Taxes on Digital Services: Challenges and Compliance in El Salvador
Rolando González, Associate at ARIAS El Salvador, expert in Taxes, presents this article on how the digital economy is reshaping how income is generated, creating overlooked tax obligations.
In recent years, the growing rise of the digital economy has redefined the way companies generate income, access markets, and structure their operations. However, along with these opportunities, relevant tax implications arise that frequently go unnoticed in taxpayers’ tax management.
Currently, it is common for individuals and legal entities in El Salvador to contract digital services with foreign providers, such as online advertising, streaming platforms, cloud storage, or software licenses, among others, without having full clarity on the tax obligations that these transactions generate at the local level. The omission or incorrect management of these obligations may imply tax risks and additional costs that compromise the financial efficiency of the business.
In this context, the ability of major digital companies to carry out activities in a globalized manner limits the powers of States to tax in an equitable manner the economic activity of such commercial operations. This evolution defiance established tax approaches, creating serious challenges for traditional tax administrations.
At a global level, the taxation of the digital economy has been one of the main points of debate in the last decade. The Organisation for Economic Co-operation and Development (OECD), through its BEPS (Base Erosion and Profit Shifting) project, has promoted the implementation of mechanisms to avoid the erosion of tax bases and the artificial shifting of profits to territories with low or no taxation. In particular, BEPS Action 1 addresses the tax challenges of the digitalization of the economy, recommending that States adapt their regulatory frameworks with the aim of effectively taxing income generated in their territory, even when the taxpayer does not have a local physical presence.
As a result of the above, several countries have responded by making adjustments to tax regulations, with which they seek to ensure efficient collection on digital services. Chile, for example, reformed its VAT Law to include, as of 2020, the obligation for foreign platforms to register in the taxpayer registry and declare the respective tax on digital services provided to Chilean consumers. In that same year, Mexico introduced specific obligations for foreign digital providers in the VAT Law and the Income Tax Law, establishing withholding and electronic filing mechanisms borne by them. Likewise, Argentina has made regulatory changes, implementing a VAT withholding system through financial intermediaries that process payments for the services provided.
These reforms demonstrate a trend toward the adoption of local withholding schemes, seeking to balance tax equity and competitive neutrality between local and foreign service providers.
In El Salvador, the Income Tax Law, which is based on an eminently territorial system, taxes exclusively income derived from local sources and not the one derived from foreign sources, establishing along this line that income from Salvadoran sources shall be considered, among others, that which is derived from services used in the national territory, that is, those from which an enjoyment is obtained in the country, even if they are provided from abroad.
The foregoing implies that, when a resident or local establishment uses digital services, such as online advertising, audiovisual entertainment platforms, cloud storage or software licenses with a non-domiciled provider, for tax purposes, the payment for such services is considered income obtained in El Salvador and, consequently, is subject to local taxation.
In accordance with the provisions of article 158 of the Tax Code, the party obliged to carry out the withholding is the local payer, who must act as a withholding agent for Income Tax. This point is especially relevant, as it shifts the burden of compliance to the local user of the service, who often is unaware of this obligation.
For its part, the Law on the Transfer of Movable Goods and the Provision of Services levies the importation of services that are provided from abroad and used or exploited in Salvadoran territory. Hence, digital services contracted with non-domiciled providers, such as those mentioned above, are subject to VAT, as they constitute an importation of services subject to the payment of such tax.
However, despite the existence of express regulation that taxes digital commerce, its application is not widespread, especially when the recipients of digital services are individuals or are not registered as taxpayers before the tax administration. This situation generates a latent risk due to possible future audits and tax adjustments that could be applied retroactively.
In this sense, the eventual adoption of mechanisms such as mandatory withholding or the registration of non-domiciled providers, following international trends, could significantly increase the levels of audit and compliance in the country.
Hence, a regulatory adjustment in that direction constitutes an important challenge for El Salvador, in order to adapt its tax system to the new dynamics of the digital economy, ensuring greater tax equity and neutrality between local and foreign operators.
For taxpayers, this not only implies a regulatory change, but an immediate need to review their operations, identify tax exposures, and adopt timely compliance measures, both in terms of Income Tax and VAT. Proactive management in this area not only reduces risks, but also allows for more efficient tax planning aligned with international best practices.