This content is from: Local Insights

A territorial or worldwide income tax system?

Juan Ernesto Menjívar

El Salvador previously operated a territorial tax system whereby only income earned within the country's borders, regardless of the citizenship or residence of the taxpayer, was taxed by the Ministry of Finance. Today, with the changes made to tax laws a year ago, those in El Salvador are facing a mixed tax system with some elements of worldwide taxation.

Before December 2009, any foreign income that was earned outside of El Salvador was not taxed by the government, and nationals having income from foreign sources had no need to worry about reporting that income to El Salvador tax authorities or taking tax credits or deductions; this foreign income was, in other words, exempt from tax in El Salvador.

After December 2009, any individual or physical person that derives income from some foreign sources must declare and pay taxes from that income in El Salvador. The foreign sources are foreign income derived from:

  • securities and financial instruments;
  • loans or financing given by Salvadorian persons or entities to foreign persons or entities located outside of El Salvador; and
  • deposits in financial institutions located outside of El Salvador.

According to the tax reforms of 2009, foreign income from loans given by Salvadorian persons or entities to foreign persons or entities located outside of El Salvador must be included in the income obtained in El Salvador. Moreover, foreign income from securities and deposits in financial institutions located outside of El Salvador will be taxed at 10% if no tax was paid at the source.

If a tax was paid at a rate of less than 10%, the rate paid must be applied to the 10% in El Salvador and the resulting difference paid locally. The treatment for these sources of income is shown in the table.

Foreign Income derived fromTax rateTax Credit
Securities and Financial Instruments10%Yes
Loans given by Salvadorian persons or entities to foreign persons or entities located outside of El SalvadorUp to 25% depending onthe tax bracketNo
Deposits in financial institutions located outside of El Salvador10%Yes

As shown, El Salvador has incorporated elements of a worldwide tax system into its tax rules, becoming a mixed tax system. Nevertheless for some instances the possibility of double taxation has been reduced by allowing a tax credit for some of the sources of income.

However, foreign income derived from loans given by Salvadorian persons or entities to foreign persons or entities located outside of El Salvador is included directly with the income obtained in El Salvador, leaving the door open to a possible double taxation. Some countries offset this problem by allowing foreign income exclusions up to certain amount.

For example, US citizens and resident aliens who live abroad are taxed on worldwide income, but can exclude from their income up to $82,400 of foreign income, providing a kind of relief for higher-tax rate US citizens and residents.

It remains to be seen in following years whether or not this mixed tax system is beneficial for citizens and residents of El Salvador. A worldwide tax system needs a solid structure of laws to administer and enforce its rules in order not to become burdensome and complicated for tax payers, nor more prejudicial to their wallets.

Juan Ernesto Menjívar

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