#184 – The Expat Files: Tax Laws, Evasion, and Financial Benefits in Latin America

Automatically transcribed from the original recording; names and wording may contain errors.

[00:03] Hi everybody, I'm Johnny Mueller and you're listening to The Expat Files, living in Latin America. The show that tells you what it's really like to live, work, play and or retire in Latin America. I tell it just like it is, not the version they give you in those glossy travel magazines, or the picture they paint for you in those international traveler websites, where they're only trying to sell you something. What's it really like for expats living in Latin America? Well, if you stick around a while, you'll find out, so let's get started. I get a lot of emails from people asking me, what are the differences between US tax law and Latin American tax law? Well, first of all, I can tell you there's a world of difference. Tax laws in Latin America are for one thing at least 90% less complicated than US tax

[00:51] law, which means even common people like us can understand them. You can't imagine the shock on people's faces when they go to their Latin lawyer for the first time and he starts talking about tax issues and he hands you a book with the country's tax codes. I mean, a thin little volume that you can hold with two fingers. That's the way it is with most every Latin American country, except of course Cuba. And though I've never seen Uncle Fidel's tax code myself, I'm told it's actually only a few pages. And by the way, I don't know anyone who's ever seen their tax code, so go figure. Anyway, most Latin American countries have about the same basic tax codes. Now I want you to think about that for a minute. You can hold the average Latin American tax code between two fingers. And I don't mean spreading those fingers wide either.

[01:39] I'm saying tax codes down here are less than an inch thick. Now compare that with a 70,000 page IRS tax code. Now get this, not since 1932 could you order a book from the IRS that had the complete tax code in it. After 1932, it didn't fit into one book. Now these days in 2012, if the IRS tax code was in book form, it would be about 46 feet high. Just think of it for a minute. The IRS code is so vast and complicated that no CPA knows even 5% of the code. But practically every Latin lawyer you talk to knows the tax code for his country by heart. At least the more important parts of it. So how do Latin American governments get away with having such a tiny tax code?

[02:25] Especially when I always talk about the fact that they're trying to be first world in every way. Well I'm sure they'd love to adopt the US tax code if they could. In all it's 70,000 pages of glorious stupidity. But the fact is in Latin America they don't have the manpower, that is the boots on the ground, to enforce the laws they have already. Which for Latins and Expats is a very good thing. Not to mention the fact that Latins hate to pay their taxes even more than first world people. Since it's so obvious everywhere they look, their government does absolutely nothing for them. The fact is in third world Latin America, tax evasion is a national pastime. And by the way, since the tax laws are so uncomplicated down here, you know what that means don't you? Well for one thing, they don't have H&R block down in the DR nor anywhere else in Latin

[03:11] America. Why? Because they don't need them. And guess what? Surprise, surprise. In Latin tax law, the average worker generally doesn't have to pay income taxes at all. And it's only phased in after someone makes a certain amount of money, which is well over the average wage of the population. That means more than half of all working Latins, the people making 200 to 350 dollars a month, the average wage, do not end up paying income taxes at all. Nor do Latin citizens or residents have to report income earned outside of the country. That's completely tax free. As opposed to US tax law, which requires US citizens who are making foreign incomes to report and pay taxes on that. And that applies to everyone living in the United States.

[03:58] Everyone that's considered a US resident for tax purposes. And that number includes about 100% of you expat wannabes. And if you fail to report foreign source income, the IRS thugs will come knocking on your door and they'll take you away. So if you're living in the States and you fail to report foreign source income, you're in big trouble. But if you're living in a foreign country, let's say the Dominican Republic or Peru, and you're not a resident for tax purposes in the United States, in other words you're living out of the US for a long enough period of time each year to qualify for that foreign earned income tax exclusion, which is $95,100. That means you can make up to that amount, $95,100, from a foreign source and not pay any taxes at all on it.

[04:45] But since you're living in another country, you'll be taxed by that country's version of the IRS for that amount. And let's say for example you're living in Peru and you're making that $95,000 limit that the IRS excludes from taxation. Well you're excluded from paying tax in the US on that, but you'll have to pay income taxes to the Peruvian government at their tax rates, which can be whittled down to around 5%. That is, if you let your lawyer and accountant handle your tax situation. Now compare that to the rate you'd be paying if you lived in the United States and made $95,100. You'd be in the 29% tax bracket, which means you'd be paying about $27,500 federal taxes on that, versus paying about $4,700 if you were living in Peru and being taxed

[05:35] at a 5% rate. Now think of that, that's about $24,000 in your pocket if you're making that kind of money living outside the United States. So what does that mean? Well that's enough money to live like an absolute king down here on just the money you've saved by legally not paying US federal taxes on your outside earned income. Instead of paying a 29% tax rate, you're paying about 5% or less. And again, it's all completely legal. But that's not all, there's no such thing as state income tax in Latin America. Whereas the vast majority of US states have income tax, only a scant few don't. So for example, if you lived in New York state, then in our example of a $95,100 income, you'd pay 6.85% state income tax in that money, which works out to about $6,500.

[06:25] That means if you lived in Latin America, you'd save that $6,500 too. So the bottom line is this, when you get that $95,100 foreign income tax exclusion by living outside the United States, if you compared the tax rates that you'd pay compared to someone living in New York, you'd be saving $34,000 a year. That would be in your pocket, just by the virtue of the fact that you lived outside of the United States for most of the year. But what you have to realize is this, with that extra $34,000 in your pocket, you're living actually like more than a king down in Latin America. Because a single expat here, if he owns his own house or apartment and doesn't have any first world lifestyle on about $15,000 a year.

[07:14] Now imagine if he had more than double that, $34,000 a year to live on. That would be a life of luxury. Now if you don't believe that you could live a pretty much equivalent first world style living on only about $15,000 a year, ask any one of the thousands of expat Americans down here who are only living on their social security check. What do you think they're down here for? And by the way, speaking of tax law down here in Latin America, that's why when first world people get in trouble with the tax authorities in the states, for whatever reason, and they end up here in Latin America, US tax authorities have absolutely no luck when trying to petition courts in Latin America to get a person extradited back to the states to face those tax charges. And they have no luck in petitioning Interpol either.

[08:02] Interpol does not intervene in tax issues, nor do they intervene in civil suits. In fact, they only act in high profile felony criminal stuff like kidnapping, child porn, rape, drug trafficking, and that most recent catch all crime, money laundering. So the bottom line is if you're an expat down here in Latin America and you know you've got some unresolved tax issues up in the states, you'll just never have to worry about the IRS or any tax agency from up north coming down here starting a legal procedure to get you extradited just so they can get you back to the states. That's not going to happen. Because you see, Latin governments do not cooperate with foreign tax agencies. Because most of what are considered tax crimes up in the states are not crimes at all in third world Latin countries.

[08:47] And Latin countries will not extradite you for a crime that doesn't exist on their soil. And no matter how severe a crime it is in the US or Europe, it doesn't matter. If it's not a crime on the books in Latin America, they just don't cooperate. And that's a big catch-22 and a lot of mud in the face for US tax authorities. Another email tax question that comes up quite often is, what about corporate taxes in Latin America? That's another case of rules and regulations that are so easy to understand, even I can figure them out. And here's one of the big differences you realize right away. And it's actually very hard to believe at first and you say, come on, that can't be right. Well, believe it or not, the happy fact is you're not only able to write off receipts directly related to business expenses, but you're able to write off receipts for anything

[09:36] and everything that you buy, business related or not. So when you have to put together your quarterly tax reports, which your account will normally do, he'll write off every single receipt that you give him, whether it's business related or not. And he can use it as a direct write off against corporate earnings. And that's why down here in Latin America, so many corporations end up paying zero taxes. Of course, they do have corporate income tax in most Latin American countries, but most small businesses like the ones expats run are able to get enough write offs to show very little or practically no net income and therefore pay little to no corporate income tax. And the same thing goes for personal income tax. Nearly every Latin American country has an income tax too, sometimes up to 30%.

[10:22] But almost no one pays 30%. First, because like I said before, more than half the people don't make enough to reach that level where the income tax actually kicks in. And besides that, they can use all of their receipts as deductions, not just that tiny window of receipts you can use in the first world as personal deductions. Like for example, hospital and medical expenses and any expenses that you incur while doing your work that weren't reimbursed by your employer. Like work uniforms and job travel expenses that have come out of your pocket. Bottom line, in Latin America, if you have a receipt, you can write it off. Now I ought to mention here that tax collection in general in Latin America is very weak, especially since 40% of the population is off the books working for cash in the street,

[11:12] so they pay no income or corporate taxes at all. That's why the government's big tax generator is the VAT tax, called EVA, which is included in the cost of everything that you buy so you can't evade it. Well, I take that back, you can still evade it, but it's not as easy as it was before. I'll explain more about that in a minute. Oh and I might mention here that the second and third biggest sources of revenue for the governments in Latin America are taxes on things like gasoline, utilities and liquor. I'd like to mention that one of the reasons why the tax codes are so small down here in Latin America is because you do not need a crazy ass idiotic tax code like in the states if you have a VAT tax. In fact you don't need a top heavy tax department at all with all kinds of agents and enforcement

[12:00] people with a VAT tax, because it's the businesses that collect that tax, like a sales tax, and turn it on over to the government. We'll talk more about that later too. Now some Latin American countries have chosen two ways you can pay your income tax, that is if you make enough money to qualify for the income tax. One of those ways is to have a choice between paying a very low flat tax, let's say for example 5% with no deductions, or you can elect to choose the 28 or 30% income tax, but then you get every deduction, like I mentioned before. Now which one of those two systems you might select depends on how much money you make, how complicated your life is, and the advice of your lawyer and your accountant. But as it turns out, most people who don't have a big income but they have enough to

[12:46] pay income tax, they usually select the 28 to 30% income tax and use every deduction they can to knock their rate down to zero, whereas people who make a lot of money just select the easy way, they pay the 5% income tax with no deductions. It's much easier that way, no receipts to collect, no paperwork basically. Now the thing is, something strange happens down here about two weeks to a month before individual tax time. And down here, April 15th is not the deadline, it's different for every country. Anyway, about two weeks to a month before individual taxes are due, there's a huge scramble throughout each country for receipts, because that's when everybody's scrambling to get those write-offs. Now like I said before, you can use any receipt, personal or business to get that write-off.

[13:32] So what happens is, Latin start calling each other up and asking each other for receipts, and the scramble begins as everyone tries to get just enough deductions to make his income tax zero, or as close as he can to zero. And I can tell you, I've been phoned up personally on more than one occasion by my Latin friends who are asking me for receipts, because you see, a lot of people who make a little more money pay just that 5% flat tax and don't use receipts. Therefore, a lot of people, expats especially, have boxes full of receipts at the end of the year that we never use ourselves. And all of a sudden for a couple of weeks a year, we find our receipts are in big demand. And to tell you the truth, in a lot of Latin American countries, a sort of gray market in receipts emerges around tax time, especially in the last few days when the rush is on.

[14:19] And at this time, hundreds of thousands of receipts are bought and sold, for maybe one or two cents of their face value, almost like newspaper coupons. Then all of a sudden, tax time comes, the rush is off, things calm down and go back to normal. And the same thing happens every year. And you might think then there might be some print shops that are printing these things out by the hundreds or thousands and selling them at that time of year. A kind of a black market receipt mill, so to speak. Well, that's right, when I first got down here some 20 years or so ago, there were certain places you could go to at the end of the year and buy receipts like that. Whatever number and amount you needed, they had them on hand. And again, you'd pay one or two cents on the face value. Because remember, if you were stuck short, you were in the 28 or 30% tax bracket. So the point is, you need enough receipts to write off to knock your tax bill down to zero.

[15:07] So paying one or two cents on the face value versus paying 28 or 30 cents if you had to pay the tax was a great deal. Printing and selling receipts like that was big business way back when, but it doesn't happen much like that anymore. Because nowadays, Latin governments maintain strict controls over your receipts. It's not like in the first world where you just print out receipts at a print shop with your logo on them, and every time someone makes a purchase, you write a receipt and give it to them. Handing out receipts is a lot different down here, and let me explain. First of all, they're not called receipts, they're called facturas. And when anyone starts a business down here in Latin America, once you've got permission to open your business from the government, and you've got all your licenses and your permits and your paperwork in order, you go to the government printing office and they give you a booklet of these facturas.

[15:57] You want 100, you get 100, you want 500, you get 500, 1000, 1000, etc. Now these things come in triplicate and they're stuck together. The business keeps one, the buyer gets one, and the government gets one. And what's special about these things and what makes them different from regular receipts is that they're numbered in sequence. If you get a booklet of 500 receipts, for example, they'll come one through 500 in sequence. And when your accountant hands in your quarterly tax statements for your business, he'll turn in all those facturas for that sales quarter too. Because based on those facturas, you'll be paying the government the VAT tax that you collected on every item you sold. Remember, I told you that the VAT tax is included in every item that you sell. And that has to be remitted back to the government quarterly.

[16:45] And woe be to you, the business owner, if just one of those facturas is missing. And about that VAT sales tax, down here in Latin America it's anywhere from 10% to 15%. And over the years it's been creeping up like all taxes do. And by the way, I hate taxes. Everybody does. But there is one thing I do like about the way Latin American countries handle their EVA tax. At least sellers don't add it on like a sales tax to your bill so that every time you buy something, you get pissed off when you see they've added 10 or 12 for 15%. You don't see it on the bill. It's already been buried within the final price. So if you buy something for 100 bucks, the real cost of a $100 item is only about $91. And the 10% has already been factored in,

[17:33] adding up to the sticker price of about 100 bucks. Sure, the government's ripping you off for 10 to 15% of everything you buy, but it's easier to handle psychologically when you don't have it written on that receipt. Or should I say factura? So again, what happens quarterly, if you have a business down here, is that your accountant hands in all those facturas to the government from the sales that you made for that quarter. And those facturas, like I said, are numbered and they're in order. And if you're missing just one of those facturas, even if the cat ate it or the dog crapped on it, you will be fined because every factura represents tax revenue to the government in the form of Eva. And what your accountant basically is doing is adding up all the sales for that quarter, taking 10 or 15% of those sales for Eva

[18:18] and giving it over to the government. So if one of those facturas is missing, the tax guys figure you're trying to scam them. Thus a relatively big fine, which is known in Spanish as a multer. Now the tax guys figure that if you're missing a factura, certainly someone used it in a purchase. And who knows how big a purchase they made. Thus how much Eva the government's losing. Whether it was a $10 sale or a $1,000 sale. Because if you do the numbers on a $10 sale at 10% Eva, you'll have to hand over $10 to the government tax authorities. But if you sold something for $1,000 with that factura, with a 10% Eva, you'd owed the government $100 on that sale. So that's why they fine you if you're missing one of those facturas in the group.

[19:04] Their first thought is that you sold something worth big money and you're trying to scam the government out of their 10% or 15%. Now forgive me if I sound a little pedantic here when I go through these examples, but I get a lot of questions on this. So I'm taking it kind of slow if you don't mind. Because you know it's obvious that all you expat wannabes up there have the desire to come down here and start a business. And that's why I'm going through this. And I realize there's nothing more boring than taxes in church. But bear with me for a minute longer, okay? Now there's a game you can play and a calculated risk you can take by omitting one of those facturas on purpose and telling the tax guys that it's lost or misplaced. Then you pay the fine but you really make out in the end. For example, let's say that fine is $50. But what if in reality that factura that was so conveniently lost

[19:54] represented a sale of $1,000? Well actually by paying the fine you've made money. Because if the fine's only 50 bucks and the Eva on the factura that was lost is 100 bucks, well you've made 50 bucks then. Quite a profit now, haven't you? But you can't pull something like that every quarter. Even though Latin government workers are especially lazy, they're not stupid. So as you can see in every country they have their little games. The people versus the government. Now as a sidebar to this factura and tax situation, if you look at any of the big Latin newspapers in the yellow pages, right after the classified ads section, you'll see some special announcements. And as often as once or twice a week, there will be some company that's offering a reward

[20:40] for the return of facturas that were stolen from their company. And we'll actually list the numbers in series of the facturas that are missing. Because you see like I said before, around tax time, there's a big scramble for facturas. Now imagine if you had a booklet of real facturas with serial numbers that are blank. In other words, not filled in yet. That means you have something that's quite valuable on the black market. Then the buyer and or his accountant can fill in that factura any way he wants to get the deduction necessary to lower his taxes to zero or near zero. You get the idea? I mean you can sell a legitimate blank factura like that for let's say $25 and the guy that buys it from you can make it work out to get any kind of deduction he wants within limits.

[21:27] Because you see facturas themselves have the company's name at the top. So if you have a blank factura in the name of let's say a construction company, then you could really go to town. You could make that factura look like a receipt for a construction job worth thousands of dollars and no one would be the wiser. So a receipt like that is very valuable on the resale market. But it works the other way too. Let's say you had a blank factura from a bookstore or a stationary store. You're certainly not going to be able to make that factura look like a receipt for thousands and thousands of dollars. Probably not even for hundreds of dollars. Anyway you get the idea. Now you might wonder why the big newspaper blurb at the end of the classifieds saying that these facturas are missing or for sure stolen. Who really cares and why should a company spend money on an ad to announce that?

[22:13] Well they do that because a company that's missing that many facturas is in big trouble at the government tax office. Now you see when your accountant files those quarterly tax returns and he shows up in his country's IRS office and says hey look I got a problem. There's 25 facturas missing from this quarter's sales. Well one of the only ways the government will accept an excuse like that without nailing you with a huge fine is to demonstrate some good faith that they truly were stolen. The best way to do that is to show you've made an effort by going to the police and filing an official complaint and showing that you paid for an announcement that was published in the newspaper. And the fact is oftentimes the business owner will know exactly who stole those facturas. Coincidentally those facturas will have gone missing and guess what?

[23:01] At the same time a certain employee will never come back to work again. He'll just disappear. That's how these factura thefts usually happen. So that's why many times when you're scanning the classified ads and you see some facturas have been stolen in that same announcement they'll have the name or the photo of an ex-employee along with his ID numbers, his cellular information and next to his name it'll say that he no longer works for this company and that they are not at all responsible for anything he does in the name of the company. Basically they're saying he's the guy that stole the facturas. So look out if he tries to sell you one. Now you might be wondering if any expat businessmen are approached by people who are selling blank facturas that are probably fake or stolen. Well the answer to that is yes. It's happened to me quite a few times.

[23:49] Okay so what should you do? The first question that might go through your mind is this. Can I get away with this? Will the tax people know this really isn't legit? And what happens if the company whose name is on this factura reported to the local tax people that it's been stolen? And what will they do to me if they find out that I have one of these things in my possession and I'm trying to use it to write off one of my personal or business expenses? Well let me assure you expats and expat wannabes this is not the first world. Computers are not connected, government workers are eminently lazy and at least up to now the people who work in these Latin American tax divisions are only high school educated bean counters if that. And remember Latin tax divisions do not have strong arm IRS type enforcement officers.

[24:39] They don't have tax agents per se that are going to knock on your door and go through your files and tax stuff with the fine tooth comb. That never happens down here because they don't have agents to do that. And basically the only punitive actions I've ever seen Latin tax divisions take besides finding you if you're missing a factura is that they do occasionally crack down on businesses that don't give out facturas at all. Because if you don't give out facturas when you sell something obviously you won't be paying much quarterly VAT tax either now will you? And that's why when you walk into any retail business you'll see a sign somewhere near the cash register that says demand your factura it's the law. Each small business is given little stickers and signs like that by the tax division and they must post them close to the cash register.

[25:25] And these stickers also have a hotline telephone number on them you're supposed to call if a store owner didn't give you a factura. But then again this is the third world and I've been told if you call that number you'll just get a recording or no one will answer at all. To which I say man you gotta love it down here huh? It's the same story everywhere as soon as a government tries to squeeze more taxes out of you in one way or another the public responds with a way of getting around it and that's true down here too. Small businesses down here get around that by having two kinds of receipts on hand the official numbered facturas and regular old generic receipts that you can buy at a print shop or office depot. And that's why so often when a gringo or an expat walks in let's say a hardware store and you buy something many times if you look at the receipt closely it won't be numbered

[26:14] it won't be a factura it'll be a regular old sales receipt. Good enough for expats and gringos like us it's proof of sale but to the hardware store owner every regular receipt he could give out like that that's not a numbered factura he saves that 10 or 15 percent VAT tax because remember only the numbered facturas are reported quarterly to their version of the IRS. And you know us gringos and expats and especially first world tourists we don't give a damn what kind of receipt we get we just take what they give us we don't care. Hell 95% or more of us foreigners don't even know what a factura is not till someone explains it to us did you? To us a receipt is a receipt right? So the question is if you're an expat business owner and it's getting close to tax time and you're short facturas to write off

[27:00] should you go to the factura gray market and buy some of these things to lower your tax rate? Well I'm not saying you should do anything illegal here but if you've been listening to my show long enough you'll know that there are so many angles you can play in Latin America that practically nothing is black and white everything is in the gray area so my advice is just go with what your accountant and your lawyer are saying let them handle it they're natives they'll know exactly what to do they'll advise you or not in fact sometimes don't ask don't tell is the best policy South of the border down Mexico way You've been listening to The Expat Files living in Latin America coming to you each week from somewhere south of the border and don't forget you can email me

[27:46] on anything at all about Latin America The Expat Files at gmail.com Once again The Expat Files at gmail.com See you next time. Nos vemos