On 25 November, Law No. 20,095 was enacted, introducing changes to Corporate Income Tax (IRAE). It was recently regulated by Decree No. 395/022 of 14 December.
The changes stem from commitments made by Uruguay in response to concerns raised by the European Union about regimes in our country considered potentially harmful or likely to encourage harmful tax competition. In particular, the concern is the possible use of shell companies, that is, companies without economic substance, to benefit from Uruguay's territorial source principle and so avoid taxation of foreign-source passive income.
Changes introduced
New cases of Uruguayan-source income are added under IRAE:
- Income from intellectual property rights relating to patents and registered software (registered in any jurisdiction) obtained by an entity belonging to a multinational group, sold or economically exploited abroad, to the extent it does not correspond to qualifying income.
- Income from real estate capital, dividends, interest, royalties not included in the previous point, other income from movable capital, capital gains from the sale of the assets that generate such income, and any other increase in wealth derived from assets capable of generating such income, obtained abroad by an entity belonging to a multinational group that is not considered a qualifying entity.
Definitions of qualifying income and qualifying entity are introduced, directly linked to substance requirements in Uruguay, together with a specific anti-abuse clause applicable only for these purposes.
Special case of trademarks:
Income from the sale or economic exploitation of trademarks outside the national territory will be considered Uruguayan-source income in all cases where the Uruguayan company obtaining the income belongs to a multinational group.
As can be seen, the new provisions affect those falling within the definition of a multinational group. This is because multinational groups tend to adopt aggressive tax planning strategies and therefore present the greatest risk of base erosion and profit shifting.
Entity belonging to a multinational group
A multinational group is defined as two or more related entities resident in different jurisdictions.
For these purposes, an entity is related if it:
- Is included in the group's consolidated financial statements for reporting purposes under the generally accepted accounting principles of the jurisdiction of the group's ultimate parent entity, or would have been included if the entity were required to prepare such statements, or would have to be included if its equity interests were traded on a public securities market.
- Meets the inclusion criteria in the previous point but is excluded from the group's consolidated financial statements solely on grounds of size or materiality.
Permanent establishments of the entities referred to in points 1 and 2 will be considered members of the Multinational Group in all cases.
Qualifying income: applies to patents and registered software
Qualifying income (and therefore not taxed under IRAE) is the amount resulting from applying the following ratio to income from the exploitation of intellectual property rights relating to patents or registered software:
Numerator: direct expenses and costs incurred to develop each asset, increased by 30%. Only the direct expenses and costs incurred by the developer, and services contracted with unrelated parties (resident or non-resident) or with resident related parties, are taken into account. The numerator can never be greater than the denominator.
Denominator: total expenses and costs incurred to develop each asset, comprising those included in the numerator, without the 30% increase, plus the expenses and costs of licensing or acquiring intellectual property rights and services contracted with non-resident related parties (*).
The regulations provide that taxpayers must file a sworn statement detailing the elements that determine the ratio, the registration number of the asset and the exemption percentage determined accordingly. They must also reliably demonstrate the relevance of the expenses and costs incurred to develop those assets.
Qualifying entity: applies to other passive income and capital gains
A qualifying entity is one that has adequate economic substance during the tax year. If the defined substance requirements are met, the IRAE taxpayer may continue to treat the income in question as foreign-source income, and it will therefore not be taxed under IRAE.
An entity is considered to have adequate economic substance if, in relation to each asset generating the income and throughout the period it is held, it meets all of the following conditions:
- It employs human resources adequate in number, qualifications and pay to manage the investment assets, and has adequate premises for that activity in Uruguay;
- It takes the necessary strategic decisions and bears the risks in Uruguay;
- It incurs adequate expenses and costs in relation to the acquisition, holding or sale, as the case may be.
For the purposes of points 1 and 2, the entity will be considered to have adequate economic substance even where the activity is carried out by third parties in Uruguay under the entity's adequate supervision.
The Decree provides that, where the activity is outsourced, the third parties must employ human resources adequate in number, qualifications and pay for the services provided. Where services are provided to several recipients, the resources assigned to them must not overlap. The service provider must detail on the relevant invoice both the staff assigned and the hours spent providing the services.
They must also have adequate premises and incur expenses and costs consistent with the activity.
To prove qualifying entity status for a tax year, taxpayers must file an annual sworn statement with the DGI setting out the above.
Special case of holding companies and real estate holding companies:
For entities whose main purpose is to hold equity interests in other entities, or whose main function is to hold real estate, only the human resources condition in point 1 must be met to be considered a qualifying entity.
Under the regulations, an entity is a holding or real estate holding company for the purposes of this Law when the assets directly associated with those activities represent at least 75% of the entity's total assets.
As regards the condition in point 1, the regulations provide that it is sufficient to have a director resident in Uruguay with the appropriate qualifications for the role, or for most of the human resources employed to be Uruguayan residents qualified to carry out the activities that generate the income.
To prove qualifying entity status for a tax year, taxpayers must file an annual sworn statement with the DGI showing that the condition has been met.
Anti-abuse clause
A specific anti-abuse clause is introduced regarding the substance requirement for qualifying entity status. The DGI may, by reasoned resolution, disregard arrangements, mechanisms or series of mechanisms put in place with the main purpose, or one of the main purposes, of obtaining a tax advantage that defeats the object or purpose of the new articles.
For these purposes, a mechanism or series of mechanisms will be considered improper when there are no valid commercial reasons reflecting economic reality for adopting or carrying them out (the Decree states that financial reasons are included). In such cases, the income or the entity may be recharacterised as non-qualifying, and the tax liability determined in accordance with the IRAE rules.
Credit for tax paid abroad
Taxpayers who have been taxed abroad on the income in question may credit the equivalent income tax paid abroad against the IRAE generated on the same income. The credit may not exceed the portion of IRAE calculated before that deduction.
Upward or downward adjustments that taxpayers must make for equivalent foreign income taxes will be taken into account in the tax year in which they are paid or the credits become available. Likewise, where those taxes can be fully or partly recovered abroad, the reduction of the credit will apply in the tax year in which it takes effect.
To apply this regime, payment of the tax abroad must be reliably proven to the DGI's satisfaction.
Entry into force
These changes apply to financial years beginning on or after 1 January 2023.
If you need further information, please do not hesitate to contact our team or email info@inglobal.com
(*) Parties are related when they are subject, directly or indirectly, to the management or control of the same individuals or legal entities, or when these, through their shareholding, have the power to direct or define the activities of the taxpayers.
Our team is available to advise you.
