Interesting Features of Guatemalan Income Tax
Eduardo Mayora of Mayora & Mayora explains the attraction of the dual taxation system available to taxpayers in Guatemala.
The Beauty of Simplicity
Tax legislation is usually regarded as complex and complicated. For example, in Guatemala and in other countries in the northern part of Central America, one of the conditions for any expense to be deductible for income tax purposes is that it must have a direct connection with the taxpayer’s activities that generate taxable income. It is not the purpose of this article to dwell on this issue here, but it is not difficult to imagine several situations where expenses relate to the generation of taxable income, but it is not clear that there is a “direct” connection.
“...in Guatemala and in other countries in the northern part of Central America, one of the conditions for any expense to be deductible for income tax purposes is that it must have a direct connection with the taxpayer’s activities that generate taxable income.”
It is obvious that, while the management of a company is incentivised to view most expenses as directly related to the generation of taxable income, and thus deductible, the tax administration’s inspectors are incentivised to question whether or not there is a direct connection. This creates a systemic tension and, depending on the varying degrees of risk aversion among decision-makers in the firm, it can become a source of disagreement and potential conflict.
Simple rules are preferrable to complicated ones, but not at the cost of paying higher taxes. Simple is beautiful, but not at any cost.
A Tale of Two Taxing Options
The Guatemalan Income Tax Act of 2012 provides a very interesting option to taxpayers that, depending on the nature of their business, addresses this issue reasonably well.
Income arising from regular for-profit business activities is taxed, at the corporate level, at 25% of net income. This is gross income minus deductible expenses. Deductible expenses include the usual: cost of production, sales costs, expenses incurred in providing services, transportation and fuel, labour costs, the employer’s contributions to the social security system, contributions to employee pension plans, severance pay, 50% of any contributions to employee housing plans, insurance premiums, leases, other national and municipal taxes, interest, maintenance costs, losses for broken or destroyed property/equipment, depreciation and amortisation, donations to registered non-profit organisations, and non-collectable receivables. Some are subject to certain limits, and all must directly relate to the generation of taxable income.
“Guatemala has a domestic-sourced income regime and, thus, any foreign-sourced income is not taxable.”
And here comes the interesting feature of the Guatemalan system: the taxpayer may elect for each fiscal year to pay income tax at 25% of net income or 7% on gross taxable income. This is still more interesting because Guatemala has a domestic-sourced income regime and, thus, any foreign-sourced income is not taxable.
The Economics of the Taxpayer’s Choice
The choice between these options may depend on several factors peculiar to each taxpayer. However, this usually hinges on:
- whether the margin between gross income and deductible expenses is 7% or more;
- the administrative and compliance costs related to the 25% option (because the taxpayer’s financial, back office, and accounting systems need to be capable of handling deductibles efficiently); and
- external auditing costs (external auditors will usually charge considerably higher fees for auditing a firm under the 25% option).
Conclusion
The combination of the optional 7% income tax on gross income may be a very economic option for business firms with high margins and foreign-sourced income. It is simple and does not consume energy and resources in compliance and tax auditing compared to those required to navigate the 25% income tax on net income.
Mayora & Mayora
