INSIGHT: Taxation on Digital Services in Paraguay

Until December 31, 2019, the Paraguayan tax system was mostly territorial, with few exceptions. The set of rules for cross-border transactions contained in the former tax law was based on principles devised at the beginning of the 20th century when the key factors of production were essentially immobile and tangible assets, combined with the labor used to employ those assets. Accordingly, traditional international rules to frame the taxation of business profits in cross-border activities, such as the physical presence requirements to determine nexus or the customary profit allocation rules, were suitable to avoid double or null taxation in international operations.

Globally, this paradigm has drastically changed, and the provision of digital services without any significant physical presence in the market country represents the leading edge of economic exchange. This ever-evolving digital economy requires an adequate reform in cross-border rules of taxation to face the 21st century’s main challenges.

As a response to the need of modernization, Paraguay enacted the Law No. 6,380/2019 (the Tax Law), which has been in force since January 1, 2020. The Tax Law modernizes the Paraguayan tax system to address the challenges that the present-day economy poses to the tax administration of a developing country such as Paraguay.

Paraguay is adopting many of the main recommendations issued by the Organization for Economic Cooperation and Development (OECD) in the Tax Law. Indeed, Paraguay has been an active member of the Development Center since 2017. Nevertheless, unilateral measures have been taken through the Tax Law to approach the issue of taxation in the new digital economy.

The fiscal norms adopted by Paraguay on digital services focus on two taxes:

• Value-added Tax (VAT) with new rules being introduced; and
• Withholding Tax on the Income Obtained by Nonresidents (INR, per its Spanish acronym), which is a new tax.

The Paraguayan tax authorities chose withholding and perception mechanisms to apply these taxes, considering that the majority of the companies that provide digital services used in Paraguay are nonresidents.

It is essential to point out that the special rules proposed through these taxes were intended to come into full force on July 1, 2020. However, due to the Covid-19 pandemic, the implementation of these norms was postponed until January 1, 2021. We are expecting new regulatory norms that will clarify some operational requirements for entities responsible for complying with the obligations proposed by the Tax Law.

Before analyzing this new set of rules, it is necessary to understand the scope of the activities and revenues which are being affected by them.

What are Digital Services?

Under the Tax Law, digital services are those provided to the consumer over the internet or any adaptation of the protocols, platforms or technology utilized via internet or any other digital network in which online services are rendered. Additionally, digital services are characterized by being: (i) automatized; and, (ii) non-viable in the absence of information technology.

As an example of these types of services, the regulatory decrees of the Tax Law mention the following companies, which usually provide digital services: Netflix, HBO go, Spotify, Amazon Prime, Google, YouTube, Facebook, Instagram, Deezer, PayPal, Twitter, Apple and Airbnb. This list is not exhaustive, and to offer some clarification, the regulatory decrees also establish that the digital services linked to the importation of goods are not subject to these taxes. The companies which provide those services are also mentioned in a non-restrictive list as follows: Amazon, eBay, Alibaba, MercadoLibre, among others.

Nevertheless, to apply these taxes, it is also necessary to determine whether the service was used in Paraguay or not, since the provision of services and income generation is taxable in Paraguay for nonresidents. Only digital services deemed to be used in the country will be subject to taxation.

When are Digital Services Used in Paraguay?

The Tax Law considers that the digital services are used in Paraguay when any of the following elements is located in the country:

• internet protocol address of the device used by the client or the SIM card code;
• billing address of the client;
• bank account used for the remission of the payment;
• billing address of the client registered in the bank;
• bank which issued the credit or debit card with which the payment is conducted.

Conversely, in case none of those elements mentioned above are located in Paraguay, the Tax Law does not deem that the service was provided in the country and no fiscal obligations arise.

By applying a broad definition of territoriality, the Tax Law creates a potential situation in which a customer might be using the digital service outside the country, while still triggering the tax liabilities. This situation can arise, for example, if the payments are conducted with a credit card issued by a bank located in Paraguay, and the customer using the service is located in another country. As can be seen, this can lead to double taxation on digital services, if similar measures are taken in the place where the customer uses the service. The Tax Law offers no solution to this potential conflict.

How Will These Taxes be Applied?

Under the Tax Law, the entities located in Paraguay who are responsible for processing the payments conducted by the consumers through debit or credit cards or the remittance of funds (the Payment Processor) are obliged to collect the VAT and INR. It is important to mention that the Tax Law does not differentiate between business-to-business (B2B) and business-to-consumer (B2C) transactions.

The Payment Processor must collect the VAT and INR when payments are remitted abroad by the users of the digital services. However, particular rules apply to each tax, and these must be analyzed separately.

VAT

• VAT at a 10% rate will apply over the price of the digital service paid by the final consumer. In this regard, the Tax Law determines that this amount is not contained within the price of the service paid. Therefore, the 10% rate must be added to the service price offered by the nonresident service provider.
• If a Paraguayan company is using the digital service for its economic activity, it can be benefited by the input VAT. The VAT collected by the Payment Processor can be used as a credit to offset the debit generated in the sale of goods or services in the country. However, if the user is a consumer, the VAT collected by the Payment Processor cannot be used as a fiscal credit.

INR

• The INR has to be effectively withheld by the Payment Processor. Based on this, the INR is subtracted from the price of the service offered by the nonresident service provider, which will receive the difference. The INR general tax rate is of 15%, which is applied over a legally presumed net income of 30%, resulting in an effective rate of 4.5%, applicable overpayments conducted abroad.

To illustrate the effect of these fiscal liabilities on a typical transaction, consider an example where the customer pays $10 to the nonresident digital service provider. Firstly, the Payment Processor will assess the 10% VAT over this amount and collect $1. Afterwards, the 4.5% INR will be subtracted from the price offered, and the Payment Processor will make the withholding of $0.45. Finally, the digital service provider will receive the net amount of $9.55 and the customer will pay in total $11, of which $1.45 will be collected and withheld by the Payment Processor and paid to the tax authorities.

Other Formal Obligations

It must be noted that the obligation to make these withholdings and collections and to enter the payments to the Paraguayan tax authorities are the main responsibility of the Payment Processor. Therefore, the nonresident digital service provider is not obliged to comply with any formal obligation, nor is it obliged to file any report or to make any tax assessment.

Nevertheless, under the regulatory provisions of the Tax Law, the tax authorities can request information from the representatives of the nonresident digital service provider.

Are Taxes Levied on Other Types of Digital Services?

The withholdings mentioned above are applied to services provided by nonresidents, as long as payments are remitted abroad, and the digital service is deemed to be used in Paraguay. The creation of value through the accumulation of user information by the digital service provider, or through any other means, is not subject to any form of taxation in Paraguay.

Other business models affected by these taxes are the multi-sided platforms, in which the consumer pays the commissions for the ride-for-hire or the rental to the nonresident digital service provider, which intermediated in the transaction. Cloud computing services are also taxed when the payment for the services is conducted. In every case, the withholding and collection methods previously described will apply.

Are Permanent Establishments (PE) Approached?

The Tax Law does not tackle the taxation of the digital economy through the PE concept. Therefore, no risk of creating a PE in Paraguay is generated based on the provision of digital services in the country by a nonresident company.

The PE concept applicable in Paraguay is contained in Section 155 of the former tax law —which is still in force to regulate tax infringements, tax determination and other formal matters.

Following this provision, a PE is created in Paraguay if any of the following is incorporated in the country:

• a branch or an agency;
• a factory, plant, industrial workshop or agricultural establishment;
• mines, quarries or any other excavation site through which natural resources are extracted; and
• any construction project which exceeds 12 months.

Planning Points

Multinational companies that provide digital services in Paraguay that fall within the scope of these taxes should address these liabilities as follows:

• Determine whether or not the price for the service charged to users located in Paraguay will be increased to translate this economic burden to the consumers or not.
• Understand how these fiscal liabilities for operations conducted in Paraguay will affect the obligations of the company in their jurisdiction. It is essential to consider that Paraguay has treaties to avoid double taxation with Chile, Uruguay and the Republic of China (Taiwan), among others.
• Stay updated on the implementation of these obligations or further regulatory norms. This set of rules has already been postponed to January 1, 2021, and due to the ongoing Covid-19 pandemic, it is still a possibility that another postponement will take place.

Nestor Loizaga is the Managing Partner and Horacio Sánchez Pangrazio is an Associate at Ferrere, Paraguay.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.