Tax Incentives, International Commitments, and Tax Sufficiency: Another Impossible Trilogy

The countries of Latin America and the Caribbean (LAC) use significant cuts in the corporate income tax rate (CIT) or tax holidays to promote investment. In turn, this incentive must comply with the condition of not discriminating between export operations and those destined for the local market, according to commitments made to the World Trade Organization (WTO) and Base Erosion and Profit Sharing (BEPS) project. This can give rise to significant tax arbitrage, when firms that benefit from a lower corporate tax rate (CTR) sell with inflated prices to firms subject to the standard rate in the local market, thereby transferring revenues to the subsidized firms from the general tax regime. This has significant and growing negative impacts in terms of revenue and equity between beneficiary firms and those subject to the general tax regime in the same sector, especially in the services currently enjoying spectacular growth (such as the digital or telecommunications segments). To mitigate such arbitrage, some practical options, such as the ones presented in this paper, will need to be applied. This can make tax rate benefits viable as a policy tool and compatible with such international agreements, and can reduce tax revenue losses. In addition, the paper includes tables that summarize the main tax incentive regimes and presents a peer review of possible harmful fiscal regimes in Latin America (BEPS Action 5).