”.  (I should add that European and American regulators would like to employ that tactic with regulation in more than one offshore jurisdiction.)

I said last year that it was wise to include Latin America as a topic at Oxford and events since then have only strengthened that conviction.  From being the road less travelled it has become one now increasingly trodden and while the region’s economic future once looked positively grim, today there is talk of this being Latin America’s decade.  Exposing my age and also because as a musician I have participated in two Beatles tribute concerts, I would like to continue by applying a musical theme and use as an analogy the Beatles in relation to the region’s popularity today.  I will call upon them again during this paper.  It might have been 20 years ago today that Sergeant Pepper taught the band to play but 50 years ago this very month the four Liverpudlians were just a backing group for Tony Sheridan when he recorded an extended play (that’s a disk, for the uninitiated, and not a reference to this year’s Wimbeldon tennis finals).  Plato said that when the mode of music changes the walls of the city shake and the Beatles certainly proved that.  50 years ago Latin America may have been an irrelevance, with many treating much of it as a backing group for the star act, the United States of America, whereas today it has shaken the walls of several stock exchanges. 

In 1980 there were just three democracies in the whole of Latin America.  Now it is the autocracies that are the odd men out.  Rather than capital leaving, it is flowing into, the region with countries being swamped with money from abroad seeking safety from the aftermath of both reckless derivative dealings and mortgage madness.  Brazil is now the world’s fifth largest economy and figures reveal some surprising facts about Brazilian productivity which cynics would argue was an oxymoron; but consider that between 2005 and 2009 Brazilian total factor productivity rose at an annual average rate of 2.1% (Peru was not far behind) and the leading Asian economies, China and South Korea, saw productivity rise 2.9%.  An encouraging comparison. 

Even so, it would be wise for the region’s governments to heed Niccoló Machiavelli’s warning about the unremitting malice of fortune and plan accordingly.  Just because today Europe and the United States have lost their confident, buoyant stance of a decade ago, it does not mean Latin America is home and dry.  It must temper its growing confidence and avoid the fate of Icarus, ecstatic with the ability to fly, who flew too near the sun on wings of feathers and wax,.  Well, Latin America is certainly flying now but still with wings of feathers and wax because the linchpin of South America’s economic health has been commodities.  This narrow focus carries inherent risks because prices can never be constant; today’s surge can be tomorrow’s decline.  Commodity prices rose strongly last year and the industrialisation and urbanisation of China is said to have created a supercycle of high demand compared with low prices in the 1990s.  But equally today’s high prices could reduce demand which would hit growth.  Weather and Mammon are key.  Look at Japan’s earthquake and tsunami as well as the Arab Spring.  These have caused spikes in prices from oil to wheat and gold.  In sum, geopolitical and environmental uncertainties could see an era of volatility in prices that might last a decade.  As you will hear the region has no cushion of income tax revenues to soften a fall. 
The important point here is that Latin American nations have to wean themselves off too great a dependency on commodity exports and begin to concentrate on finding ways to develop viable and long-term alternatives, such as services industries, the foundation of Panama’s success, while at the same time tackling high crime rates, corruption, shaky tax systems, and political divisions.  But for me one of the most important issues has been raised by Mexico’s Economic Secretary, Bruno Ferrari García, who says that the region’s economies need to be integrated to bolster the future economic well – being of the region.  Importantly, intra-trade could lead to closer integration of tax systems, promoting more uniformity and clarity. 

The region needs to look inward, and not just outward, to a Latin American market of some 550 million people in a region that at this time is experiencing a level of growth that is only second to Asia’s.  While the region’s natural resources fuel the engines of growth in China and India, meeting domestic demands will be a powerful back-up in the future. 

The vision of a Latin American trade bloc appears to have edged nearer with Mexican, Chilean, Colombian and Peruvian representatives participating in working sessions ahead of establishing a Pacific Accord.  It is difficult to think of a region that has more to gain from stronger intra-regional economic ties.  Perhaps unnoticed by outsiders, intra-trade has been growing at an annual 8 – 9% in the last decade and this year the inter-Oceanic highway will be completed:  the first paved road to cross Latin America coast to coast.  It will be to the pantechnicon what Panamá’s canal is to the container ship. 

The United Nations Conference on Trade and Development reports that trade flows within Latin America from 2000 to 2009 grew from US$134 billion to US$290 billion.  Brazil, Argentina, Mexico, Chile and Colombia had the highest volumes, but Panamá, Ecuador, Paraguay, Bolivia and Peru experienced the fastest growth in their share of regional trade.  Panamá, in fact, saw its regional flow of trade rise by a factor of 6.2 in the decade ending 2010 – despite the Great Recession. 

Brazil, of course, is Latin America’s Goliath, but successes can be found throughout the region.  Look at the improved situation in Paraguay following rapid growth, the surprising degree of financial recovery in Argentina, the improving security in Colombia – not to mention similar positive signals in other countries on the Continent – which means that Brazil is not the only horse pulling the cart.  In the case of tax innovation, however, it does seem to be the lead horse.

And let’s not forget that beyond the rivalries of China and the US, vying with each other in their bid to capture market share in Latin America, the European Union still remains the region’s second largest trading partner – although there are predictions that it will likely be overtaken by China in the next three or four years.  Even so, it is a fact that the EU has provided the main source of direct foreign investment in the region during the last decade.  The EU has enthusiastically pursued trade deals with Colombia and Peru, for example, which should not only open up markets but see substantial reductions of tariff barriers.  It is worth noting that trade between the EU, Colombia and Peru alone was worth 16 billion euros in 2010.  Panamá remains the economic success story in Central America (excluding Mexico) and the new UK ambassador in Panamá told me that the British government has targeted the country as one of several in Latin America that offers great trade potential for the UK.

The region’s generally investment-friendly fiscal policies resulted in a 40% increase in Foreign Direct Investment last year.  2011 is expected to see an upsurge of between 15% and 20%.  2010 statistics show inflows of US$112 billion with outgoing FDI reaching an all-time high of US$43 billion due in part to the continuing strength of transnational business.

Predictably, Brazil attracted the lion’s share of FDI in 2010 while battling the real’s rapid appreciation.  There was an incredible 87% increase over 2009 seeing a leap from US$26 billion to US$48.5 billion.  To put this in perspective, Mexico came second in the ranking but with only just over US$18 billion, next was Chile (US$15 billion) then Peru (just over US$7 billion) and fifth was Colombia with just under US$7 billion.

The US accounted for 17% of FDI in 2010, with China contributing 9%.  The US$15 billion invested by Chinese companies revealed a more active role in the region’s infrastructure and manufacturing sectors; a few years ago the extent of China’s contribution to the region’s economic health was surface, being a more cash-and-carry relationship, without any long-term financial commitments, but last year the destination of 43% of its FDI was natural resources and another 30% went to the services sector.

Where can investors feel that their money can be put to work and a reasonable return in these dark economic days can be hoped for?  Not just in Asia; with Latin America (in particular Brazil) experiencing growing domestic demand – itself a buffer against future global downturns – and by already trading less with the rest of the world than Asia does, this makes investment prospects promising.  At least by being more self-reliant it stands a better chance of lasting 10 rounds in the global ring, even if bloody and bruised. 

Trade ties between regional countries are strengthening.  Just consider the case of Brazil and Mexico which are the largest economies in Latin America, making up 74% of the region’s gross domestic product.  They are the most populous countries with a joint population of about 300 million, not far off the number of people in the US.  After a series of successful business negotiations more Mexican goods are heading south to Brazil rather than remaining in the local market.  And not just Brazil.  According to Mexico’s economy ministry, exports to South America last year were 50% higher than in 2009.  Although the EU is the biggest investor in Latin America, last year for the first time in more than a decade, South America overtook the European Union as a destination for Mexican exports.  But to get this in perspective, 80% of Mexican exports still go to the US and the importance of the US market remains; unfortunately, it follows that Mexico’s economy is, to a great extent, a hostage to the one north of the border. 

Latin America can avoid this fate – a dependency on foreign trade partners – by continuing the policy of integration.  Other illustrations can be found and just as an over-reliance on commodities brings dangers with it, so does over-reliance on China, the world’s top manufacturing country.  Already cracks in South America’s relationship with the Middle Kingdom have become more visible during the past decade.  Then there’s the US reluctance to move from just talk to treaties on trade (witness the Colombian and Panamánian situation where the pace of progress has been leaden).  These are two reasons to heed the title of a Beatles song:  Come Together which I used to emphasise the point in my July Latin Letter column in Offshore Investment.com.  Intra-trade is important and we are not talking fruit and vegetables; quite the contrary:  the items available today are often, I quote, “truly globally competitive products that are diversified”, in the words of Chris Sabatini, senior director of policy at the New York-based Council of the Americas.  The top-10 traded products in Latin America in 2009 included either medium or high-tech goods such as passenger vehicles, tractors, medicines and telecommunications equipment. 

But cracks or no cracks in Chinese walls, Latin America has seen its overall trade with China grow 16-fold during the last decade.  This has come at a price and the currency imbalances caused by capital inflows, with China as the main culprit, resulted in Guido Mantega, Brazil’s finance minister, pronouncing that “This is a currency war that is turning into a trade war”.  His remark has echoed across continents and only the surge (for how long?) in international commodity prices has served as a counter-weight for exporters with anti-competitive strong currencies.  The Brazil China Chamber of Commerce for its part, complains that Brazil’s tax system is too complex and regressive.  This is but one of many major headaches, and not just in Brazil. 

When I was preparing this paper I thought back to a comment made by Winston Churchill during the Second World War, when the pace and uncertainty of momentous events was unprecedented.  He said that the receptive capacity of a man’s mind was like a three-inch pipe running under a culvert.   When a flood comes the surplus water flows over the culvert whilst the pipe goes on handling its 3 inches and no more.  Well today the changes (and the speed of them) taking place across Latin America can flood the human mind.  Progress will be slow and tax reform must wait its turn so I am afraid last year’s report card is unchanged:  taxes remain high while levels of collection are low with evasion of them still easy. 

It’s hard to keep abreast of things, which brings me to the tax men in Argentina who are on the trail of tax-evading plastic surgeons not declaring income from breast implant surgery.  It has been estimated that the value of imports of implants from Brazil, France and the US was US$15 million in 2008-9 which should have generated US$50 million revenue for doctors and clinics but according to income declared there is a tax shortfall of US$10 million.  No fear of them going bust.  The tax authorities reckon that up to 80% of the income earned from all plastic surgery performed is undeclared. 

But that’s not to say that things aren’t changing; like a fully-laden oil tanker, turning the ship around takes time.  As in many things, it is Brazil that leads the way and if, as Jean Baptiste Colbert asserted, the art of taxation means plucking the goose in such a way that the maximum of feathers with the minimum of hissing is achieved, Latins are not familiar with this delicate art and the number of geese hissing in the region is growing.  Regular readers of Offshore Investment.com will know that last October I wrote about the changes to Brazilian tax law under the title “The Hissing Goose” which put Delaware and other US states offering Limited Liability Companies in the spotlight.

And it is no use the US crying foul (no pun intended) but suffice it say that in the case of Brazil new reporting rules and regulations have impacted on the ease with which foreigners can use such entities to, euphemistically speaking, lighten their tax burden.  Now that the term “tax favourable jurisdiction” in Brazilian tax law has been extended to countries beyond the usual suspects, the tax havens, the rules of the game have changed.  Back in 2003 Brazil introduced legislation which increased the withholding tax rate from 15% to 25% on capital gains incurred by non-resident beneficiaries doing business in Brazil.  Originally the tax code only covered payments to non-residents located in a “country that does not tax income, or that taxes it at a minimum rate lower than 20%” whereas now it is specifically stated that, and I quote:  “It is also considered a tax haven the country or dependency where the law does not allow the access to information regarding the shareholding composition of the company, its ownership, or the effective beneficiary of income earned by non-residents”.  The reference to “or dependency” in this context includes states within the US, whether the country itself has been blessed by the OECD and placed on its tax white list. 

Delaware, a favourite with foreigners, is not the only casualty because presently there are in fact 7 other countries with entities that have been classified as privileged fiscal regimes, which include Luxembourg, Denmark, the Netherlands and Spain.  But for Delaware to be singled out by Brazil is somewhat of an embarrassment, considering the United States’ vocal condemnation of what it labels jurisdictions plying their trade with the benefits of secrecy. 

While US taxes due from LLC operations will be paid, those with no physical or economic links with the US can operate non-US business anonymously, like Argentinean plastic surgeons, for example, and elect not to declare earnings to their own government; when such disinterest is shown by IFCs that prejudice the US, its government considers them hostile.  No US public record shows LLC ownership details so an enquiry from a foreign government is obstructed.  In fact, the head of the Global Forum Secretariat called the LLC issue a “serious deficiency”.  It was said that Delaware has the largest number of LLCs of any state, and that the representatives of LLCs based there aren’t required to know who owns them, let alone the authorities.  I expect Brazil’s approach to be taken up by other countries and already Mexico, Argentina and Venezuela have enacted controlled foreign corporation rules.  Also, Brazil’s largest trading partner, China, has got smarter and no longer accepts treaty benefit applications from Delaware LLCs. 
A  June report released under the auspices of the OECD by the 101-member Global Forum on Transparency of Information for Tax Purposes stated that the US tax system complies with most international standards but two concerns have been raised.  The study recommends that the US improve disclosure of ownership and accounting information of single-member LLCs and goes on to say that the US should respond more quickly to other countries’ requests:  those, such as Panamá, who have signed TIEAs with the US, take note.

Just one interesting observation.  The Global Forum, as I say,  recommended more transparency for single-member LLCs but, of course, LLCs can and do have more than one member, with perhaps a mix of US and non-US persons. 

The tax policies in the region have not really addressed income inequality and much of this has been blamed on the popularity of regressive indirect taxes instead of personal and corporate tax, the former being far easier to collect, but harder on the poor.  Latin America, however, also focuses on tax exemptions (including customs duties) or tax credits from such activities as tourism, forestry, mining and agriculture.  The contrarian view, shared by many economists in developed countries, believes that taxes should be switched more from income and investment to taxes on consumption; these countries, of course, already have established tax systems in place.  Not that the picture is an ideal one.   

One thing I can tell you:  the North and South America divide is undivided on one issue:  who pays the most.  In California, for instance, the top 1% of payers by income accounted for 43% of income tax revenues in 2008. You might be interested to know also that in America as a whole the last figures I have show that the top 1% paid 38% of federal income taxes and the top 5% paid 58%.  And if the Latins do have confusing tax systems, consider this:  America’s tax code has grown from 2.4 million words in 2001 to 3.8 million last year.    

It is estimated that developing countries receive just 15% of global FDI – despite having 80% of the world’s population and as this percentage is surely going to steadily increase, Latin America must ensure that investors are faced with a less complex tax system.  Chile is considered as being the most attractive place to invest, especially on the question of a stable economy, followed in descending order by Mexico, Brazil, Perú and Colombia. How can the system be made more welcoming?  This is the challenge.  Within the OECD, active foreign trade business sometimes is subject to special rules for passive income and the territorial tax system, found in Panamá, is applied.  What might evolve in Latin America is not clear, but I fear we are light years away from a Latin American solution.

Meanwhile, many Latin American countries are signing tax treaties internationally in order to promote FDI – and therefore growth – in their respective countries.  To the surprise of many, including myself, Panamá, the region’s banking centre, has signed a Tax Information Exchange Agreement with the US supposedly on the strength of securing a trade agreement with Washington, sacrificing absolute confidentiality on the alter of economics.  The country continues to ratify and negotiate Double Tax Treaties with other countries, having reached the OECD’s mandatory 12.    And as the economies of countries in Latin America begin to trade more openly with each other, we are seeing regional tax agreements being signed as well, such as the one between Argentina and Ecuador which covers all taxes in both countries and will apply to taxes modified or added in the future.  Argentina has said it will continue to sign agreements in line with its efforts to improve transparency in the economic transactions of Argentines abroad.  Watch out, plastic surgeons in Buenos Aires.

Up to now the most popular model which has been used to negotiate treaties has not been the OECD template which is associated with IFCs especially, but the one offered by the United Nations Tax Model Convention. Latin America is included on the Committee of Experts on International Co-operation of Taxation Matters formed by the UN and currently the representatives are Uruguay, Perú, Chile and Mexico.  If this approach has caused bristling in Brussels the fact remains that the OECD assumed a symmetry in the commercial exchange among nations whereas more FDI from developed countries into developing countries puts the tax authorities in the latter case at a disadvantage.  What the UN model achieves is a fairer balance between the respective revenue interests, granting greater relevance to taxation at source. 

Consequently, a criticism is that the measures adopted in tax treaties are mostly enacted in favour of developed countries with their greater negotiating power, a revelation none of us here today will be shocked by. Assuming Panamá gets its free trade agreement with the US, it is clear that regional free trade agreements come at a price and the implementation of tariff reductions results in a decrease in fiscal revenues.  The Inter-American Development Bank says, for instance, that participants in the Central American Free Trade Agreement (Costa Rica, El Salvador, Guatemala, Honduras, Dominican Republic and Nicaragua) with the US will lose between 3% and 6% of their fiscal revenues because of it.  This loss of revenue has to be compensated for with other taxes and VAT, or its equivalent, is the common route.  In countries such as Chile and Venezuela, VAT represents almost one-half of total fiscal revenues obtained from taxes and in Argentina, Brazil and Mexico the amount is one-third.  But remember, this VAT burden falls on the shoulders of those least able to pay it.

Having said that most of the Latin American tax systems remain, in varying degrees, a quagmire open to manipulation and often suffering from under-staffed and under-financed tax authorities, what might be the way forward for improving Latin America’s international tax policy?  In order to encourage FDI and at the same time collect fiscal revenues from it without discouraging investment in the first place, the region’s countries need to work towards greater tax co-ordination and integration despite disparities in their tax systems. 

A first step would be a Latin American Income Tax Treaty in conjunction with an effort to reach more agreement over tariffs so that the CAFTA experience of losing up to 6% of fiscal revenues can be avoided.  Panamá did not join in CAFTA and let’s hope that by holding off, the separate free trade agreement it expects from the US will be worthwhile and not worse in the long run.  A “deep integration” pact between the fast-growing and market-led economies of Chile, Perú, Colombia and perhaps Mexico is promising.  They represent a combined gross domestic product of US$1,600 billion and provide a counterweight to Brazil’s prominence. 

But a general Latin American Income Tax Treaty faces the almost insurmountable task of achieving compatibility, co-ordination, co-operation and convergence.  Encouragingly, Brazil, Colombia, Uruguay, Paraguay, Chile and Mexico have achieved some degree of it either through exemption or tax credit systems.  If, however, the whole region is to have a uniform Tax Treaty a Latin American body must be formed to oversee the process. One institute already in place, the Inter-American Centre of Tax Administrations, is based in Panamá, and is already recognised for its regional tax expertise.  This might be the answer.

In 1966 the Beatles album entitled Revolver – the very weapon that would kill John Lennon – warned us about the Taxman, telling the dead to declare the pennies on their eyes.  Fortunately, the level of UK taxation then is not a problem facing Latin Americans now.  It’s getting one that works and this will entail experiencing Paul McCartney’s long and winding road. 

Here’s how one president described his tax system.  It is “complicated, unfair, cluttered with gobbledygook and loopholes designed for those with the power and influence to hire high-priced legal and tax advisers”.  Any country in the region fits the bill except that in this case the country was the US and the president was Ronald Reagan making a televised speech in 1985. 

“Help!” The Beatles might have said.  But don’t give up on Latin America.  Don’t be overwhelmed and be Churchillian, accept the 3-inch pipes limitations and if you can navigate the shoals and get a good adviser, the adventurous in the financial services industry will find the hidden treasure that Latin America promises to the bold.  Thank you for your attention.



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