Latin America (LATAM) is emerging as a significant market for foreign digital service providers. This growth is driven by increasing internet usage, a growing middle class, and widespread use of digital technologies. Demand for digital services such as video streaming and online education is increasing rapidly. By the end of 2024, revenues in the electronic services market are expected to reach $10.36 billion, and the digital media market alone could generate $11.87 billion.

However, entering the Latin American market presents unique challenges, particularly with regard to value added tax (VAT) on cross-border digital services. Governments in the region have begun to impose VAT on these services to ensure they generate revenue from this growing sector. For foreign sellers seeking to enter the Latin American market, understanding and complying with these tax regulations is critical to successfully entering and continuing to operate.

The introduction of VAT on digital services provided by foreign sellers in Latin America began in the mid-2010s. Before this regulation, many foreign digital service providers in several Latin American countries did not pay taxes, giving them an advantage over local companies. To address this problem and increase tax revenues, countries in the region introduced VAT regulations. Colombia and Argentina were among the first countries to impose VAT on digital services provided by foreign companies back in 2017, followed by Chile, Uruguay, Costa Rica and Mexico.

Different approaches to VAT collection in Latin America

Although LATAM countries are often considered a unified region, they vary significantly in how they collect VAT on digital services. Some countries require foreign sellers to register for VAT and comply with local tax laws, while others use payment intermediaries to withhold taxes from transactions. Over time, a hybrid model combining both approaches has become the most common way to ensure VAT compliance.

Registration requirement for foreign sellers

This approach requires foreign digital service providers to register for VAT in the country where they offer their services, collect VAT and remit it to the local tax administration. This model is similar to VAT systems in other regions, such as the European Union.

For example, Mexico’s VAT system for cross-border digital services, which takes effect in June 2020, requires foreign companies that provide digital services to Mexican customers to register with the Mexican tax authority. Foreign sellers must collect VAT on their services, file monthly VAT returns, and remit the tax collected to the Mexican government. They have 30 days from the date they first provide services in Mexico to register. As of January 2024, there were 201 foreign companies registered in Mexico.

To complete registration, foreign companies must appoint a legal representative in Mexico and submit various documents, such as:

• A certified and translated power of attorney, company statutes and foreign tax number.
• Proof of a tax address in Mexico, such as a rental agreement or electricity/gas bills.
• Identification of the designated legal representative.

Mexico is known for its very burdensome tax registration requirements. Recently, the tax administration introduced new registration requirements, including:

• The company’s articles of association must explicitly state that the services are provided via a “technological platform”.
• An affidavit from the legal representative detailing the services offered, the website used and the company’s principal place of business.

If a Mexican customer purchases services from an unregistered foreign company, he or she must pay VAT. The Mexican tax authority publishes a list of registered foreign service providers to make it easier for consumers to verify compliance.

Tax withholding by intermediaries

With this method, intermediaries such as payment processors or financial institutions are responsible for collecting VAT, so foreign sellers do not need to register in the country or file VAT returns. Instead, VAT is automatically withheld and remitted to the tax authority at the time of payment.

Argentina was one of the first countries in Latin America to implement this system for cross-border digital services. When an Argentine consumer pays for a digital service provided by a foreign company, the payment processor withholds VAT and sends it directly to the Argentine tax authority. The supplier does not handle VAT, and the consumer is treated as a taxpayer for VAT purposes. If VAT is not withheld by the intermediary, the Argentine customer must pay VAT directly to the tax administration.

The withholding system benefits the state as it collects VAT without having to manage compliance with numerous foreign companies, while foreign companies avoid potentially complex VAT registration processes. However, problems can arise such as incorrect withholding of VAT and increased responsibilities for intermediaries, especially if they do not fully understand the transactions they process.

Hybrid approach

Many Latin American countries use a hybrid approach to collect VAT on digital services. This method combines elements of direct registration and tax deduction, enabling more effective VAT collection while providing flexibility for different scenarios.

In Colombia, foreign companies that provide digital services to Colombian consumers can either register for VAT or use a VAT withholding system. The Colombian Tax Administration provides a list of withholding entities. If a foreign provider decides to use this system, it must inform the Tax Administration of its decision. The withholding mechanism also applies to foreign service providers who fail to comply with their Colombian VAT obligations.

Ecuador and Costa Rica use a similar withholding system. Foreign sellers can register for VAT, but if they don’t, intermediaries such as credit card companies will withhold VAT when paying. In Chile, foreign companies are expected to register and collect VAT, but from August 2022, if a foreign supplier has not registered, intermediaries will have to withhold VAT on payments to non-compliant suppliers.

Peru is currently setting up a hybrid model that will come into effect in October 2024. Nonresident providers of digital services to Peruvian consumers will have to register for VAT and act as withholding agents. These providers will have to file a monthly tax return and remit the VAT collected. If a foreign company does not comply, it will be added to the list of non-compliant companies and payment processors will withhold the tax.

Tax compliance considerations for foreign sellers

Mastering tax compliance in Latin America requires understanding different approaches to VAT collection, each with its benefits and challenges. The tax registration approach requires foreign digital service providers to register for VAT in the countries where they offer their services. This provides a straightforward way to collect VAT, but represents a significant compliance burden for foreign sellers. The tax withholding approach, on the other hand, simplifies compliance for foreign sellers as they do not have to interact directly with local tax authorities. However, this system can lead to errors and disputes if intermediaries miscalculate VAT. The hybrid approach offers more flexibility but adds complexity as foreign sellers must decide whether to register locally or rely on intermediaries for VAT withholding, depending on their business model and the regulations of each country.

Foreign companies registering for VAT in Latin America must determine whether their digital services are taxable and, if so, determine the applicable VAT rate. While most digital services are subject to the standard rate, there are exceptions. For example, Colombia does not tax cloud computing services, while Mexico exempts digital publications. VAT rates in Latin America are generally lower than in the European Union but higher than in the United States, ranging from 13% in Costa Rica to 19% in Colombia and Chile. Notably, Ecuador has increased its VAT rate from 12% to 15%, effective April 1, 2024, through the end of the year.

Another important consideration is whether VAT must be charged on all sales or only on B2C transactions. The rules vary from country to country: Mexico, Ecuador and Costa Rica require foreign digital service providers to collect VAT on both B2B and B2C transactions. In contrast, Colombia and Chile limit the tax collection obligation to B2C transactions only.

Future developments

As the digital economy in Latin America grows, VAT rules for cross-border digital services are also expected to evolve. One important development is Brazil’s ongoing tax reform, which aims to modernize and simplify the country’s complex tax system. The reform proposed by Brazil envisages the consolidation of several taxes into a dual VAT that is applied uniformly to goods and services, which will have a significant impact on digital service providers.

Other countries, such as Bolivia and Panama, may also update their digital services VAT systems. While these countries have announced plans to introduce tax collection obligations for foreign digital service providers, these have not yet been implemented. It is critical for foreign sellers to stay up to date with these developments. As Latin American markets continue to attract international business, understanding VAT rules and being prepared for changes is essential to complying and capitalizing on opportunities in this dynamic region.

The opinions expressed in this article are those of the author and do not necessarily reflect the views of any organizations to which the author belongs.