How to take advantage of withholdings from other jurisdictions in Peru
Abigail Alayo & Gustavo Martinez
by Abigail Alayo & Gustavo Martinez
I. Context
In Peru, resident entities are subject to taxation on their worldwide income, which includes Income generated from Peruvian Sources (IPS) as well as Income from Foreign Sources (IFS).
Due to the sovereignty of each jurisdiction, countries apply what in legal circles are known as "nexus criteria" to determine the taxpayer's obligation to pay taxes within that country. The most commonly used nexus criteria are residence and source.
When two countries apply each of these criteria simultaneously, International Double Taxation (IDT) arises due to the conflict between residence and source taxation. For the purposes of this article, we will further analyze this scenario below.
II. When does International Double Taxation (IDT) arise under Peruvian tax legislation?
When a Peruvian resident legal entity earns IFS, such income is taxed on the basis of the Peruvian residence criterion. However, in other countries this same income may also be taxed under the source of income criterion, thereby creating a situation of IDT.
To mitigate or eliminate the effects of IDT, Peruvian tax law provides for a unilateral foreign tax credit, provided that certain requirements are met. This credit may be used to offset the income tax determined for the corresponding fiscal year.
III. What is the unilateral credit method for IDT relief?
The unilateral credit method is a mechanism established under domestic Peruvian law and it can be applied in two forms:
Direct Credit: The Peruvian taxpayer offsets the foreign tax paid directly against their income tax liability in Peru.
Indirect Credit: The Peruvian taxpayer offsets the foreign tax paid by a subsidiary or affiliate against their income tax liability in Peru, a situation triggered when dividends are received.
IV. What rules govern the application of this method?
There are common rules that must be considered for the application of both direct and indirect credits:
The foreign tax must have been effectively paid.
The foreign tax must correspond to income that is considered to be foreign-source income subject to Peruvian taxation. The credit only applies to IFS and not to IPS.
V. Additional considerations
In order to properly apply both types of credit, the following aspects must also be taken into consideration:
For the determination of the direct credit, the foreign income tax paid cannot exceed the amount resulting from applying the “average rate”. Any amount not utilized in the current fiscal year cannot be carried forward to subsequent years nor does it entitle the taxpayer to a refund.
The indirect credit can only be utilized by resident legal entities in Peru. As with direct credit, it cannot be carried forward to other years nor does it generate a right to a refund.
Abigail Alayo is a Certified Public Accountant by the Association of Public Accountants of Lima and an Administrator (UPC) with postgraduate studies in Corporate Finance, Tax Law, and Transfer Pricing. Abigail boasts more than ten years of experience in accounting, tax, and legal areas. At present, she is pursuing a Master's in Tax and Business Taxation.Contact Abigail.
Gustavo Martinez is a Lawyer (UNMSM) specialised in Tax Law. He is a winner of the UNMSM Tax Competition. Gustavo has over five years of experience in Tax Consulting and Compliance. He is currently in the process of completing a Master's in Tax Law at the University of Lima.Contact Gustavo.
GGI member firm VAG GLOBALLima, PeruT: +511 627 9787Auditing & Accounting, Tax, Advisory
VAG Global is a multidisciplinary firm of accountants, auditors, lawyers, and economists with over 25 years of experience in audit, consulting, and tax services. Our commitment to clients and the expertise of our diverse team enable us to consistently deliver high-quality, tailored solutions.
