The Uruguayan “lock rule”: premonition of OECD/G20 Inclusive Framework on BEPS’s “GloBE proposal – Pillar Two”?

By Andrea Laura Riccardi Sacchi[1]

  1. Introduction

In 2006 a substantial tax reform (Law No 18,083 of 27 December 2006, hereinafter referred to as Tax Law Reform or TLR) was approved in Uruguay. Amongst one of its various novelties, and within the corporate income tax or IRAE (as per the Spanish abbreviation, Impuesto a las Rentas de las Actividades Económicas)[2], the so-called “lock rule” (regla candado) was introduced as an anti-abuse rule aimed at coping with the erosion of the IRAE tax base. In this regard, presenting this measure may contribute to the current discussion at the OECD level on a “tax on base eroding payments” rule under the “Global anti-base erosion (GloBE) proposal – Pillar Two” of the Inclusive Framework’s work on BEPS Action 1.

  1. What is exactly the lock rule?

The lock rule is a general rule, i.e. it applies to every expense incurred by an IRAE taxpayer whether the counterpart is a local or foreign person, related or non-related, which operates as an additional requirement for the deduction of expenses when calculating the corporate income tax base.

The IRAE is paid at a flat rate of 25% by local companies as well as Uruguayan PEs of non-residents on net profits of Uruguayan source. Indeed, the IRAE is based “exclusively”[3] on the source principle, taxing therefore profits derived from activities developed, assets located or rights economically used within the Uruguayan territory.

To determine the taxable base, IRAE taxpayers are allowed to deduct  expenses which (i) are accrued during the fiscal year, (ii) are necessary to obtain and maintain the taxable income, (iii) are properly documented and, added by the above-mentioned TLR, (iv) represent income of the counterpart which is effectively taxed[4], whether under the IRAE, the personal income tax or IRPF (as per the Spanish abbreviation, Impuesto a las Rentas de las Personas Físicas), the non-residents income tax or IRNR (as per the Spanish abbreviation, Impuesto a las Rentas de los No Residentes) -all three, local income taxes- or a foreign income tax.[5]

The IRPF is a dual tax on capital income (Category I) and labor income (Category II) obtained by resident individuals. The general tax rate taxing capital income has been set at 12% while labor income is taxed by progressive rates, which go from 10% to 36%, with a non-taxable minimum amount. Meanwhile, the IRNR taxes income of any nature at a general tax rate of 12%, obtained by non-residents – individuals or other entities – and as long as they do not act within the Uruguayan territory through a PE. The IRNR rises to 25% if the non-resident entity obtaining the Uruguayan source income is located in a low or non-tax jurisdiction -according to a list issued by the Tax Office.

But the story does not end there and further analysis is needed when the counterpart is either taxed by IRPF Category I, IRNR and/or a foreign income tax. In those cases, the IRAE taxpayer must calculate the deductible portion of the expense, i.e. the expense will be deducted according to the relation between the income tax rate paid by the counterpart (whether locally and/or abroad) and the IRAE rate. If the counterpart is taxed by a local income tax and a foreign one, then both rates must be added to calculate the coefficient.[6]

Tax paid by the counterpart Deductible portion of the expense[7]
IRPF Category I 12/25 = 48%
IRNR 12/25 = 48% or

25/25 = 100%, if low or no-tax jurisdiction

Foreign income tax FETR[8]/25 (limited to 100%)[9]
Both, local and foreign taxes (12 or 25+FETR)/25 (limited to 100%)

Source: the author

This lock rule, which has been in force for fiscal years commencing as of 1 July 2007 and which is applicable on expenses incurred both, locally and abroad, has some exceptions[10], i.e. some expenses accrued, necessary to obtain taxable income and duly documented can be deducted in full even if they were subject to a tax rate lower  than 25% or no taxation at all. Some of these exceptions, such as the cost of imported goods[11], respond to practical reasons (otherwise the implementation by the taxpayer and the enforcement by the tax authority, would be very difficult), others are based on the promotion of certain activities, e.g. interest payments on debt issued under public and transparent conditions.

  1. Why a premonition of the GloBE proposal – Pillar Two?

 After realizing that anti-BEPS measures implemented as a result of the other fourteen BEPS actions may have not been that successful in combating base erosion and profit shifting to low tax jurisdictions, the GloBE proposal is being studied as part of the unfinished work on BEPS Action 1. However, and as explicitly pointed out in the corresponding documents, the scope of this proposal is not limited to highly digitalized businesses.

This GloBE proposal addresses the development of two inter-related rules: an income inclusion rule and a tax on base eroding payments. In particular, the tax on base eroding payments rule establishes (i) the denial of the deduction[12] or the imposition of source-based taxation, and (ii) the denial of treaty relief, for payments which were not subject to an effective tax rate at or above a minimum rate, rules which have been referred to as an “undertaxed payments rule” and a “subject to tax rule”, respectively. The “undertaxed payments rule” reminds us of the existing Uruguayan lock rule, right?

Moreover, we must not forget the existence of the Uruguayan extensions of source, in particular those related to technical services and propaganda -referred to in our previous blog – which, remember, apply only on services rendered from abroad  linked to an effectively taxed IRAE recipient and, therefore, on services payments that may be eroding the IRAE tax base. One of the tax policy rationales behind these extensions was precisely that these services, being deducted as expenses by Uruguayan enterprises or Uruguayan PEs of non-residents, may be eroding the national corporate income tax base. To avoid this possibility, the counterpart’s income is now deemed as of Uruguayan source. This is also similar to “the imposition of source-taxation” being considered as part of the undertaxed payment rule of GloBE proposal.

4. Final comments

 It must be recognized that the lock rule implemented by Uruguay more than a decade ago was a visionary one. However, is there any limit to the adoption of measures under this kind of “anti-base erosion principle at source” flag? We explain ourselves.

Firstly, the very big difference between the lock rule and the undertaxed payments rule is that the latter is only aimed at payments to related parties. At least this seems to be the intention explained in the preparatory documents. It makes sense as the GloBE proposal intends to “ensure that all internationally operating businesses pay a minimum level of tax”. On the other hand, as we mentioned above, the lock rule is a general rule. Notwithstanding, as it does not deny the deduction of the payment in full but the portion corresponding to “non-taxed income”, it reflects the counterpart’s tax burden (both, local and foreign). However, when applying the extensions of Uruguayan source there is no consideration of whether the counterpart has paid any foreign tax; then these extensions may be the origin of double taxation…

To respond to our question on limitations, we should first pose and answer the following: should countries combat base erosion based on an international perspective or just on a national perspective? Considering the guiding principles of cooperation and coordination it advocates, we know at least what the OECD’s answer would be.

[1] The appraisals expressed in this comment belong to the author and do not compromise any of the institutions to which she is related.

[2] Impuesto a las Rentas de las Actividades Económicas (IRAE): Title 4 of Texto Ordenado 1996 (T4 of TO 1996) and Decree No 150/007 of 26 April 2007,

[3] As we mentioned in our previous blog, some exceptions to this general criterion, so-called “extensions of source” -as recognized by the Uruguayan tax authority itself-, have relaxed the traditional approach to the definition of source; e.g. the case of technical and advertising services being rendered abroad under certain conditions. Please see section 2 of Riccardi Sacchi, A.L., While in the quest for the Holy Grail… Uruguay is already taxing income from Uber and Netflix

[4] Meaning that, to fulfill the condition, effective taxation is needed, i.e. if the item of income is covered by an income tax but has been exempted, this item is not considered to be effectively taxed on the head of the counterpart.

[5] Arts. 16 and 19, T4 of TO 1996, and Art. 25, Decree No 150/007

[6] Art. 20, T4 of TO 1996, and Art. 26, Decree No 150/007

[7] For determining the coefficient, as the income may be taxed locally at a reduced tax rate, it was established that the IRAE taxpayer may consider, as the local tax rate, the maximum tax rate in force, which is 12% under IRPF Category I and IRNR, except when the counterpart is located in a low or no-tax jurisdiction, in which case, the actual tax rate, i.e. 25%, applies.

[8] FETR: “foreign effective tax rate”. The effective foreign tax rate is deemed to be the nominal rate unless a special regime or exemption exists.

[9] The amount being deducted will never be higher than the amount actually incurred.

[10] Art. 22, T4 of TO 1996, and Art. 42, Decree No 150/007

[11] The lock rule also applies to costs (Art. 16, T4 of TO 1996)

[12] In full or a proportionate amount (see par. 74, OECD, Programme of Work…, ob.cit.)

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