Small individual taxpayers, micro and small enterprises (SMEs)have always been , have always been a factor of concern among tax policy makers. On one hand, since they constitute the largest universe of taxpayers (60 to 96% depending on the country), on the other their importance in the collection in the region is very small (0.1 to 3.9%).  In this blog we propose a special tax regime for SMEs after the pandemic.

These taxpayers are, in many cases, in the subsistence economy, where informality is the dominant factor, with scarce social security coverage, with reduced administrative capacity and their operations are mostly cash-based. The challenge for tax administrations in Latin America and the Caribbean is to ensure that these taxpayers fulfill their obligations while keeping the costs of tax compliance and control at affordable levels, so as to stimulate  productivity and formalization. Small and micro enterprises (SMEs) usually are the largest employer in our countries and dynamic factor in the economy; however,  they suffer from a high mortality rate and a low productivity so that the  vast majority of SMEs remain stagnant.

To solve this challenge, the region has tried different solutions.

Since the 1970s, the strategy has been to create simplified Value Added Tax (VAT) regimes. Given the failure of this approach, the 1990s saw the emergence of a more comprehensive strategy, which combined income tax (IT) and Social Security contributions (SSC) (mainly pensions and health services) to promote economic and social inclusion, but also to help  strengthen  the weak controls in place.

Prevailing special regimes and lessons learned

At present, there are basically 4 types of regimes:

• the regime of based on physical magnitudes (quantitative limits) according to the economic activity, which substitutes the value added tax (VAT) and the income tax (IR). An example of the regime is the Spanish Modules Regime (1992, which included even the agricultural sector);
• the specific regimes by activity and/or taxes, such as in Chile, Peru[1], etc., which, due to their multiplicity, have made control impossible and have favored arbitration, generating privileges;
• a single regime for small taxpayers, where  taxes and social security resources are substituted. An example of this regime the single-payment regime (Monotributo), pioneered by in Argentina[2],sought to spur social inclusion by incorporating SSC for the first time, and to mitigate “fiscal dwarfism” by introducing other parameters in addition to gross revenues[3] for inclusion, categorization and exclusion[4], and
• the fiscal (tax) incorporation regime (FIR), developed by Mexico, whose main feature is its transitional nature since   its main goal is to facilitate the graduation of small taxpayers to the general regime[5]. However,  it does not take into account the fiscal situation of small taxpayers who remain in that condition over time and run the risk of re-registering in the regime at the end of the transition period. 

Having reviewed the region’s approaches, the first conclusion is that there is no single solution for all types of small taxpayers, and in some countries, some specific regime must be considered for special economic activities developed.

Secondly, the establishment of a gross income limit as the sole parameter for a small taxpayer regime definition has been proved to be ineffective, because thresholds can easily be circumvented, with the consequent loss of revenue and the transfer of taxpayers from the general regime to the special treatment.

Finally, the characteristics of the economy and the capacity of the Tax Administration (TA) are relevant elements in defining the structure of the regime.

Updating the design of the existing regimes

The analysis above underpins the following recommendations that seek to increase the development and formalization of small taxpayers by streamlining processes which enhance compliance and reduce control  costs:

• Encourage formality and social inclusion by providing pension and health coverage, including for employees and family members where appropriate, with reduced contributions to social security contributions (SSC). In addition, administrations may consider to credit part of the VAT paid in purchases, if these are documented by electronic invoicing (EI). This allows a “contraposition of interests” scheme and cross-control by taxpayers, by incentivizing them to require purchase invoices from their suppliers so as to get tax credits.

• Promote the technological development of micro and small businesses by the TA provision of free of charge web services, electronic invoicing solutions operating on mobile equipment, and the electronic payroll services. These services should be bundled with simplified accounting and tax settlement systems, which in turn reduce  (or even suppress ) other obligations, such as in the Brazilian and Chilean cases, bookkeeping and providing tax advice.

• Simplify voluntary compliance and reduce its associated costs by granting longer deadlines for returns (e.g. quarterly pre-made using electronic invoices) and payments (e.g. bi or quarterly) always on an accrual basis. Payment arrangements should also be provided, through more benevolent surcharges and default interest.

• Promote a series of non-tax incentives linked to SME development, such as, among others, technical assistance, improved access to credit based on the balance sheets generated by the TA or the implementation of “factoring” (credit based on the EI recognized by the TA).

Proposal for a special regime for individual taxpayers, micro and small enterprises

It is clear that the challenges for the development and formalization of these taxpayers are multidisciplinary and, therefore, no optimal tax treatment can be defined, but our region has accumulated important experiences. Therefore, following the recommendations described in the previous point, we propose:

A simplified regime, consisting of a combination of the single-payment (Monotributo regime) as a matrix, complemented by a process of transition to the general regime based on the experience of the fiscal (tax) incorporation regime (FIR).

I.It is based on a single-payment regime (Monotributo style), with very few substitute categories of taxes (VAT and income) and Social Security contributions. Subnational indirect taxes could also be included where appropriate. This regime would have an upper income limit, combined with other parameters, which, if exceeded, would imply automatic transition to the FIR-type system. In other words, it would move the SME to the intermediate stage of fiscal incorporation and would not be able to return to the single-payment regime for a period (e.g. 3 to 4 years).

II.The regime is complemented by an intermediate system of incorporation (FIR type) intended to be a “silver bridge” to the general regime for a transitional period (3 to 5 periods) where an increasing percentage of taxes (VAT, income and CSS) generated is paid.

Once the SME moves into the general regime, it will not be able to return to the intermediate regime until after some time (e.g. 3 to 4 years) if its income falls along with other control parameters .

Similarly, should the small taxpayer directly exceed the upper income limit to automatically switch to the general regime, the taxpayer would not be able to return to the single-payment regime until a similar period has elapsed.

To avoid abuse through the cessation and artificial creation of a new company, they must be controlled by registering the “Ultimate Beneficial Owner” as committed by our jurisdictions following the directives of the Global Forum.

In conclusion, although the modernization of special regimes was necessary prior to the pandemic of COVID-19, today it is imperative to implement it in view of the pandemic’s economic-and social consequences and the acceleration of technological change that have impacted on this universe of taxpayers, so important in the creation of jobs and poverty reduction.

The authors appreciate the valuable contributions and comments of Daniel Alvarez, Fernando Diaz Yubero, Ubaldo González de Frutos, André Martinez Fritscher, Dalmiro Morán, Jerónimo Roca and Raúl Zambrano.

[1] in Peru there are three special regimes: NRUS (new simplified single regime), RER (Special Income regime) and RMT (MYPE tax regime).
The decrease of taxpayers of the general regime was: 606 thousand (2016) to 208 thousand (2018).
[2] created in 1998, today it has 3.2 million individual taxpayers. They are covered by social Security (Health, pension, etc.) and health (social works). Their tax collection is approximately 1% of the VAT and IR income that they replace, and 2.2% of the SSC.
[3] electricity consumed, area affected by the activity, rental income, and maximum unit selling price.
[4]The SIMPLES NACIONAL (Regime Especial Unificado de Arrecadação de Tributos e Contribuições das Microempresas e Empresas de Pequeno Porte) of Brazil, is a special case. This optional regime replaces 8 taxes, two of them subnational. Created in 1996, it now has 5 million registered taxpayers, and relies solely on gross revenues with a high ceiling of USD 1 million, which has caused the reverse transfer of taxpayers from the general regime. In fact, currently, it concentrates almost 90% of companies in several states due to the effect of “fiscal dwarfism”.
[5]It has a 10-years duration. In the first, small taxpayers (up to $100 thousand a year in revenues), they do not pay anything and each year add 10% of the taxes of the general regime, and have a more generous sub-regime for taxpayers who invoice less than USD 14 thousand.

This article was reproduced with the authorization of the authors (Alberto Barreix and Dario Gonzalez) originally published on the IDB blog.

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