It is true to say that in many contexts Latin America has been the road less travelled but when looking at the future, who could have imagined Robert Zoellick, the World Bank president, would apply the 1980s Latin American term La Década Perdida (Lost Decade) as a future scenario for some of today’s developed economies which are swamped by debts and living beyond their means?  The bulls for now have left Wall Street as well as the European bourses and the only noticeable bull run this year is likely to have been in Pamplona in Spain.  Probably the Shakespearean direction “exit pursued by a bear” is more apt on Wall Street.  A Winter’s Tale indeed.

Some ten years ago it was all so different:  Europe was confident, buoyant and expanding whereas Latin America was in the doldrums.  Now the world’s emerging markets are experiencing never-before growth; their consumers have outspent Americans since 2007; in 2009 their share of global consumption was 35 per cent whereas America’s was 27 per cent.  Economic growth between 2010 and 2015 for several Latin American countries will be healthy, according to figures released by the International Monetary Fund, with Panama perhaps having the highest growth in 2011 (6.3%) and 2015 (6.5%).  This year’s projected leaders include Brazil, Uruguay, Paraguay and Peru.  Mr. Zoellick thinks that growth in developing economies will average around 6 per cent this year and next, which will probably be twice that of high-income countries. 

This is not a technical paper and the purpose of my talk today is to attempt to give a taste, a feel of Latin America and although I intend to restrict my comments to general remarks concerning taxes I will be pleased to speak with anyone who has specific issues but suffice it to say that in many cases they are high for individuals and corporations, the regimes are complex for taxpayers to comply with and there are insufficient tax collectors with the necessary expertise to enforce them.  Latin Business Chronicle’s Latin Tax Index reports that Brazil has the worst tax environment while Chile has the best.  The index measures a country’s overall tax climate by considering these factors:  corporate tax rates, tax rates as a per cent of profits, and the number of payments and hours spent to pay taxes yearly.  In any event, to understand the current systems of taxation across Latin America which are beset by many problems, one must first appreciate its history and development which does not have the same background as Old Europe, as Mr. Rumsfeld would say.   I have prepared supplementary notes to accompany this lecture as an additional source of reference and I hope that those with only a surface knowledge of Latin America will find them useful with apologies to those for whom I am going over familiar ground.

Brazil

I wrote recently in the Offshore Investment.com journal about Brazil and it is somewhat ironic that the largest country in South America does not feel part of it, so when reflecting on doctrines of American exceptionalism, one should also think of Brazil which together with the US represent the two biggest economies in the Americas.  This sense of separateness and proud independence has led Brazil to want a permanent seat on the United Nations Security Council.  Brazil has actively encouraged a community of South American countries to be created along European Union lines.  That is why the North American Free Trade Agreement signed by Mexico and the US is not seen by Brazil as a unifying step for all of the Americas:  quite the opposite. 

“No nation is fit to sit in judgement upon any other nation”.  U.S. President Thomas Woodrow Wilson’s sentiment is certainly one shared by Brazil.  Reports last year caused a stir in the U.S., after Brazil’s central bank and aides to President Luiz Inácio Lula da Silva announced that Brazil and China will move towards using their own currencies in future trade transactions.  There are several reasons why the greenback’s prominence should be questioned, a status that was established from the remnants of the Bretton Woods system created after the Second World War.  Today the dollar isn’t fixed to gold and the U.S. is no longer the world’s largest creditor; there are those who argue that it is an empire that can only maintain the upper hand by military, rather than economic, strength.  Consequently, Brazil’s attendance at meetings in Russia last June, along with the leaders of the six-nation Shanghai Co-operation Organisation, an alliance which includes Russia and China, should not come as any surprise.  The intention of the gathering was to discuss mutual aid which would lead to trade between the countries being conducted in their own currencies; pointedly, U.S. officials who had wanted to attend as observers were not allowed to.

According to Jorge G. Castañeda, a former Foreign Minister of Mexico, and Stephen Haber, a professor of political science at Stanford University in the U.S., Latin America (despite pockets of resistance) is entering a phase of unprecedented political and economic stability which is amply illustrated by the degree of progress being made in countries such as Brazil, Chile, Costa Rica, El Salvador, Mexico, Panama, Peru and Uruguay.  In varying, but nonetheless positive, degrees these countries have pursued good macroeconomic policies that have effectively fought inflation; they have opened their markets and encouraged investments.  

The result is a significant shift towards more economic opportunity, social mobility and political democracy.  These countries have broken with the past, but the opposite applies in Argentina, Bolivia, Ecuador, Nicaragua and Venezuela.  Not only that, this awkward squad of countries also fosters an elevated level of hostility towards the U.S.  The argument goes that since the 1950s, and up to the election of Barack Obama, every U.S. president since Dwight Eisenhower – other than Jimmy Carter – has interfered, in one way or another, in the domestic affairs of one or more countries in the region.  What has evolved, as I mentioned before, is a regional divide between autocracy and democracy.

The previous century belonged to America.  What about this one?  Much is spoken about the BRICS – Brazil, Russia, India and China, an acronym created by Jim O’Neill at Goldman Sachs back in 2001.  Brazil is a BRIC with a boundless supply of commodities (and now potentially huge offshore oil reserves).  Unlike the remaining BRICS it also has a plus (not to mention that it has one of the world’s cleanest energy systems) which is a combination of 5 factors:  it is a democracy; there is a respect for human rights; it has renounced nuclear arms; there is a high degree of racial harmony; and there are no border conflicts.  The whole of South America is destined to fall within its influence and Brazil has made it clear that it will be very comfortable in the role.  It sees the rim of a wheel encircling the continent whose hub is Brazil.  Certainly, its economic ties with the US have weakened and last year China replaced the US as Brazil’s biggest trading partner.  Some ten years ago the IMF loaned $42 billion to Brazil – one of its biggest–ever rescue packages – with  stringent conditions attached.  Today the Brazilian government has loaned $14 billion to the IMF. 

Opportunities and Tax Matters

Putting politics and all other considerations aside, there is a wealth of business for foreign wealth managers in Latin America although my firm deals mainly with the reverse:  non-Latins using Panama as an alternative to financial services centres predominantly in the Caribbean;  our clients are seeking guidance in fiduciary and corporate business, in first-language English coupled with an understanding of fiduciary relationships under common-law principles, Cayman on the Isthmus in other words whereas many Latins are looking in particular for international investment expertise rather than the parochialism (perceived or otherwise) of some local professionals.  It can be argued, however, that local professionals can serve as a stepping stone between international practitioners and Latin clients with a local partner helping to cross the cultural divide.  This desire for outside expertise has been spurred by the 1980s and 1990s in particular when dictatorship, not democracy and economies in crisis were the problem.  Latins felt that they could not trust their governments and anxiously transferred assets to other countries for safekeeping:  expropriation and political uncertainty (still relevant in parts of the region today) were the real concerns. 

Taxes

Those Latins lax with their taxes feel no real pressure because of the creaking tax systems most of which still need a complete overhaul.  This, however, is changing as governments start shifting more towards direct, rather than indirect, taxes.  As economic progress is made, more sophisticated tax regimes are being created which will encourage sensible tax planning.  It will include international structuring to mitigate taxes for sophisticated businessmen. 

Tax rates, excise taxes and contributions have increased and whilst a few countries in the Americas have territorial tax regimes, the majority now have a worldwide taxation policy.  The quality of the tax departments across Latin America today is like the curate’s egg:  good in parts.  Argentina, Brazil, Bolivia, Chile, Colombia, Guatemala and Panama stand out as having officials with a reasonable level of tax competency and technical knowledge.  Collecting the taxes is another matter.

Let me mention some of the problems the tax systems face.  The level of tax evasion in Latin America is high.  Evasion is part of the business culture; sadly, in addition to this many citizens simply don’t trust their governments to use the taxes for the common good.  It must, however, be understood that evasion can be part of a survival strategy for those firms that would fail because of onerous and cumbersome regulations.  And do remember that evasion, like corruption, is an international issue.  It is estimated that EUR 100 billion a year is lost in taxes in Italy, about 6 per cent of GDP.  Complexity compounds the problem and it seems to be a vicious circle that can only be broken if governments start to simplify the tax regulations.  Until this is addressed tax revenues in Latin America will remain low by international standards.  And while firms in high-income countries spend an average of 177 hours a year in tax-related transactions (such as preparing, filing and paying taxes) Latin American businessmen on average spend 320 hours doing the same thing.  In Bolivia that figure is 1,080 hours and in Brazil, the region’s economic powerhouse, an incredible 2,600 hours. 

But let’s not overlook the fact that simplifying taxes is not just a Latin American problem.   Remember that William the Conqueror tried to simplify matters by creating his Domesday Book which, in 888 pages, compiled the English nation’s wealth for purposes of taxation.  Britain’s tax law today runs to 11,000 pages and now the government has had to create the Office for Tax Simplification.  We must all surely have some sympathy for Latin America’s problem.

In Latin America the largest percentage of tax revenues come from corporations so corporate tax income is crucial to the region’s tax collection system.  That said, the majority of the firms are small enterprises and perhaps over 80 per cent of manufacturing establishments employ fewer than 10 workers (often referred to as micro-enterprises).  In the services sector this percentage is even higher and in Mexico, for example, 97 per cent of retail establishments fall into the category.  Collecting taxes is a nightmare, even before addressing evasion, and I am reminded of Dr. Johnson’s dog that walks on its hind legs rather badly, but even so one is surprised that it can do so at all.  And introducing special tax regimes for such micro-enterprises has not really eased the problem.  In one study of 17 countries, 13 of them have at least one special tax regime for smaller companies.  But if the regime is simple, applying to qualify for it, by going through bureaucratic hoops, is not.

There are so many small firms in Latin America and it is very difficult for the tax authorities to track them down; because of this, efforts are concentrated on the easy prey.  This means that the main targets are the largest and most productive firms in Latin America.  But if large firms are targets they are also sometimes guilty of tax evasion too.  What is for sure is that tax authorities need to spread the burden more evenly and ratchet up the efforts to increase the amount of taxes paid by individuals. 

Even so, low levels of personal income limit the scope for income taxes in Latin America and the region continues to lead the world in income inequality according to the OECD.  This inversion of the personal tax pyramid with the pinnacle supporting the system (including social security contributions) with too few contributing to it remains a key issue whereas in Japan and much of Europe, unlike Latin America, this is unavoidable due to ageing populations. 

Figures from 2008 revealed that in OECD countries individual tax payers represented 27 per cent of the total of tax revenues whereas in Latin America the figure was 4 per cent.  Approximately 90 per cent of working people in Brazil, Chile, Colombia and Costa Rica had earnings below the minimum threshold at which tax becomes payable.  Even if taxes were properly paid, the fact remains that the size of the tax base will still be small.

It seems, therefore, that most revenues in Latin America are derived from imports and state-owned enterprises.  In some countries the large, small and micro-enterprises under- report as much as 40 per cent of sales.  Take Mexico, for example, where McKinsey and Company say nearly 70 per cent of micro-enterprises are not registered and so pay no taxes.  63 per cent of registered small and medium size firms report not paying taxes at all and 48 per cent of large firms don’t pay any taxes either.  Just a couple of years ago the Mexican government received 40 per cent of its revenues from petroleum. 

A study by the Inter-American Development Bank on the various tax regimes says, and I quote, “At the end, these regimes create incentives for firms not to grow beyond a certain point.  If they invest and grow, they will not be entitled for such special treatment and their taxes will increase dramatically.  The additional taxes they will have to pay will, many times, not pay for the investments they make.  So they simply don’t invest”.  As I say, governments need to streamline and simplify their systems.  It is estimated that only one in three Latin Americans is subject to income taxation and more than half of all Latin American workers are not entitled to pension rights through their jobs. 

Brazil is leading the way on the matter of tax collection from rich individuals with assets offshore and legislation published in June named 65 jurisdictions that it considered as tax havens in addition to those classified as having tax privileges that work against the spirit of Brazilian tax laws so will be subject to special tax requirements.  Those named include 4 Latin American countries:  Costa Rica (the only one that is not a finance centre of some description) Belize, Panama and Uruguay.  In the classic sense Panama is not a tax haven with 7 per cent VAT, corporate tax rates of 27.5 per cent and individuals subject to 25 per cent.  Planned as well are Double Tax Agreements awaiting ratification such that Panama expects to be white-listed by the OECD next year.  There are 21 in the pipeline.  Significantly – and wisely I believe – no Tax Information Exchange Agreements are contemplated.

One casualty of Brazil’s tax changes is the US Limited Liability Company through which many foreign individuals and multinationals invest in and a new blacklist is split between low tax jurisdictions and tax privileged regimes.  When the LLC is composed of non-residents not subject to federal income taxation it will be classified as a tax privileged regime.  At this stage it is not clear whether just one non-resident member would trigger the classification.  For now this and several other practical issues have still to be ironed out and bear in mind that the classifications are subject to changes in the future.  It is also known that the Brazilian authorities have been very critical of Delaware, especially concerning corporate secrecy.

Being a blacklisted LLC means:

1. Transfer pricing and thin capitalisation rules
2. Capital gains of at least 15 per cent.
3. Withholding taxes of at least 15 per cent.

For non-resident investment funds who have enjoyed up to now exemption from capital gains on the disposition of shares in publicly-traded Brazilian companies using a US LLC this will be a harsh blow.  And for most large and medium-sized multinational companies investing in Brazil through US LLCs, preferential tax withholding rates on interest and royalties is important.  This might see a flight of LLC business in favour of, for example, a US or Canadian limited partnership or a UK LLP.

Taxes to Trusts

Significantly for all of you here today, besides any issues of tax, Latins, like Asians, value privacy and personal relations highly.  Joe Field, in the August issue of STEP’s Asian Adviser, highlighted this issue in the case of Asians.  They adhere to Anton Chekhov’s contention that every person lives his real, most interesting life under the cover of secrecy.  And as with the kindness found in strangers, comfort for Latins is found in foreigners when it comes to isolating their financial affairs.  Strong ties have already been established with financial institutions especially in Europe where empathy for those wishing privacy is strong.  The office which I ran in Miami back in the 1990s catered exclusively to such individuals from Latin America. 

I would like to move away from taxes to trusts and in doing so what follows are just my own thoughts, bearing in mind that both foundations and trusts were thoroughly reviewed yesterday.  In the past a common remark among Latin Americans was that companies with bearer shares were their trust, the certificates being placed perhaps in the hands of a confidant.  In so many cases it is a leap of faith to replace such control with a trust.   Trust between individuals is one thing, but trust reduced to a deed is quite another thing.  As income tax regulation, however, becomes more sophisticated and some individuals wealthier because of growing economies, there is the imperative to make more structured plans and this is where, as I have said, a great deal of opportunity lies for international practitioners offering financial services.

Perhaps the methods used to structure investments is universal but not when it comes to estate planning which is dependent on domicile and residence.  It is true that the traditional English tool for protection and efficient tax and estate planning, the trust, is known and used in Latin America, but, like a vintage wine, its circulation among general consumers has been limited.

Latins using trusts for tax planning purposes are faced with 3 issues:

1. Recognition of foreign trusts in Latin American countries.
2. The issue of forced heirship rules.
3. The availability of offshore expertise for proper and sound tax planning. 

Trusts today may be big business but not in Latin America where they must vie with foundations which are far more popular.  In the same way that taxing a foundation can confound the US Internal Revenue Service, it is quite possible that Latin American tax authorities will be confused by a trust.  And as for forced heirship rules, it should be added that in Latin America only Panama’s foundation law, I believe, specifically addresses the issue.  Panama has no forced heirship and its foundation legislation excludes it in the case of the founder’s own jurisdiction as well.  Obviously, lex situs rules excepted.

Trust officers worldwide now have their own society based in the United Kingdom called the Society of Trust and Estate Practitioners and even if trust officers of the Latin variety who are members of STEP spend more of their day with foundation charters and regulations rather than trust deeds, the society is certainly contributing to a firm understanding in Latin America of a fiduciary’s responsibilities as well as a deeper appreciation of the virtues of trusts.  There are members in Argentina, Belize, Brazil, Colombia, Ecuador, Mexico, Panama and Uruguay; Panama, according to STEP’s 2010 directory, has 50 members, more than the combined total of the other 7 jurisdictions.  Uruguay is second with 19 members which, like Panama, is a banking centre (although I believe the largest regional concentration of trust companies can be found in Panama).  STEP has now launched an exclusive foundation course for fiduciaries in civil code jurisdictions which is co-ordinated from Panama.  

Meanwhile in some offshore common law jurisdictions the ubiquitous trust now has foundations quietly nibbling away at its prominence in estate planning as foundation laws are introduced and trust officers begin to get familiar with the concept. 

Those offshore common-law jurisdictions which have adopted the foundation will have to subsequently grapple with an absence of legal precedents when disputes reach the courts.  Instead of the Superman cry of “is it a bird”?  is it a plane?” you will hear “is it a company?, is it a trust?”  Trusts will continue to encounter a similar vagueness in Latin America and whenever a client wishes a local trust, I always make its governing law that of a user-friendly offshore common law jurisdiction.

I appreciate that there is some rivalry between civil code and common law countries as to the origins of the trust and I am sure the debate will continue to run on.  This competitive comparison of laws reminds me of the American lawyer and political figure, Newton Minnow, who, during the days of the old Soviet Union, said:  “In Germany, under the law everything is prohibited except that which is permitted.  In France, under the law everything is permitted except that which is prohibited.  In the Soviet Union, everything is prohibited, including that which is permitted.  And in Italy, under the law everything is permitted, especially that which is prohibited”.

As I wrote in the July issue of Offshore Investment.com and have often said before, tortillas and trusts do have something in common:  their meaning depends on where you are and although you may be able to redomicile your trust to southern climes, you can’t do the same with the personnel who manage it.  I am afraid that I take a pragmatic approach, believing in horses for courses.  Many Swiss bankers are wary of trusts, as their Latin American counterparts should be for the same reason:  they are interlopers in the civil law system and can prove to be problematic.  Everyone here appreciates that the level of expertise and understanding in fiduciary matters is crucial, just like it is – as we now realise – in banking.  Walter Bagehot, in his classic 19^th century work “Lombard Street:  A Description of the Money Market”, was spot on:  “Common sense teaches that booksellers should not speculate in hops or bankers in turpentine; that railways should not be promoted by maiden ladies, or canals by beneficed clergymen…”.  We should all stick to our knitting.

Those wishing to capture some of Latin America’s lucrative investment market and who conquer the conundrum of the confidant versus the professional, might still have to consider replacing the trust with a foundation, and yet still retain the ubiquitous company as a common denominator being the operating arm for investment planning. 

Panama is the ideal platform for co-ordinating much of the financial services business in Latin America.  It’s political stability, as well as its infrastructure (the most developed in Central America), suggests that its regional banking centre with some 90 banks and nearly 60 trust companies will continue to develop and although its government is reluctant to dilute the country’s prized banking secrecy, it will not choose isolation to become the North Korea of offshore banking.  As the STEP statistics suggest, it is the main centre in Latin America for trust practitioners and whatever the pace I do believe that the trust concept will continue to gain ground.

Panama has caught the economic wave that is passing across the region that I have written about in my supplementary notes and in doing so, it has, so far, like the Chinese, adopted the bamboo policy:  bending with the wind rather than standing straight and eventually snapping.  Recent developments in firming-up Double Tax Agreements with several countries has illustrated this.

Conclusion

In conclusion, it is important that as Latin America moves out from the economic darkness of the past it must avoid stumbling in the sunlight.  Failure will just feed that existing body of prejudice which is now, I suspect, also tinged with envy.  That said, no amount of evidence will convince some, however, because of the Worm Syndrome.  Let me explain.  In an effort to warn a meeting of Alcoholics Anonymous about the dangers of drink a religious minister dropped a worm into a jar of pure alcohol.  It disintegrated almost upon impact and the minister, with furrowed brow and stern gaze asked:  “What does that tell you about alcohol?”  A voice from the back of the room replied:  “that you’ll never get worms”. 

Worms or otherwise, if Panama as predicted does achieve the highest regional growth in GDP in 2015, it, like several other rising stars in Latin America, must be careful not to become intoxicated by success and become incautious.  They must remember the words of Juan Bautista Alberdi, a nineteenth century Argentine constitutionalist:  “Nations, like men, do not have wings; they make their journeys on foot, step by step”. 

Thank you very much for your attention.