6. Tax policy for investment
This chapter describes and assesses corporate taxation in Uruguay with a focus on tax incentives. Tax incentives in Uruguay are used extensively and vary across investments depending on where, when and by whom an investment is made in the country. The chapter first provides an overview on tax revenues and the corporate tax system in Uruguay. It then provides a description and an assessment of the country's tax incentives regime for investment. Two following sections further discuss the use and governance of tax incentives in Uruguay, providing specific policy recommendations on how to enhance the use and governance of tax incentives in alignment with investment and tax policy objectives.
Governments around the world provide corporate tax incentives with the aim of achieving certain policy goals, including attracting investment in specific activities and regions or increasing investment overall. By providing a favourable deviation from a country’s general tax treatment, tax incentives reduce or postpone the tax liability of an investor, which can encourage investment in certain circumstances.
However, tax incentives often come at a substantial cost to a country and their use deserves careful monitoring and analysis to understand whether these costs outweigh the benefits. In particular, tax incentives can result in considerable forgone government revenue, i.e. tax revenue that authorities do not collect because business receives preferential tax treatment on investments that it would have made in the absence of the incentive. Furthermore, there are costs from additional administrative and compliance procedures that come along with a fragmented tax code, costs from a distorted allocation of resources that is driven by the incentive, e.g. by treating taxpayers unequally, and costs from an increasingly complex tax system, one that may incentivise business to shift taxable income.
Forgone government revenue is particularly worrisome when tax incentives create little additional investment (i.e. investment attracted exclusively by the incentive) and instead are largely redundant. Redundancy refers to tax incentives granted to investment that would have taken place anyway – even without the incentive. For example, an investor may come to a country independently of the tax treatment but thanks to favourable investment conditions in general, or with the objective of gaining access to specific resources or a particular market.1 In such a situation, granting a tax incentive would be redundant and equivalent to providing a pure windfall profit to business, while creating a loss to the government without additional benefits to the country. It is therefore of paramount importance that governments deciding to offer tax incentives design them in ways that maximise additionality and avoid granting incentives that risk large redundancies. Regular monitoring and reporting of tax incentives can support tax policy analysis and reform in this respect.
Evaluating whether there are net benefits from tax incentives is of particular importance when public revenue is scarce. Forgone revenue reduces opportunities to spend public funds in other (potentially more productive) ways, e.g. infrastructure, public services such as health and education. Striking the right balance between an efficient, predictable and attractive tax regime for domestic and foreign investment and securing the necessary revenues for public spending and development is important and requires insight into the actual effectiveness of tax incentives for investment (i.e. how much additional investment is generated), how good design fosters effectiveness, and the revenue implications.
This chapter describes and assesses corporate taxation in Uruguay with a focus on tax incentives. Tax incentives in Uruguay are used extensively and vary significantly across investments depending on where, when and by whom an investment is made. The chapter first provides an overview on tax revenues (Section 1) and the corporate tax system in Uruguay (Section 2), before turning towards a description and an assessment of the country's tax incentives regime for investment (Section 3). Sections 4 and 5 further discuss the use and governance of tax incentives in Uruguay, with each of these sections providing specific policy recommendations on how to enhance the use and governance of tax incentives in alignment with investment and tax policy objectives. Section 6 highlights the key recommendations.
Tax revenue expressed as a percentage of GDP is higher in Uruguay than in the Latin America and the Caribbean (LAC) region on average (Figure 6.1). Total tax revenue in Uruguay increased from 20% of GDP in the 1990s to 31% of GDP in 2017, thereby approaching the OECD average, which stands at 34%.
Note: LAC = Latin America and the Caribbean countries; The LAC average represents the unweighted average of 24 Latin American and Caribbean countries included in the OECD Global Revenue Statistics Database (OECD, 2018[1]). (Argentina, Bahamas, Barbados, Belize, Bolivia, Brazil, Chile, Colombia, Costa Rica, Cuba, Dominican Republic, Ecuador, El Salvador, Guatemala, Guyana, Honduras, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, Trinidad and Tobago and Uruguay). It excludes Venezuela due to data availability. The OECD average represents the unweighted average for OECD member countries.
Source: OECD Revenue Statistics in Latin America and the Caribbean 2019 (OECD et al., 2019[2]).
The Uruguayan tax system has undergone several reforms in recent years. In particular, it was substantially reformed in 2007 (Law 18,083) and tax revenues as a share of GDP have increased considerably since then. The reform rationalised the tax structure (eliminating 15 tax types), reduced standard valued added tax (VAT) rates, introduced the personal income tax (IRPF) and the non-resident income tax (IRNR) and modified the corporate income tax, creating a new tax (IRAE). It reformed the tax administration and strengthened the coordination with the social security agency. Smaller changes in 2008, 2014, and 2016 further modified corporate tax provisions. For example, in 2014, new provisions reduced the standard VAT rate to 20% for payments with debit cards and other electronic means of payment. These measures, together with the provision of free bank accounts and debit cards for all workers, pensioners and beneficiaries of social plans, and the requirement to use bank deposits for paying wages, increased formalisation substantially.
Taxes on goods and services and social security contributions (SSCs) represented the largest source of tax revenue in Uruguay in 2017 (Table 6.1). Taxes on goods and services, including VAT accounted for 37.2% of Uruguay’s total tax revenue, while SSCs represented 31.2%. Revenues from the personal income tax (PIT) and the corporate income tax (CIT) amounted to 24.4% of total revenues and property taxes to 6.8% (amongst which the corporate net wealth tax accounts for 3.1% of total tax revenue).
Over time, Uruguay’s tax structure has remained fairly stable, with the main change arising in 2007 with the introduction of the PIT (Figure 6.2). From that date onwards, PIT revenues have constantly increased as a share of total taxation at the expense of other taxes on goods and services. CIT revenues, in particular, have remained stable in the last twenty years, representing around 10% of total taxation.
Uruguay’s tax structure partly resembles the LAC and OECD averages, respectively (Figure 6.3). The reliance on revenues from VAT and other consumption taxes in Uruguay aligns with the LAC region on average. On the other hand, the prevalence of revenues from SSCs and the relatively low weight of revenues from corporate income tax bears resemblance with the tax structure across the average OECD country. Generally, SSCs are highest in OECD countries when compared to other regions in the world (Modica, Laudage and Harding, 2018[3]). Revenues from SSCs in Uruguay are particularly high even by OECD standards. The personal income share of tax revenue is relatively small in Uruguay and the average LAC country compared to the OECD average.
Note: LAC = Latin America and the Caribbean countries; The LAC average represents the unweighted average of 24 Latin American and Caribbean countries included in the OECD Global Revenue Statistics Database (OECD, 2018[1]). (Argentina, Bahamas, Barbados, Belize, Bolivia, Brazil, Chile, Colombia, Costa Rica, Cuba, Dominican Republic, Ecuador, El Salvador, Guatemala, Guyana, Honduras, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, Trinidad and Tobago and Uruguay). It excludes Venezuela due to data availability. The OECD average represents the unweighted average for OECD member countries.
1. includes "other profit taxes"
Source: OECD Revenue Statistics in Latin America and the Caribbean 2019 (OECD et al., 2019[2]).
The main corporate tax provisions in Uruguay are summarised in Table 6.2.
Corporate income tax
Corporate income tax (Impuesto a las Rentas de las Actividades Económicas, IRAE) is levied on income generated in Uruguay both from resident legal entities and permanent establishments of non-resident entities (territorial system).
The standard CIT rate in Uruguay (25%) is higher than the OECD average (21.9%) but is lower than some of its key neighbouring countries: Argentina and Brazil at 30% and 34% respectively (Figure 6.4). However, Paraguay’s standard CIT rate is significantly lower (10%).
While dividends and profit distributions are not subject to tax at the resident corporate level, resident and non-resident individuals are subject to IRPF or IRNR, respectively, when receiving dividends and profits by companies subject to CIT.
Certain expenses are deductible from corporate tax only if the other party to the transaction is subject to CIT, IRPF, IRNR, or a foreign tax (Art. 19, Title 4 Texto Ordenado 1996, CIT Law). This rule informally named the “lock rule” aims at deterring avoidance. Deductions include interest payments, taxes (other than CIT and net wealth tax) and certain losses. If expenses constitute a capital gain to a person subject to IRPF (Cat 1) or IRNR, the allowed amount of the deduction is 48% (i.e. the quotient of the maximum tax applicable to capital gains to the standard CIT rate, 12/25). If expenses represent a capital gain to a person also liable under the PIT abroad, the deduction will be 100% in cases where the effective tax rate is larger or equal to 25%. The deduction will be proportional [e.g., calculated as (12 + Foreign Income tax rate) / 25] in cases where the effective tax rate is below 25%.
Taxation of small- and medium-sized enterprises (SMEs)
Companies with gross sales lower than 4 million indexed units2 (approximately USD 480 000) can choose to be taxed by presumed or real income. The presumptive tax is levied on gross income depending on the company’s level of sales. Companies with gross sales lower than 305 000 indexed units (approximately USD 36 000), with certain exceptions, are exempt from CIT, net wealth tax (IP) and VAT and pay a monthly flat tax of UYU 3 680 (approximately USD 105) named “minimum VAT”. Half of the OECD countries levy a reduced CIT rate for SMEs, reducing country’s CIT rates on average by approximately 4 percentage points. Nonetheless, it should be noted that size-based tax preferences may impede firm growth as they provide companies with an incentive to remain below the threshold in order to continue benefiting from such targeted regime (OECD, 2017[4]).
Special taxation regimes by sector
Certain sectors, e.g. educational and cultural institutions and software production, are fully exempt from corporate tax. Companies in the agriculture and livestock sector earning a gross income below 2 million indexed units (approximately USD 240 000) may choose to pay Impuesto a la Enajenación de Bienes Agropecuarios (IMEBA) instead of CIT. IMEBA is a presumptive tax that levies on the first sale of the produced goods at a rate ranging from 1.5 to 2.5% depending on the type of good. Research and development in biotechnology and software are also exempt from CIT with some restrictions (Art. 247, Law 19,535). Independent workers may be subject to CIT rather than PIT if their earnings exceed 4 million indexed units (approximately USD 480 000) or if they opt to pay CIT instead of PIT.
Net wealth tax
The net wealth tax (Impuesto al Patrimonio, IP) applies to assets of companies that are subject to CIT. All property located in Uruguay for business purposes is subject to this tax. The tax base is defined as the difference between taxable assets and deductible liabilities (debt with local financial institutions, local commercial debt, and debt in the form of bonds). Assets held abroad by domestic residents are not subject to net wealth tax in Uruguay. However, only the amount of liabilities that exceeds the value of those assets constitutes a deductible liability (Art. 13, Titulo 14, Texto Ordenado 1996).
The standard rate of the net wealth tax is 1.5%, while a rate of 2.8% is applied to financial institutions and 3% to entities in low or no tax jurisdictions (listed in Decree 56/009) holding assets in Uruguay.
There is a specific regime for companies in the agriculture sector. Net wealth in agriculture is exempt if assets are less than 12 million indexed units (approximately USD 1.4 million). Assets in the agriculture sector that exceed 30 million indexed units (approximately USD 3.5 million) pay a surtax ranging from 0.75% to 1.5% (depending on the value of the assets).
Withholding tax
The standard withholding tax rate on Uruguayan-sourced income is 12%.3 A reduced rate of 7% applies to dividends from income subject to CIT in Uruguay. The withholding tax rate on interest payments ranges from zero to 12% depending on the asset. Since March 2017, notional dividends have been subject to a 7% withholding tax. Royalties paid to non-residents are subject to the standard withholding tax rate of 12%. A 25% withholding tax applies to residents in a low or no tax jurisdiction. Currently, Uruguay has 21 bilateral double taxation treaties in force. These treaties may lower the withholding tax rates on dividends and interest payments to non-residents and may vary across partner countries.
Given Uruguay’s territorial regime, tax is levied only on income sourced in Uruguay. In the past years, some foreign income started to be subject to taxation. In fact, technical services (defined as services in the fields of management, technical, administration, or advice of any kind) provided by non-residents outside Uruguay to a local user that are associated with taxable income of the local user in Uruguay, are considered to be Uruguayan-sourced and subject to withholding tax. The application of Uruguay’s bilateral tax treaties may affect the taxation of technical services by non-residents.4
International taxation
Uruguay has implemented several features to protect the domestic tax base from cross-border tax minimisation strategies by multinational enterprises (MNEs), but it is advisable to further extend these efforts and the effectiveness of recent measures should be carefully monitored.
To combat aggressive tax planning, the Uruguayan tax authorities have been closely collaborating with the OECD and other key partners. For example, Uruguay is a member of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS), which is monitoring the implementation of the four BEPS minimum standards and completing the work on remaining BEPS issues.
In recent years, Uruguay has amended those preferential regimes providing benefits to geographically mobile business income that were reviewed by the Forum on Harmful Tax Practices (FHTP) as presenting harmful features against the FHTP standards. Preferential regimes have been either abolished5 or amended to comply with the BEPS Action 5 minimum standard6 (OECD, 2019[5]). Next steps within the FHTP include the monitoring of the substantial activities requirements in respect of non-IP regimes7 and grandfathered non-IP regimes8. In this context, Uruguay is invited to ensure the effective implementation of the standards agreed by the FHTP, in particular the substantial activities requirements.
Monitoring the substantial activities requirements of non-IP regimes will ensure that the regimes continue to operate consistently with the legislative framework that forms the basis of the FHTP findings. These include, for example, reviewing taxpayer compliance as well as relevant statistical data, including aggregate numbers of employees and income benefitting from the regime, and denying tax benefits if substantial activities requirements are not met.
Monitoring grandfathered non-IP regimes will ensure that jurisdictions are enforcing and implementing their grandfathering provisions in an effective way. In particular, authorities should collect additional information. This information should include a description of the mechanisms that ensure new entrants (i.e. new taxpayers and new assets or activities) entering the regime after the cut-off date (16 October 2017) are not benefiting from grandfathering and that benefits are not granted to those entitled to benefit from grandfathering after the end of the grandfathering period (30 June 2021).
Recent updates of domestic legislation and regulations (Law 19,484 and Decree 353/018) incorporate the BEPS Action 13 recommendations (OECD, 2015[6]) into the Uruguayan transfer pricing rules. Recent regulation (Resolution 94/019) establishes filing and notification obligations and deadlines regarding country-by-country (CbC) reporting as well as content mostly in line with BEPS Action 13. The law requires multinational enterprises to file CbC reports with the Uruguayan tax authority for fiscal years starting as of 2017. It should be pointed out that the local filing requirements remain wider than required under the Action 13 minimum standard and it is recommended that these regulations are brought fully in line with the BEPS Action 13 minimum standard and terms of reference for the peer review process.
The treatment of interest expense may be an area for review. Although Uruguay has a rule (the “lock rule” referred to above) that implies proportional deductions for expenditure, including interest, it currently has no general interest limitation rules. In line with the best practice recommendations of BEPS Action 4 (OECD, 2015[7]; OECD, 2016[8]), legislation could be implemented that limits the amount of deductible interest expense of an entity to an amount based on its economic activity.
The recommended approach in BEPS Action 4 is to limit net interest expense to a fixed percentage (set within a recommended corridor of 10% to 30%) of its level of economic activity within the jurisdiction measured as earnings before interest, taxes, depreciation, and amortisation (EBITDA). Such a rule could be supported by a group ratio rule to restrict the amount of disallowed interest in situations where the worldwide group is comparatively highly leveraged, as well as introducing targeted rules to address specific base erosion concerns arising in the context of interest expenditure.
Uruguay deposited its instrument of ratification for the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) on 6 February 2020. The MLI entered into force on 1 June 2020.
In 2020, Uruguay modified requirements linked to acquiring fiscal residence in Uruguay. Since 2007 and up to 2020, an individual could become a tax resident in Uruguay either proving presence in the country for more than 183 days or proving that the base of his/her economic or vital interests were located in Uruguayan territory. An individual could also become tax resident by making a significant investment in Uruguay. In 2020, decree 163/020 and laws 19 904 and 19 937 introduced a new definition of a tax resident that has the aim of attracting investment to Uruguay. As of July 2020, an individual can become a tax resident in Uruguay if he/she remains in the country at least 60 days per year and invests in immovable property at above 3.5 million indexed units (approximately USD 370 000) or if he/she invests 15 million indexed units in a company creating at least 15 full-time jobs.
The new provisions also significantly reduce the tax treatment of the new tax residents under the personal income tax regarding passive income earned abroad, thereby increasing incentives to acquire fiscal residence in Uruguay. Individuals that became tax residents in Uruguay between 2007 and 2020 were given the option to enjoy a 5-year tax holiday on capital gains earned abroad under non-resident income tax (IRNR) instead of paying the standard personal income tax on this income (IRPF). As of 2020, following laws 19 904 and 19 937, new tax residents can choose whether to be taxed under the non-resident income tax (IRNR), enjoying a more generous tax holidays for 10 years on capital income earned abroad, or to be taxed under the personal income tax (IRPF), enjoying an unlimited reduced rate of 7% (instead of the standard 12%) on capital gains earned abroad .
The change in requirements to acquire fiscal residence may have two noteworthy implications in terms of tax treaties. First, an individual may be considered as being a tax resident of Uruguay and another country at the same time, and could thus be taxed as a tax resident of those two countries without relief from double taxation. If Uruguay and the second country have concluded a bilateral tax treaty based on the OECD or UN Model Tax Convention, the individual would be subject to the tie-breaker rule in the treaty (which is likely to be based on Article 4 of the OECD or UN Model Tax Convention).9 The treaty and tie-breaker rule could then generally break the tie in favour of the other country – and not Uruguay.
Second, an individual that will be considered as being a tax resident in Uruguay could take advantage of the bilateral tax treaties concluded by Uruguay and could be entitled to treaty benefits with respect to income he/she earned from sources in third countries with which Uruguay has a treaty in force. Concerns could be raised with respect to persons that would only seek to become a tax resident of Uruguay in order to get treaty benefits with respect to the income he/she would earn in those third countries.10 Such behaviour could undermine the tax base of those third countries as a person would be claiming treaty benefits in situations where these benefits were not necessarily intended to be granted.
Third countries that may have concerns related to such behaviour could consider to add anti-abuse measures in their tax treaties with Uruguay. The BEPS Action 6 Report (OECD, 2015[9]) sets out one of the four BEPS minimum standards, which is that members of the BEPS Inclusive Framework commit to include in their tax treaties provisions dealing with treaty shopping to ensure a minimum level of protection against treaty abuse. Progress on the implementation of the Action 6 minimum standard follows a peer review process (OECD, 2020[10]).
Uruguay relies significantly on tax incentives as a means to attract investment. It relies upon a number of different regimes that range from general benefits that are automatically available, a more generous scheme (COMAP regime) that requires submission and approval of an investment project by the government and even more generous tax treatment of projects established in free zones and free ports. This section discusses the design of these different incentives and closes with an evaluation and recommendations.
Tax incentives for investment prescribed in the Corporate Tax Law
The CIT regime (Texto Ordenado 1996) grants companies with turnover below UI 4.000.000 the right to deduct immediately 40% of qualifying capital expenditure in machinery, equipment, agricultural inputs and fertilisers, among others. In addition, companies can deduct 20% of qualifying capital expenditure for construction of buildings for touristic, industrial or agricultural purposes. The deduction is limited to 40% of the company’s annual net income once other deductions are applied and can be carried forward for the following two years.11
Tax incentives prescribed in the Investment Promotion Law
In 1998, the Investment Promotion Law (Law 16,906) declares of national interest the promotion and protection of investment and establishes an equal treatment of foreign and national investors. The law defines two types of tax incentives: general and specific incentives.
General incentives
Companies subject to CIT or IMEBA, which develop industrial or agricultural activities and invest in movable goods used in the production cycle, automatically benefit from the following incentives:
Exemption from the net wealth tax for the whole lifecycle of the movable good.
Exemption from VAT and excise tax (IMESI) if the good is imported.
These benefits are compatible with the general benefit in the CIT Law. Since 2014, these benefits have been restricted to SMEs.
Specific incentives (the COMAP regime)
The COMAP regime describes a specific incentive scheme for investment under the Investment Promotion Law that is not automatically granted, but involves a project-based evaluation by the Uruguayan authorities based on a set of eligibility criteria and involving the calculation of a score that triggers a specific credit amount. While the Investment Promotion Law creates the COMAP regime, Ministerial decrees describe its implementation, application and administration details.
Since 2007, the COMAP regime has become significantly more generous and the list of eligible activities has been expanded. In addition, modifications in the allocation mechanism increased transparency in the application and allocation compared to the previous procedure, which assigned incentives by decree. The regime was further revised in 2012 and 2018 seeking a greater impact for the sectors of development and innovation and trying to reduce incentives granted to redundant investment i.e. investment that would have occurred without the incentive (Decrees 455/007, 02/012, 143/018).12
Benefits under the COMAP regime consist of:
CIT credits that range from 20% to 100% of new capital expenditures depending on the nature and size of the project. The amount of the tax credit and period in which it can be used depend on a score obtained through a scoring matrix that is described in more detail in Table 6.3.
Exemption from net wealth tax: Movable goods benefit from an unlimited exemption, while construction projects are exempt for eight years in Montevideo and for 10 years in the rest of the country.
VAT returns for the local purchase of goods or services for construction projects.
Exemption from import tariffs and VAT for movable goods and construction material that does not compete with the national industry.
To obtain these incentives companies must submit a project to the Private Sector Support Unit (UnASeP) in the Ministry of Economy and Finance. The Investment Law Application Commission (COMAP) will subsequently evaluate the project according to several principles and eligibility criteria.
Activities are eligible for the COMAP regime if declared as promoted activities by the government (Art. 11, Law 16,906) and include industry, construction, tourism, retail, and generation of non-traditional renewable energies, and public-private partnerships, among others. COMAP evaluates projects based on a predefined scoring matrix that establishes how well they satisfy different policy objectives, namely: employment, decentralisation, exports, clean technologies, research and development, and investment in certain sectors of activity.
Companies that submit a project to UnASeP select one or more objectives to which their investment project contributes (column 1 in Table 6.3) COMAP evaluates the investment projects by calculating a weighted score (0-10 points) based on indicators that are associated with each objective as described in column 2 of Table 6.3 (weights are specified in column 3). Projects that accumulate at least 1 point in the weighted sum and 0.5 points in the sum of the Employment, Exports, Clean Technology, Research Development and Innovation and Sectoral indicators will be evaluated further. If the project satisfies these requirements, it receives a minimum corporate tax credit of 20%. The exact percentage of the tax credit is determined by the following formula:
The total tax credit granted is limited to 100% of the amount of the effective capital expenditures.13 In addition, the annual credit is limited to 60% of the annual CIT liability based on the company’s actual net income. Projects submitted by newly established companies, benefit from an annual limit of 80%.
The period in which the tax credit can be used is determined according to the following rules, but must always exceed three years14:
A higher tax credit and an extended period apply in certain circumstances. For example, if SMEs15 apply to the COMAP regime for an investment project of up to 3.5 million indexed units (approximately USD 430 000), they benefit from an additional 20% credit of capital expenditures and one additional year to use the benefit. Similarly, if the company applying to the COMAP regime opts to locate in an industrial or science park (according to Law 17,547 and Art. 251-256, Law 18,362), the tax credit and period are increased by 15% (i.e. the tax credit and period obtained following the criteria of the scoring matrix will be multiplied by 1.15).
With the objective to accelerate investment in the period 2018-2019, decree 218/018 established a transitory 10% increase of the tax credit for projects submitted since Decree 143/018 was in place and up to 28 February 2019. To be eligible for this transitory increase, companies need to ensure that 75% of the investment took place prior to 31 December 2019. Moreover, investment received between 1 March 2018 and 28 February 2019 can include 120% of the capital expenditure in calculating the tax credit.
Tax incentives for specific sectors
In addition to the tax incentives described above, there are schemes that are more beneficial for certain sectors. Most notably, the forestry sector enjoys a permanent tax holiday regarding CIT, net wealth tax and rural property tax. More recently software production, generation of non-traditional renewable energies, R&D in biotechnology, the maritime and electronic industry and call centres have benefited from particularly generous incentives via the COMAP system. Some benefits, such as those granted to the forestry and tourism sectors, have been in place for a long time and defined in separate laws, whereas those approved since 2007 are embedded in the COMAP regime. Table A.C.4 in the Annex C summarises the characteristics of the most relevant regimes.
Free zones
Free zones (FZs) in Uruguay are authorised with the aim of promoting exports, output diversification, fostering employment, skill formation and investment in research and development under Law N° 15.921 further amended by Law 19,566. Some of the most frequent activities currently carried out in the FZs are the commercialisation of goods, storage, assembly, manufacturing as well as service provision. Law 19,566 also approved the creation of Theme Free Zones specialised in specific services, such as audio-visual and entertainment, as long as they are located at least 40 km from the centre of Montevideo.
Companies that are involved with FZs can be operators or users. FZ operators provide necessary infrastructure for the FZ to operate and can be the government or a private entity. Direct FZ users are consumers of the FZ facilities who contract directly with the FZ operator, while indirect FZ users contract with the direct FZ user in order to use the FZ facilities.
Both direct and indirect FZ users benefit from a full tax holiday for the duration of the user contracts. This means FZ users are exempt from all tax that is currently levied on companies (including CIT, net wealth tax, VAT, ICOSA, IMESI, excise tax) and any new tax that may be introduced in the future, except for social security contributions (Laws 19,566 and 15,921). An extension of the period is possible by resolution of the Ministry of Finance.
Prior to 2018, the law included no limit for the duration of user contracts, which was set for each specific FZ by ministerial resolution. The duration of existing user contracts could cover 20-50 years depending on the FZ (Table 6.7). Since 2017 (Law 19,566), direct FZ users can carry out industrial activities in the FZ for 15 years, or provide services for 10 years. Indirect users can carry out any type of activity for a maximum of five years. However, subject to certain requirements, it is possible to extend these terms, e.g. depending on whether the FZ is located outside or within the metropolitan area. FZs outside the metropolitan area benefit from longer durations if they employ more than 50 employees or invest more than 20 million indexed units (approximately USD 2.4 million).16 As for FZs within the metropolitan area, the requirements to extend terms are to employ more than 100 employees or invest more than 40 million indexed units. The extension of the duration is determined case-by-case by a Ministerial resolution signed by the Minister of Finance and the President.
Restrictions to the corporate tax holiday apply to certain activities related to intangibles. Income from the exploitation of IP rights and other intangibles are exempt of CIT according to the nexus ratio, which includes a 30% up-lift to expenditures that are included in qualifying expenditures, only if they are linked to income from R&D activities carried out in the free zone in relation to copyrighted software and patents. Income from industrial activities is exempt from CIT for the part attributable to IP rights associated to R&D activities carried out in the free zone (i.e. embedded IP income). In this case, income associated to IP rights must be identified according to transfer pricing principles and will be exempt according to the nexus ratio plus 30% up-lift to qualifying expenditures (art 54 Decree 309/018 and Decree 405/018).
FZ operators outside the metropolitan area (i.e., at a 40 km distance from the centre of Montevideo), as opposed to operators in the metropolitan area, are exempt from all taxes except CIT and social security contributions. All FZ operators are eligible to apply for the tax credit under the COMAP regime described in section 6.20.2. FZ operators pay a fee to the Ministry of Finance. There is no rule as for how the fee operators of FZs pay is set and generally, it has been set at a token amount.
Goods imported from abroad to a FZ are exempt from customs duties and VAT. FZ purchases of goods from the Uruguayan territory represent an export transaction from the national territory point of view. Hence, they are not subject to VAT (nor IMESI), and the exporter recovers any inbound VAT. Selling goods from FZs to the rest of the Uruguayan territory represents an import transaction from the national territory point of view and is subject to import duties and taxes. However, selling FZ imports to the domestic market is temporarily free of VAT and customs, if these goods continue to be used in the production of Uruguayan export goods. There are no export-share requirements for FZ users.
To be eligible for the preferential tax regime in FZs, a minimum of 75% of employees of FZ users must be of Uruguayan nationality. This threshold decreases to 50% if the FZ user is a service provider. The Directorate of Free Zones at the Ministry of Finance can reduce the thresholds under certain circumstances.
FZ users can provide services within FZs to other FZ users, other countries and to corporate taxpayers in national territory. International trading (purchase and sales of goods that do not enter Uruguayan territory) is allowed within FZs (Art. 10, Decree 309/018). The scope of transactions that FZ users can perform with non-FZ areas was recently further expanded (Law 19,566). There are certain activities that FZ users can provide companies within Uruguay that are not corporate taxpayers (call centres, distance learning, audio-visual, among others). In addition, the government can allow other types of activities judged to be beneficial for Uruguay’s development.
Upon request from the FHTP, Uruguay’s FZ regime was amended in 2017 and 2018 and substantial activities requirements (i.e. definition of core income generating activities, adequate number of full-time skilled employees, adequate amount of operating expenditures and monitoring and enforcement mechanisms) are now in place (OECD, 2019[5]). In particular, FZ users need to follow a business plan in order to monitor the creation of substance within FZs and every two years they are requested to submit a sworn statement documenting that the company has pursued the substance and complementary activities stated in the business plan (Decrees 309/018 and 405/018).17
Free ports and airports
The “puerto libre” regime governs Montevideo port and some commercial ports (Nueva Palmira, Fray Bentos and Colonia) and exempts imports to Uruguay from customs duties. Goods are treated as imports only if they enter national territory after entering these ports (Laws 16,246 and 19,276). An identical regime applies to Carrasco International Airport (Law 17,555).
Evaluation of tax incentive design and recommendations
General recommendations
The simultaneous existence of different laws and decrees providing tax incentives for investment, the Investment Promotion Law (Law 16,906) establishing the COMAP regime, the different sector specific regimes (see Table A.C.4 Annex C) and the FZ Law (Law 19,566), can complicate investors’ understanding of which tax provisions and eligibility criteria apply to their activity. This uncertainty risks reducing the effectiveness of the incentives and creates additional costs to investors. It can also unintentionally create scope for investors to negotiate a customised policy. In addition, there is a risk that companies use the existence of different laws to reduce their overall tax liability via tax planning, e.g. through establishing separate entities under different laws and shifting profits.
It is recommended that efforts be taken to increase transparency and legal certainty by consolidating all tax-related provisions within those legal statutes from which the incentives provide relief (IMF OECD UN World Bank, 2015[11]). Corporate tax incentives (such as the COMAP tax credit) would best be provided through the Income Tax Law, whereas exemptions from VAT and customs should figure in the VAT and Customs law respectively. This suggests amending tax incentive provisions within the Investment Promotion Law, the FZ Law and the sector specific laws and decrees so that they refer to relevant articles in the Income Tax, the VAT and the Customs Laws.
A multiplicity of tax incentives co-exist in Uruguay and there is significant heterogeneity in the actual tax benefit that companies can obtain, which depends on the exact timing and the location of the investment, but also on the specific conditions that govern their availability (e.g. the duration of user contracts for FZ benefits). This fragmentation opens room for rent seeking behaviour and creates an uneven playing field across investors. Both can reduce the effectiveness of the incentives and create distortions.
Compared to other Latin American countries with relatively high income, Uruguayan corporate tax incentives for investment stand out as particularly generous. According to Agostini and Jorratt (2013[12]) and Intelis (2017[13]), Chile has the same standard corporate tax rate of 25% as Uruguay, and provides tax credits of 4% for general investment and of 35% for investment in R&D, which compare to a maximum credit of around 60% for a regular company investing in Uruguay.
Authorities can improve the fragmented incentive framework by bringing all companies under one single regime, e.g. the COMAP tax credit and making sure no company-specific incentives are granted via decrees or other special agreements. Systematically monitoring the actual application of tax rules ex post will support the government with understanding to what degree the tax incentive framework is fragmented in its application today and where unequal treatment of investors occurs. (Sections 0 and 0 provide more details on reporting and monitoring of tax incentives.)
Regime specific recommendations
Free Zones
As highlighted in IMF, OECD, UN, World Bank (2015[11]) income-based tax incentives, such as the corporate tax holiday available to FZ users or the forestry sector in Uruguay, are often redundant and generally less efficient than expenditure-based tax incentives, such as accelerated depreciation or tax credits. Income-based incentives relate to the profit rate of a company and reduce tax liability independently of the size of the investment. This benefits highly profitable companies that plausibly would invest in a country or a zone also without the preferential tax treatment.18 This design feature of income-based incentives risks generating large windfall gains for companies but revenue forgone to the Uruguayan government, without generating additional investment.
Furthermore, using income-based incentives in the presence of multiple incentive regimes increases the risk of tax avoidance through profit shifting. More precisely, fully exempting profits of FZ companies from CIT, while taxing profits of non-FZ companies creates opportunities for harmful tax planning through transfer pricing or specific financial arrangements.
Given the numerous disadvantages of income-based incentives, the Uruguayan government is encouraged to phase-out opportunities for investors to obtain tax holidays in the future. Although it is a good sign that the government recently fixed the maximum period for tax holidays to FZ users, a full removal of this legal provision is preferable. With respect to existing tax holidays and to avoid retroactive changes to investment conditions, the government should eliminate tax holiday provisions when renewing existing FZ user contracts and not extending tax holidays beyond the contract’s initial maturity date.
The revision of FZs could also be done in light of tax reforms undertaken by other countries, in particular in relation to global minimum taxes. The 2017 US tax reform contains a provision, the Global Intangible Low Taxed Income (GILTI), which constitutes a minimum tax on the profits of subsidiaries abroad controlled by US parent companies. Thus, under certain conditions, part of the income of a Uruguayan company controlled by an American company should be included as part of US business income, reported to the US tax administration, and taxed up to 10.5% by the United States (13.125% after 2025). Hence, if the taxation of profits is low (less than 10.5% currently, then less than 13.125% after 2025), Uruguay will lose tax revenues from companies controlled by American parent companies. This is particularly relevant for FZs where companies are foreign. The effects will be all the more significant if similar taxes are put in place in other countries or if a global minimum tax is adopted as part of the OECD solution to address the tax challenges arising from digitalisation (Pillar 2 of the OECD/G20 Inclusive Framework on BEPS Programme of Work). In that event, removing CIT exemptions to FZs could be advisable.
Overall, the Uruguayan government should re-evaluate the necessity of using tax incentives in FZs at all. The investment climate in FZs differs importantly from that in other parts of Uruguay in many respects, e.g. access to infrastructure, simplified administrative procedures and other preferential treatment granted through the FZ status, and may reduce incentives for the across the-board improvement in the quality of the business climate and investment facilitation (see Chapter 6). The necessity of granting a tax benefit on top of these advantages to attract additional investment should be supported by rigorous impact evaluations as to whether government revenue could be used more productively elsewhere in the economy than via decreasing tax liability for FZ users. In case the government decides, nevertheless, that a tax incentive is necessary to enhance regional development or other policy objectives, alternative and likely less-costly tools to the tax holiday exist in the current legal framework, for example via the COMAP regime.
COMAP Regime
As indicated above, expenditure-based tax incentives, such as the accelerated depreciation available in the CIT Law or the COMAP tax credit granted through the Investment Promotion Law, are generally preferable over income-based incentives, mainly because they tend to yield more additional investment per dollar spent. Expenditure-based incentives directly target investment expenses. By reducing the user cost of capital, they target better new investment and investment that would not be profitable without the incentive (marginal investment). This increases the probability of generating additional investment, i.e. new investment that would not occur without the incentives.19
Although expenditure-based incentives often represent an improvement over income-based incentives, they still come at a substantial cost to a country. Careful and regular monitoring and analysis to understand whether these costs outweigh the benefits is needed. To increase investor certainty, it would also be advisable to prescribe a timeline for an evaluation of whether the benefits of the COMAP tax credit justify their costs.
The revision of the COMAP regime in 2007 increased the transparency of the system substantially and reduced discretion in the application of the regime’s eligibility criteria. Further revisions in 2012 and 2018 improved its design. For example, the new scoring matrix (Table 6.3) clearly and objectively outlines the requirements that are necessary to obtain a tax credit and that apply uniformly across all types of investors.
Nevertheless, several areas of improvement are possible: The policy objectives applicable to justify an incentive are numerous and associated indicators for calculating the score are complex and overlap to some extent. In addition, many exceptions to the regime and special treatments for companies are available via decrees. All these characteristics reduce transparency and clarity of the system and increase administrative and compliance costs. In particular, it requires substantial monitoring from the side of the Uruguayan authorities to run the COMAP regime smoothly and extensive compliance efforts from the side of the prospective investor to prepare an application and to file necessary documentation ex post. The complexity of the regime can deter investors from applying to the regime and represent a barrier in particular for small enterprises, which can reduce the efficiency and effectiveness of the regime.
Furthermore, the measurements used to calculate additional employment or additional exports are insufficient to avoid redundancy, thereby risking that the tax credit is granted to support employment or exports that would have occurred in the absence of the incentive and providing a pure windfall profit for companies. For example, the measure of incremental employment included in the COMAP scoring matrix (Table 6.3) compares the number of future full-time employees as stated in the project application to the average number of employees in the previous year. On the one hand, this difference is not necessarily a measure of additional employment, i.e. employment that is attracted through the incentive regime and not for other reasons. On the other hand, the measurement can incentivise a company to keep a low number of employees in the years before filing an application to COMAP. With respect to exports, the indicator is sensitive to exchange rate fluctuations and its appropriateness should be evaluated.
To improve the clarity of the COMAP regime and reduce monitoring and compliance efforts, it is recommended that Uruguay generally avoids introducing special treatments and exceptions by decree and rationalise the COMAP scoring matrix, e.g. by reducing the number of policy objectives and focusing only on the most important areas where support is to be targeted. For example, the numerous sectoral objectives may be removed and a uniform scoring system be applied to provide a consistent and comparable application of the incentives across investors. When adjusting the objectives, the government should consider the specific needs in the economy and evaluate whether policy instruments other than a tax incentive may be more appropriate to meet the policy objective. For example, to strengthen local financial markets it is likely more effective to provide regulatory and institutional stability and to reduce entry barriers to the market instead of adding a local financial market indicator to the scoring.
South Africa, which operates an investment allowance that is also based on a scoring approach, uses fewer objectives (namely direct employment creation, business linkages, energy efficiency, innovative processes, location in special economic zones, skills development, and SME procurement). Other interesting features of the South African regime are the use of a sunset clause for the overall regime and a ceiling for the total amount granted through the program.
Finally, applying a credit ceiling and a well-designed and -implemented sunset clause may bring benefits to the COMAP regime as well. In particular, a maximum credit amount would introduce a limit to government expenditures in terms of revenue forgone through the incentive. Without expenditure ceilings, governments have no control over future funds that they forgo through tax incentive regimes. Applying a ceiling per project (as opposed to a ceiling for the total regime) may increase the value of the incentive for smaller companies, relative to larger ones. Sunset clauses can also have positive effects, as they introduce a temporary limit to the incentive regime and can trigger periodical evaluation of the incentive’s efficiency. This strengthens a company’s incentive to accelerate investment immediately and avoids extensive revenue losses to the government. On the other hand, such a provision can also bring uncertainty to investors and increase the complexity of the tax system.
Sector-specific regimes
Granting additional benefits to certain sectors that are already covered by the COMAP regime increases the complexity of the incentive framework and creates an unequal treatment of investors. Providing additional benefits to sectors currently not covered by the COMAP regime raises questions about the regime’s pertinence.
Overall, the process and criteria chosen for selecting sectors to benefit from special regimes has not always been clear, which gives rise to opportunities for rent seeking and negotiation of customised deals. In addition, the sector-specific regimes generally do not include a mechanism for phase-out, once they no longer serving the purpose or meeting the objective for their introduction. As indicated above, sunset clauses, as the one used for the tax allowance in South Africa can provide for a phase-out requirement and trigger necessary evaluation of the suitability of an incentive regime.
Authorities can reduce the complexity of the incentive framework by bringing all companies under one single regime, e.g. the COMAP tax credit, or phasing-out incentives altogether.
This section, first, discusses the relative importance of different tax incentive regimes measured in terms of tax expenditures and, second, describes in more detail the use of incentives under the COMAP and FZ regimes.
The relative importance of different tax incentive regimes in Uruguay
By summarising the tax expenditures from each tax incentive regime as reported by the General Directorate of Taxation (Dirección General Impositiva, DGI) in their annual tax expenditure reports, this section shows the relative importance of different tax incentive regimes discussed in Section 0 over time. Expenditures (i.e. forgone government revenue) are calculated following a simple accounting approach excluding behavioural effects. That is they represent “…the amount by which tax revenue is reduced (increased) as a consequence of the introduction (abolition) of a tax expenditure, based upon the assumption of unchanged behaviour and unchanged revenues from other taxes” (Kraan, 2004, p. 136[14]). (Section 0 discusses in more detail the methods used to estimate forgone revenue including benefits from incorporating (or not) behavioural effects.)
Over the period 2008-2017, revenue forgone from tax incentives for investment measured as a share of GDP peaked in 2012 amounting to 2.2% of GDP and decreased afterwards to reach 1.3% of GDP in 2017 (Table 6.4). The development of tax expenditure-to-GDP ratios over time should be interpreted with care, as they can typically involve changes in both the numerator and the denominator and can also be driven by changes related to tax policy (i.e. changes in tax rates and tax bases), the development of tax base, as well as changes in GDP.
FZs represent the incentive regime generating the largest amount of forgone revenue measured as a share of GDP, followed by the incentives provided through the Investment Promotion Law. The peak in foregone revenue associated with the COMAP regime can be mainly associated to investment in non-traditional renewable energy that took place in 2012-2013.
DGI estimates forgone revenue in FZs as the difference between current tax liability (i.e. zero under the holiday) and a counterfactual tax liability that considers the most beneficial option for the company had the FZ tax holiday not existed.20 Choosing the most beneficial tax option as a benchmark to establish tax expenditures instead of an alternative benchmark (e.g. the standard corporate tax rate applied to the entire tax base) affects the amount of estimated revenue forgone. For example, many FZ users may benefit from the regime specified in Resolution 51/997 for international trading operations (if they operated outside the FZ. Net income from international trading operations generated on Uruguayan territory (i.e. the purchase and sale of goods for which Uruguay is neither the origin nor the final destination and the intermediary in the provision of services) is determined on a notional basis of 3% of the operation’s gross margin (difference between sales price and purchase price). Hence, the counterfactual tax liability for these firms concerns only 3% of their income. The benchmark choice may partly explain the relatively moderate estimate of revenue forgone from CIT in FZs. It also complicates the comparability of estimates across the different incentive types. (Section 0 provides more details on the approaches to estimate forgone revenue from tax incentives.)
Measuring foregone revenue as a share of total tax revenue per tax type shows that the relevance of corporate tax incentives for investment can be high and fluctuates considerably (Table 6.5). It represented more than 55% of CIT revenue in 2008-2012, while decreasing to 26% of CIT revenue in 2017. Net wealth tax expenditures on incentives for investment peaked in 2013, representing 51% of total net wealth tax revenue and settled at 34% in 2017. VAT incentives related to investment are minor compared to those related to CIT and net wealth tax.
Use of tax incentives in the COMAP regime
Since 2007, the number of projects and the amounts of investment approved by the COMAP regime has risen significantly (Figure 6.5). In the period 2008-2018, COMAP approved 6 233 projects equal to USD 16 881 million in capital investment.21 According to UnASeP, forgone revenue through COMAP credits in this period may have reached up to USD 8 158 million. The average credit represented 47% of the eligible capital expenditure for an average credit period of 4.7 years.
USD investment approved by COMAP peaked in 2013, which mainly relates to investment in non-traditional renewable energy. During 2013-2016, investment in wind power and generation of other non-traditional renewable energies amounted to USD 3 042 million representing 28% of the total amount approved under the COMAP regime (UnASeP, 2017[20]). Investment projects in renewable energies enjoyed credits that were relatively more generous compared to the average COMAP credit, receiving an average credit of 51% for an average duration of 11 years. Overall, the majority of all projects approved in 2008-2018 relate to the industry or energy sector, with the Ministry of Industry, Energy and Mining responsible for evaluating the applications (Table 6.6).
The effectiveness of the incentives in creating additional investment is, however, unclear, as the amounts reported by UnASeP do not account for redundant investment that would have come even in the absence of the incentive. For example, investment in renewable energies receives many additional benefits beyond tax incentives, such as preferential Power Purchase Agreement (PPA) contracts with the state-owned electric power companies that committed to buy wind power and biomass from windmills and large industries on a fixed price for periods of 20 years approximately. These additional benefits may have had an important impact on attracting investment.
Note: The amount of investment approved in one year does not necessarily imply that the investment occurred in that year. Furthermore, the projects approved under the COMAP regime do not necessarily represent additional investment, i.e. they may have occurred not necessarily because of the incentive.
Source: UnASeP.
Most companies submitting a project under the COMAP regime chose to file under the policy objectives related to the generation of employment and clean technologies (as detailed in Table 6.3). These companies committed to create 47 825 new jobs, to invest USD 5 071 million in clean technologies, to increase exports by USD 2 455 million and to invest USD 479 million in research and development during 2008-2018. Roughly 1 850 projects selected the decentralisation objective.
During 2008-2018, the COMAP regime covered projects from existing companies more often than projects filed by new companies, with SMEs taking the largest share. The percentage of approved projects filed by new companies (as opposed to existing companies) ranged from 10 to 20% depending on the year. From 2009 onwards, the percentage of successful SMEs continuously exceeded 60%.
Use of tax incentives in Free Zones
In 2019, there are eleven FZs on Uruguayan territory, one operated by the government. As Table 6.7 shows, FZs are established for extensive periods of 20-50 years so that the corporate tax holiday associated with these projects is available for large periods of time. Gross value added by all FZs expressed as a share of GDP was estimated at 3.49% in 2012 (INE, 2015[21]), while their contribution to Gross National Income is said to be much smaller, according to the Central Bank, because a significant part of income is transferred overseas.
One of the objectives of FZ is to increase exports from and employment in Uruguay, FZ exports accounted for only 28% of Uruguayan exports in 2016 and 43% of the FZ companies did not export at all. Services, particularly in the areas of administration, finance and insurance, account for a larger share of FZ exports compared to Uruguayan exports not originating from FZs. Central Bank estimates even suggest that FZ exports in 2017 accounted for 21% of total goods and services exports.
Approximately 14 000 workers were employed in FZs in 2016, which represents only 1% of total employment in Uruguay (MEF, 2018[22]). Zonamerica stands out as the largest employer and contributor to GDP.
Impact evaluation studies
Although the use of tax incentives for investment seems to be somewhat correlated with observed private investment in Uruguay, it is challenging to determine whether they effectively caused additional investment or whether the investment occurred thanks to favourable investment conditions in general or other benefits. Very few studies have aimed to determine the causal impact of tax incentives on investment in Uruguay. All of them concentrate on the COMAP regime, while there is no impact analysis on FZ tax holidays in Uruguay.
Artana and Templado (2012[24]) analyse the impact of the COMAP regime under decree 455/007 on total investment across sectors in 2008-2010 as opposed to 2000-2007. They use data from companies’ tax returns reported to DGI and apply a difference-in-difference estimation strategy. The analysis is restricted to companies that had received another type of tax incentive prior to 2008. The authors conclude that the change in regime towards COMAP is associated with an increase in existing companies’ average investment by 7 percentage points.
Llambi et al. (2018[25]) analyse the impact of the COMAP regime on investment, employment, exports and labour productivity for the 2008-2011 period (decree 455/007). They use firm level data from tax returns provided by DGI, employment data from the social security agency and exports data from Uruguay XXI, and data from COMAP for those companies that submitted investment projects. By means of an identification strategy combining difference-in-difference and matching, they find a positive and significant correlation between the COMAP regime and investment, employment and exports, while they do not observe significant differences in labour productivity. The authors estimate that affected companies increased their investment on average by 11%. According to their estimates, the associated forgone revenue in 2008-2011 represents 33% of the additional investment achieved by the regime over the same horizon.
So far, no study assesses the impact of FZ on additional investment. Tax incentives are costly, especially if the investment benefiting from the tax incentive is redundant. The anecdotal view in the Uruguayan administration is that FZ companies would not operate in Uruguay without the preferential treatment and in this sense, any investment in FZs is considered additional. To date no reliable analysis has investigated the role that tax incentives play in attracting investment to Uruguay or to what extent it would have come in the absence of the incentive, nor whether their benefits outweigh their costs. There is also no analysis of whether a more targeted and less costly (e.g. expenditure-based incentive) scheme could be (more) beneficial.
Although some analysts have highlighted the relevance of FZs to the Uruguayan economy given that their exports account for 28% of Uruguay’s total exports (21% in 2017 according to unpublished data from the Central Bank), FZ’s contribution to employment generation appears minor: FZ’s employees represent only 1% of Uruguay’s employed population, which is also encountered in other countries. However, Labraga (2017) estimates a sizeable impact of knowledge spillovers of companies operating in FZs that export services on output growth. Additional data that FZs will submit as of 2019 allow for more detailed studies to determine the extent to which FZs are beneficial for Uruguay or not.
This section describes and evaluates the current governance arrangements for tax incentives in Uruguay, focussing on the decision-making process, the monitoring and the reporting of incentives. Authorities in Uruguay are encouraged to consider reform in the area of tax incentives to stimulate investment and to continue working towards a more transparent and coherent regulatory framework; one that reduces discretion in the decision-making and administration of tax incentives and that minimises opportunities for corruption, rent seeking and for negotiating investor-specific policy.
Decision-making process
While the creation of new tax incentive schemes requires parliamentary approval, most design features of the incentives are determined by decrees or resolutions, which are much less scrutinised. For example, the Investment Promotion Law (Law 16,906) introduces general tax incentives and the COMAP regime, but Ministerial decrees outline the specificities and details of these incentives (e.g. indicators in the scoring matrix, evaluation criteria, exemptions and special treatment to accelerate investment in specific periods). Similarly, Laws 19,566 and 15,939 create tax holidays for FZs and the forestry sector respectively – although the specific implementation details for each FZ figure in specific decrees and resolutions (e.g. extension of user contracts). The President and the respective Ministers responsible for the topic, sign the decrees or resolutions.
Discretion in the interpretation and implementation of laws can lead to important distortions in the economy and tax policy frameworks, as it reduces the accountability of decision-makers, creates uncertainty for investors and risks arbitrary variation in the application of tax rules. This may create opportunities for rent seeking and corruption; it can also unintentionally create scope for particular investors to negotiate customised tax policy.
Good practice in this respect would be to minimise issuing tax policy decisions via decrees, resolutions or company-specific agreements that are less subject to scrutiny, but to codify them in laws. Ensuring that the Minister of Finance has the final authority to determine the design of tax incentives (in cooperation with relevant ministries and agencies) and to ratify provisions via the legislative body, can increase transparency, certainty and foster the rule of law (IMF OECD UN World Bank, 2015[11]).
Decision-making under the COMAP regime
As described in section 6.15, companies that apply for a COMAP tax credit submit their application to the Ministry of Finance’s Unit of Support to the Private Sector (UnASeP) for an ex-ante evaluation of their investment project. UnASeP sends the project to COMAP, a commission that advises the government. COMAP consists of delegates from the Ministry of Finance (MEF), the Ministry of Agriculture (MGAP), the Ministry of Industry and Energy (MIEM), the Ministry of Labour (MTSS), the Ministry of Tourism (MINTUR) and the Planning Office (OPP). COMAP decides which ministry is in charge of evaluating the investment project depending on the investor’s activity outlined in the application.
Based on the evaluation, COMAP is expected to advise the Ministry of Finance within 60 days on whether the project should receive support in the form of the incentive, and the Ministry of Finance establishes a resolution on whether and what tax credit is granted. So far, the government has always followed COMAP’s advice. COMAP publishes the resolution signed by the Ministry of Finance and associate ministry for each successful investment project including information on the amount of announced capital expenditures and the size of tax incentives granted.22
The COMAP coordinator belongs to the Ministry of Finance and has double vote in case the commission disagrees on the evaluation and conclusions. In circumstances in which the commission does not agree with a ministry’s project evaluation, the responsible ministry re-evaluates the project.
According to UnASeP, rejection of a COMAP credit rarely occurs. UnASeP officials argue that the clear rules of the COMAP scheme typically lead to an approval of every application. Currently, no official statistics exist on the number of applications that COMAP approved or rejected.
Assigning different line ministries to evaluating COMAP projects is useful to ensure the right expertise applies to the evaluation of applications and the granting of incentives. However, it can also lead to a disproportionately high level of approvals of projects and an unequal treatment of investors across different sectors: the associate ministry may aim to attract investments to their specific sector and may be less concerned with protecting the tax base, therefore interpreting favourably the COMAP eligibility criteria and scoring matrix. It is advisable to confer to the Ministry of Finance the right and the capacity for the final decision, in close cooperation with other stakeholders to ensure a smooth information exchange.
A first step to increase transparency and evaluate the implications of the COMAP decision-making process would be to publish regular statistics on the evaluation process. Such statistics could summarise the number of project applications per year, the percentage of approved as opposed to declined projects per year and per evaluating ministry and the number of projects cancelled by the investor including their reason. The South African Report to Parliament on the “12i Tax Allowance” gives some indications for a light version of such a statistic (Dti, 2017[26]). Preferably, information that is more detailed would be included in a future Uruguayan version. (Sections 0 and 0 provide more details on monitoring and reporting of tax incentives.)
Decision-making under the Free Zones regime
A Ministerial resolution establishes a free zone status for FZ operators and users. Companies interested in becoming FZ operators must submit an investment project to the government “reliably demonstrating its economic viability and the benefits it will bring to the country” (Art. 10, Law 19,566). The Minister of Finance and the President of the Republic sign the resolution drafted by officials from the Ministry of Finance. Companies interested in becoming direct or indirect FZ users file an application to the Directorate of Free Zones at the Ministry of Finance (Art. 29, Decree 309-018).
The decision-making process to determine FZ status and to define the specific governing criteria of the FZ appears open to discretion and negotiation of customised tax incentive arrangements for single investors. For example, no specific and objective criteria exist to decide on FZ status nor on the generosity of the tax benefits (e.g. length of the holiday). Although it is a good feature that the government recently fixed the maximum period for tax holidays to FZ users, a simple resolution can extend the duration of the holiday for specific users. This ultimately leads to an unequal treatment of investors in Uruguay; not only between companies investing in FZs as opposed to other parts of the country, but also between different FZ companies (Table 6.7). Furthermore, important distortions can arise in the Uruguayan economy, if it is an investor’s bargaining power and relation to government officials that determines the approval and duration of a tax holiday, rather than the projected performance and efficiency of the investment project.
As long as no phase-out of the FZ tax holiday takes effect, the government should establish clear and uniformly applied eligibility criteria and requirements for receiving this benefit in order to ensure a uniform and objective application of the incentive regime across investors.
Monitoring
Monitoring the operations and the outcomes of tax incentive frameworks is essential to verify the integrity of the tax system, to review, analyse and adjust policy or practice where misalignments occur and to minimise distortions. Monitoring can cover many areas of tax incentive policy, for example, the monitoring of an investments’ performance, compliance with qualifying conditions, and audits to detect potential fraud or abuse of the incentive framework. Credible monitoring can also help to prevent tax avoidance.
Reaping the full benefits from regular and careful monitoring requires administrative capacity and assigning clear responsibilities that are guided by the rule of law, with clarity about eligibility criteria. Therefore, it is necessary to consider monitoring needs and available resources when designing and legislating tax incentives. Establishing and enforcing penalties in case of non-compliance or abuse can be an effective deterrent to fraud.
Monitoring of the COMAP regime
According to the Investment Promotion Law, COMAP monitors ex post the execution of the approved investment projects and the accomplishment of the announced commitments (e.g. in terms of investment and employment). Each year, companies have to submit documentation, signed by an accountant, who certifies that they effectively carried out the announced investment. A company that does not submit follow-up documentation or that does not fulfil the objectives it had committed to in the application triggers the full elimination of the tax credit and a recalculation of tax liability.23 The resolutions of the revocations are available online but no official statistic is published currently.
In practice, however, COMAP rarely monitors ex post the information filed by companies. According to COMAP, prior to 2017, companies had to submit documentation to both COMAP and the ministry in charge of the ex-ante project evaluation. Since 2017, companies submit ex post records only to the relevant ministry. COMAP does not automatically receive information on whether the ministry carries out monitoring. Effectively, COMAP has only received documentation on projects relating to retail and services that were evaluated and approved by the Ministry of Finance. This relates to the fact that COMAP officials are employed by the Ministry of Finance.
UnASeP publishes reports summarising the number of projects and amount of investment approved under the COMAP regime as well as some ex-ante descriptive analysis of the projects by sector and company size. Two reports summarise information on investment projects monitored by the Ministry of Finance (UnASeP, 2014[27]; UnASeP, 2017[20]).
Although monitoring is foreseen in the law, the government needs to ensure a sound implementation of the regime in practice, e.g. by improving ex post monitoring. In this respect, conferring the monitoring responsibility to one agency is important in ensuring effective monitoring of the implementation. There is a need to strengthen inter-institutional cooperation and coordination and enable a smooth exchange of information and documentation between responsible ministries, agencies and COMAP.
Given the complexity embedded in the current COMAP regime, effective monitoring may require additional administrative capacity beyond the current 19 COMAP and seven UnASeP employees. Concentrating monitoring efforts first to medium and large investment projects can reduce the monitoring burden. Rationalising the COMAP mechanism, e.g. by reducing the number of policy objectives used in the scoring matrix and focusing only on few key areas for support would further facilitate the monitoring effort, while improving clarity of the system. (Section 6.10.2 provides more details in this respect.)
Effective monitoring of companies’ compliance with the qualification requirements and scoring matrix of the COMAP regime is crucial. Establishing regular statistics will support monitoring compliance with the criteria under which companies file their application (e.g. employment, investment) and specific scoring indicators. Such statistics could for example compare indicators based on what companies announced ex-ante in the application as opposed to what they achieved ex post. Authorities should establish an objective system of procedures and potential penalty system to follow when the statistics reveal important divergences. (Section 6.15.1 mentions other parameters that may be included in the statistics.)
To evaluate whether additional investment, exports or employment is created by the COMAP regime, more substantial analysis would be needed. The indicators chosen for the COMAP matrix are not necessarily a proxy for additionality. For example, measuring additional employment by the increase in the number of full time employees relative to the average number of employees in the previous year does not control for employment, which would have occurred in the absence of the incentive and which should not count towards matching the eligibility criteria. The methodologies used in the ex post analyses discussed above can serve as an example for future analysis. Merging data from companies| tax returns with employment information from the Social Security agency, similarly to Llambi et al., (2018[25]) can help to verify compliance in terms of employment increase. Cooperating with academia can provide a win-win situation to carry out such analysis based on reasonable time frames and technical capacity.
Monitoring of Free Zones
The Directorate of Free Zones at the Ministry of Finance is in charge of monitoring FZ activities. Since 2008, a resolution (1859/008) requires FZ users to file account balances to DGI. In addition, a 2018 decree (309/018) requests FZ users to file every two years a sworn statement to the Ministry of Finance on income earned and activities performed, the investment executed and the number of employees hired and their education level.24
The filing requirement of FZ users is a positive development as it enables the authorities to assess the revenue costs associated with the incentive and can reduce opportunities for tax planning and avoidance. Taxpayers who shift income from a taxable entity to the entity that qualifies for the tax holiday need to file account balances even if no tax is due.
Nevertheless, it would be advisable to ensure a smooth exchange of information between the different ministries and government agencies involved in monitoring FZ outcomes, to motivate DGI to audit companies that operate under the tax holiday and to establish a formal monitoring mechanism for evaluating whether FZ users are complying with the FZ regulation. This could for example include monitoring whether commitments announced in the investment project are met or whether eligibility requirements for longer holidays in terms of employment and investment size hold. Although this may require additional resources, it also helps to understand the performance of new FZ investment and incentivises investors to make realistic ex-ante projections.
Establishing clear and uniform eligibility criteria will facilitate the monitoring process in FZs and allow an equal treatment across investors.
Reporting
The regular reporting of tax expenditures is a cornerstone of good practice. By highlighting the revenue costs associated with tax incentives, it creates accountability and better control over the use of public funds. It also supports the analysis and evaluation of tax incentive effectiveness and efficiency.
Governance
DGI reports tax expenditures on an annual basis in Uruguay since 2008. As of 2018, tax expenditure reports in Uruguay are associated with the budget (Art. 183, Law 19,438), which represents a significant improvement. Indeed, revenue forgone from tax incentives is typically much less visible than expenditures from direct spending programs, despite their comparable effects on government budgets. By embedding tax expenditure estimates in the budgetary process, the revenue costs associated with granting tax incentives become transparent and can be considered by policy-makers in fiscal management (IMF OECD UN World Bank, 2015[11]).
It is advisable that one authority estimates forgone revenue from tax incentives to ensure a consistent application of methodologies across incentive types and sectors. Authorities involved with estimating, administrating and evaluating the incentives need to cooperate well to make sure all necessary information is available for the estimation process.
Key elements for good tax incentive reporting
The current format of the Uruguayan report is not straightforward to interpret as a stand-alone document, mainly because it does not include an adequate description of the different incentives, nor a sufficient explanation of the method applied to estimate forgone revenue. The current report provides only a simple table that lists the type of incentive granted, mentioning the relevant legal basis together with the estimated amount of tax expenditure per year. It does not include an analysis of expenditures either.
The standard advice for establishing a tax expenditure report is to provide a list of all tax incentives and to mention systematically the following elements. (i) the type of preferential treatment granted, (ii) a description of the incentive, (iii) their stated policy goal, (iv) a precise legal reference, (v) potential time limits, (vi) estimates of forgone government revenue, and (vii) a detailed description of the estimation method (IMF OECD UN World Bank, 2015[11]).
Redonda and Neubig (2018[28]) review the reporting practices on tax expenditures across 43 G20 and OECD economies along several dimensions. They list nine countries with detailed and comprehensive reports that lag behind best practice in only one or no dimension: Australia, Austria, Canada, France, Germany, Italy, Netherlands, Korea and Sweden. These countries’ reports would be a good example to follow.
For example, the German report provides a detailed information sheet per tax incentive, listing the key elements mentioned above. In addition, it provides information on whether an evaluation of the tax incentive was performed in the recent past or will figure in the upcoming activities of the ministry. The German Subsidy Policy Guidelines are added to the report reminding that tax incentives are “subject to regular evaluation” and “should be reviewed with the view to replacing them”. The report also contains an analysis of tax expenditure trends and ranks the incentives in terms of forgone revenue with the objective to determine the most important expenditure item that would be in the focus of a future evaluation (BMF, 2018[29]).
In view of these best practices, the Uruguayan reporting practice should follow the list of key elements outlined above and add missing elements. In particular, the report should mention the policy objective for introducing the incentive, a short but self-explanatory description of the incentive, more detailed reference to the legal basis and a detailed explanation of the methods used to estimate revenue forgone. On the basis of these estimate, an analysis over time and across incentives could be added to the report as well. Similar to what was done in Germany, the authorities may also consider introducing a compulsory evaluation of the most expensive incentive programs determined by a ranking of incentives based on the estimates.
Estimating forgone revenue
Estimating revenue forgone from tax incentives requires specifying a benchmark tax system. This allows calculating revenue forgone as the reduced tax liability of all beneficiaries relative to this benchmark. The natural benchmark in most countries is to apply the standard corporate tax rate to the entire tax base, which generally constitutes income net of business expenses incurred in deriving that income. Using simple accounting principles, a static measure of revenue forgone is calculated as the difference in tax revenue under a scenario in which the tax incentive applies relative to the benchmark scenario, where the tax incentive is removed from the tax system. Such a measure does not consider changes in the behaviour of taxpayers owing to the removal of the incentive.
Calculating forgone revenue including behavioural effects would improve the estimation result, but is not a straightforward exercise. For example, it would require detailed information or assumptions on how investors react to a change in tax policy. The static evaluation, excluding behavioural effects, already gives a good first indication of the relative size of incentives and is similar to the method used to calculate budgetary transfers through direct spending programs, so facilitates comparability. The technical background document by IMF, OECD, UN, World Bank (2015[30]) elaborates on the different methods to calculate revenue forgone through tax incentives.
Although, it is advisable to include estimates of forgone revenue in any tax expenditure report, it remains a country’s choice to define the benchmark tax system and the specific estimation method.
It appears that Uruguay has not chosen the same benchmark corporate tax system across incentive types, but has used the most preferential treatment available to a company in the absence of the incentive. This leads to the use of different benchmark tax rates according to the activity of a company, which complicates the comparison of revenue forgone across incentives and largely reduces the information value from deriving such an estimate. For example, and as highlighted in Section 0, forgone revenue in FZs is estimated as the difference between current tax liability and a benchmark considering the most beneficial tax treatment available to companies, in the case where the tax holiday does not exist.
It would be preferable that Uruguay chooses to apply the same benchmark across the entire corporate tax base, e.g. the standard corporate tax rate, and to remove preferential treatment from the benchmark. This would improve comparability of revenue forgone from different incentive regimes and improve consistency over time. It would also lead to a more comprehensive estimate of the cost of incentives, which can then be compared to direct spending programs, thereby improving the decision-making of budgetary priorities. IMF (2019[31]) discusses the use of different benchmarks and elaborates on tax expenditure reporting more in general.
Uruguay relies significantly on tax incentives as a means to attract investment. A number of different regimes exist, ranging from general tax benefits that are automatically available to investors, over a relatively generous scheme (COMAP regime) that requires submission and approval of an investment project by the government and even more generous tax treatment of projects established in free zones and free ports. Tax incentives in Uruguay vary across investments depending on where, when and by whom an investment is made in the country.
While tax incentives may be capable of attracting investment, with potentially positive spillovers on output, employment and productivity, they can also reduce revenue-raising capacity, create economic distortions, increase administrative and compliance costs and potentially trigger harmful tax competition. Even when the incentive attracts additional investment, there is a risk that the costs associated with the policy exceed the benefits.
Continue constructing a transparent and coherent regulatory framework for tax incentives to deliver certainty and stability to investors
Improve the design of tax incentives by broadening tax bases and treating investors uniformly for more efficiency
Rationalise the COMAP scoring matrix, by reducing the number and the overlap of objectives and revise its scoring indicators.
Consider introducing a ceiling for the COMAP credit and a well-designed sunset clause.
Phase-out the legal basis for corporate tax holidays and eliminate tax holiday provisions when renewing existing Free Zone user contracts.
Re-evaluate the need for generous tax incentives in Free Zones on top of existing economic zone benefits to attract additional investment.
Continue ongoing efforts to protect the domestic tax base from cross-border tax minimisation strategies and carefully monitor the effectiveness of measures recently implemented, in particular
Reduce discretion in the decision-making and administration of tax incentives and minimise opportunities for corruption, rent seeking and for negotiating investor-specific policy.
Monitor the operations and the outcome of the tax incentive frameworks to verify the integrity of the tax system, to review, analyse and adjust policy or practice where misalignments occur and to minimise distortions.
Confer the monitoring responsibility to one agency and verify effective implementation.
Strengthen inter-institutional cooperation for a smooth exchange of monitoring information between responsible ministries and agencies.
Provide regular statistics on company compliance with COMAP eligibility criteria and the scoring indicators.
Ensure the monitoring of eligibility criteria for corporate tax holidays in Free Zones until holidays are removed.
Use reporting tools to highlight revenue costs associated with tax incentives by providing comparable estimates of tax expenditures.
Improve existing reporting practice by providing additional information per tax incentive regime in the report: include the policy objective and a self-explanatory description of each incentive and a detailed explanation of the method used to estimate revenue forgone.
Apply the same benchmark across the entire corporate tax base when estimating forgone government revenue and avoid using preferential treatment as a benchmark.
References
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[28] Redonda, A. and T. Neubig (2018), “Assessing Tax Expenditure Reporting in G20 and OECD Economies”, CEP Discusion Note, No. 2018/3, https://www.cepweb.org/assessing-tax-expenditure-reporting-in-g20-and-oecd-economies/.
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[27] UnASeP (2014), Cumplimiento de los proyectos promovidos por la ley 16906 y sus decretos reglamentarios, https://www.mef.gub.uy/9823/8/areas/informe-de-cumplimiento-de-los-proyectos-promovidos-por-la-ley-16906-y-sus-decretos-reglamentarios---version-actualizada.html.
Notes
← 1. IMF, OECD, UN and World Bank (2015[11]) summarise that tax incentives are often found to be redundant and that taxation is only one of many factors that determine an investors’ location decision – and usually not the most important one in developing economies. In addition, without well-functioning infrastructure, macroeconomic stability and a stable rule of law, tax incentives are unlikely attracting (additional) investment. The effectiveness of tax incentives, however, is sector and incentive specific and deserves careful monitoring and analysis.
← 2. Indexed units (UI) are adjusted by consumer price inflation. Their value varies daily.
← 3. Non-residents, that is, those that have not established domicile in Uruguay, are subject to Impuesto a la Renta de No Residentes (IRNR). Residents are subject to Impuesto a la Renta de las Personas Físicas (IRPF).
← 4. For instance, under bilateral treaties based on the OECD Model Tax Convention on Income and on Capital (OECD, 2017[32]), profits of a company of a contracting state shall be taxable only in that state unless the company carries on business in the other contracting state through a permanent establishment (as defined under the bilateral treaties) situated therein.
← 5. These regimes include the Intellectual Property (IP) aspects of the regime allowing benefits for biotechnology under Law 16,906; and the (non-IP) regime for financial company reorganisation.
← 6. These regimes include the (non-IP) shared service centre regime; the free zones regime, with regard both to the IP and non-IP aspects; the non-IP aspects of the regime allowing benefits for biotechnology under Law 16,906; and the regime for biotechnology and software under Lit S Art. 52, with regard both to the IP and non-IP aspects.
← 7. These regimes include the shared service centre regime; the free zones regime; the regime allowing benefits for biotechnology under Law 16,906; and the regime allowing benefits for biotechnology and software under Lit S Art. 52.
← 8. The free zones regime.
← 9. Under such treaty, where an individual would be a resident of both countries, then his status would be determined as follows: a) he shall be deemed to be a resident only of the country in which he has a permanent home available to him; if he has a permanent home available to him in both country, he shall be deemed to be a resident only of the country with which his personal and economic relations are closer (centre of vital interests); b) if the country in which he has his centre of vital interests cannot be determined, or if he has not a permanent home available to him in either country, he shall be deemed to be a resident only of the country in which he has an habitual abode; c) if he has an habitual abode in both country or in neither of them, he shall be deemed to be a resident only of the country of which he is a national; d) if he is a national of both country or of neither of them, the competent authorities of the countries shall settle the question by mutual agreement.
← 10. Treaty shopping typically involves the attempt by a person to indirectly access the benefits of a tax treaty between two jurisdictions without initially being a resident of one of those jurisdictions.
← 11. Art. 53, Título 4, Texto Ordenado 1996 and Art. 114-121, Decree 150/007.
← 12. The main changes introduced by Decree 143/018 to the COMAP regime are the following: simplifying the employment indicator; separating indicators for R&D and clean technologies; allowing companies that do not generate profits in a certain year to postpone benefits; increasing to 80%the ceiling from the percentage of benefits that new companies can use each year; increasing to 10% the amount of planned, but not executed, investment for unforeseen reasons; discontinuing to allow investment carried out six months prior to submission of the project unless it represents less than 20% of total amount; setting at six years the maximum time schedule for the project.
← 13. In the event that a company ultimately invest more than indicated in the project proposal submitted to UnASeP, they have the opportunity to increase the amount of capital expenditure for the approved investment project by up to 20%, provided they submit information justifying that they score higher in the matrix by the second year of the project.
← 14. Companies can suspend the period of promotion for 1 year in case their score yielded a period of up to 5 years. The suspension can take 2 years if the benefit was approved for 6 years or more.
← 15. The regime defines SMEs as companies with a maximum of 19 employees and sales lower than 10 million indexed units (approximately USD 1.22 million).
← 16. Unit adjusted by consumer price inflation. It varies daily so that by the end of the month it accumulates the price increase of the previous month. On 6 June 2019, 1 UI was equivalent to 4.1827 UYU.
← 17. The FHTP conducts a yearly monitoring process of the implementation of certain aspects of preferential regimes in practice. The last monitoring process of Uruguay included, for the first time, monitoring of the substantial activity requirements of four regimes, i.e. Benefits under Law 16,906 for biotechnology, Benefits under lit S Art. 52 for biotechnology and for software, free zones and shared service centre (OECD, 2019[5]).
← 18. Artana (2015[33]) analyses FZs in Costa Rica, El Salvador and Dominican Republic and concludes that FZs generally benefit high profitability projects that would have been implemented anyway in the absence of incentives.
← 19. For example, House and Shapiro (2008[35]) find that accelerated depreciation reduces the user cost of capital in the US (2002 and 2003) and estimate an elasticity of investment to user costs of capital between 6 and 14.
← 20. Since 2008, FZs are required to submit their account balances to DGI.
← 21. These amounts do not include investment projects under Decrees 110/016 (Parking) and 329/016 (Construction of immovable goods for sale or rent) as detailed in Table A.C.4 in Annex C.
← 22. Recent resolutions on the COMAP regime by investment project are available under: www.mef.gub.uy/6421/7/areas/resoluciones.html
← 23. In recent years, many tax credits were revoked by COMAP upon request of the beneficiary company.
← 24. In addition, the Directorate of Free Zones has undertaken Census of FZs in agreement with the National Statistics Institute and reports numbers for exports, employment and contribution to Gross Value Added. The latest reports available refer to data from 2016.