Cablegate: Nicaragua's Taxman Cometh

VZCZCXYZ0000
OO RUEHWEB

DE RUEHMU #1151/01 3552252
ZNY CCCCC ZZH
O R 212251Z DEC 09
FM AMEMBASSY MANAGUA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 0318
INFO WHA CENTRAL AMERICAN COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

C O N F I D E N T I A L MANAGUA 001151

SIPDIS
DEPT PLEASE PASS MILLENNIUM CHALLENGE CORPORATION

E.O. 12958: DECL: 2019/12/21
TAGS: ECON EFIN EAID PGOV PREL NU
SUBJECT: NICARAGUA'S TAXMAN COMETH

REF: MANAGUA 1141

CLASSIFIED BY: RobertJCallahan, Ambassador, STATE, Embassy Managua;
REASON: 1.4(B), (D)

Summary

------------

1. (C) The Nicaraguan National Assembly passed a sweeping tax
reform package with the approval of President Ortega on December 3,
which, according to most observers, will lead to price increases
and decreased demand during an economic downturn. The GON cited the
need for increased tax revenues in order to address a projected
$282 million deficit in 2010. The petroleum and supermarket
industries appear to be the most at risk as a result of a new tax
on gross sales, which will negatively affect these
high-volume/low-margin businesses. Critics have also noted the
GON's failure to use Venezuela's ALBA (Bolivarian Alliance for the
Americas) funds to resolve the deficit, along with its reluctance
to rein in government spending. Several economists here predict
that the GON's new tax law will only push more Nicaraguan consumers
into the unregulated informal sector, far from the grip of the tax
authorities. At the same time, most businesses acknowledge that
while any tax hike is unwelcome, it could have been worse. End
Summary.

Higher Taxes and More of Them

------------------------------------------

2. (U) On December 3, the Nicaraguan National Assembly passed a
controversial tax reform package designed to address the GON's
projected fiscal deficit in 2010 of approximately $282 million
(reftel). In a speech on November 18, President Ortega stated
that the GON needed to raise additional revenue to fill the deficit
because of the effects of "savage capitalism" which had created the
world economic crisis. Ortega also blamed the International
Monetary Fund (IMF) for Nicaragua's current financial predicament,
referring to the Fund as an "instrument of capitalism." The
following measures constitute the major elements of the new law: a
1% minimum tax on gross sales for businesses, a 10% tax on interest
income generated by deposit
accounts, a 10% tax on dividend income, a 1.5% tax on transactions
in the Nicaraguan commodities exchange market, and a 20% tax on
income earned in Nicaragua by citizens who reside abroad (rental
income, for example). The GON claims that these new taxes will
raise the equivalent of 0 .7% of GDP, or approximately $45 million.

3. (C) The new law affects employees who earn as little as $3,700
per year, who will now owe 10% of their wages in taxes. At the
other end of the bracket, those who earn over $25,000 per year will
be taxed at a rate of 30%. The new law also cracks down on
tax-exempt abuses prevalent among Nicaraguan NGOs, prohibiting
tax-free treatment for the following items:

alcoholic beverages, tobacco products, jewelry, perfumes,
cosmetics, yachts and sport and recreational boats, and airplanes
for private use. [Comment: It is common knowledge that many "NGOs"
in Nicaragua are nothing more than shell companies which exist
purely for members of the ruling class to import the aforementioned
products into Nicaragua duty-free. End Comment.] Jose Adan
Aguerri, President of the Nicaraguan Federation of Businesses
(COSEP), represented a wide range of commercial sectors negotiating
the tax package with the GON. He told the media that these new
taxes will negatively impact economic growth, but added that all
Central American countries are introducing tax reform packages,
some of which may prove much tougher than the GON's.

Exxon, WalMart Share Concerns...

--------------------------------------------

4. (C) The supermarket and petroleum industries are likely to be
the hardest hit as a result of the new tax law. On December 14,
econoff met with Joaquim De Magalhaes, Country Manager for Exxon in
Nicaragua, to discuss the effects of the GON's new tax reform law
on its operations here. Exxon operates the country's only refinery,
and is the sole supplier of gasoline and diesel to the Nicaraguan
market. De Magalhaes told econoff that Exxon's primary concern is
the new 1% tax on gross sales. While Exxon is analyzing the
implications of this new tax, the nature of its
high-volume/small-profit margin business likely means that this new
tax will result in increased gasoline prices at the pump.

5. (C) Similarly, Eduardo Garcia, Corporate Affairs Manager for
WalMart/Nicaragua, told econoff on December 10 that the new 1% tax
on gross sales will strongly affect its grocery business given low
industry profit margins (1 to 2%). Garcia claimed that the GON's
new law means that WalMart will see its tax bill climb by 400%. He
recounted to econoff his meetings with various deputies in the
National Assembly, in which he explained to them how PALI (one of
the supermarket chains in Nicaragua operated by WalMart) earns 80%
of its revenue by selling basic food items (rice, beans, for
instance). Garcia noted that with the new 1% tax on gross sales,
WalMart will be compelled to raise prices, and that as a result
low-income customers will
purchase basic foodstuffs in unregulated, informal local markets.
As a result, according to Garcia, the GON will ironically collect
less tax revenue.

6. (C) Garcia asserted that from a regional perspective, the new
tax law renders Nicaraguan products less competitive throughout
Central America. For example, Garcia said that almost all beef
sold by WalMart in El Salvador is imported from Nicaragua. Since
Nicaraguan beef prices will increase as a result of the new gross
sales tax, WalMart will turn to more competitive
suppliers, possibly in Guatemala. Despite the GON's new tax law,
Garcia refuted reports in the local media that WalMart plans to
leave the Nicaraguan market, at least in the short term. He held
out the possibility, however, that should the new tax burden result
in consistent losses, ultimately WalMart would be forced to
discontinue its operations here. Garcia expressed
hope that the National Assembly might pass a legislative fix during
the first quarter of 2010 specifically addressing the grocery
sector's tax dilemma.

...While Others Claim It Could Have Been Worse

--------------------------------------------- ------------------

7. (C) Most attendees at the Ambassador's December 4 Economic
Roundtable acknowledged Aguerri's efforts at heading off a much
more onerous tax law; originally, the GON sought to raise revenue
equivalent to 1.5% of GDP, but in the end settled on 0.7%. Julio
Cardenas of BANCENTRO, Nicaragua's second-largest bank, observed
that the tax reform law could have been much worse. However, he
said it will still result overall in higher prices throughout the
economy, leading to a corresponding reduction in demand. Cardenas
told the Ambassador that banks in Nicaragua will see their tax bill
rise from 30% - 40%, making them less competitive compared to other
regional banks. Cardenas said he believes the GON will review the
effects of the new tax reform in six months to determine whether or
not amendments are necessary. Another prominent banker, Gabriel
Solorzano of BANEX, characterized the tax reform as yet another
grim development in the context of anemic economic growth in
Nicaragua, brought on by the recent drought, the lack of
international credit, and the increasingly authoritarian nature
of the GON. Solorzano said that all of these factors are
contributing to a steady exodus of the country's best and brightest
out of Nicaragua.

8. (C) During the same event, Erwin Kruger, former head of the
Nicaraguan Federation of Businesses (COSEP), lamented that
President Ortega could have easily filled the nation's budget gap
with Venezuelan ALBA funds. He opined that this would have been a
far better fiscal solution instead of a new tax law which further
impedes investment and economic prosperity. Luis Rivas, General
Manager of BANPRO, Nicaragua's largest bank, said that his bank,
along with several others, had offered to purchase $60 million in
GON bonds to fill the budget deficit. Unfortunately, according to
Rivas, the IMF did not approve this initiative, arguing that such a
move was not sustainable and would harm credit availability in
Nicaragua. All of the
participants in the Roundtable agreed that the new tax reform law
could have been avoided had the FSLN (Sandinista National
Liberation Front) not engaged in the widespread electoral fraud
perpetrated in November 2008, which in turn led European donors to
withdraw crucial budget support funds from the GON. Others
commented that the FSLN will suffer political consequences in the
lead up to the 2011 presidential elections as a result of this
unpopular new tax.

9. (C) As described in reftel, the tax reform passed with the
support of one nominally opposition party (the Nicaraguan Liberal
Alliance - ALN) and the abstention of another (the Constitutional
Liberal Party - PLC). COSEP head Aguerri argued to the DCM on
December 15 that even those parties that opposed the reform (Vamos
Con Eduardo - VCE and the Sandinista Renewal Movement - MRS)
understood perfectly well that this was the best deal that could be
gotten and their denunciations were pure political posturing. He
was particularly angry at Eduardo Montealegre's attack on Carlos
Pellas, Nicaragua's most powerful businessman, for negotiating the
reform with Ortega. Aguerri said that it was absurd for
Montealegre to attack the same people from whom he is seeking
funding. Comment: Aguerri was clearly unhappy that the business
community, of which he is the public face, now has to take partial
ownership for what will inevitably be an unpopular measure.

Comment Continued

---------------------------

10. (C) A widely-held misconception here is that the IMF, under
its Poverty Reduction and Growth Facility (PRGF), initiated this
tax reform in order to increase GON revenues to address the looming
budget deficit. In fact, the GON itself proposed these new tax
measures to the IMF last summer on its own accord, instead of
utilizing Venezuelan ALBA funds or cutting government spending
sufficiently to fill the deficit. While most of these taxes
primarily affect the wealthiest echelons of Nicaraguan society, it
is likely that these measures will result in higher prices
across-the-board, so all segments of the socioeconomic ladder may
feel a hit, which could result in political costs for the FSLN.
Collecting these new taxes will prove to be
challenging for the GON's tax authority, which lacks sufficient
resources and technology even to collect current taxes on the
books.
CALLAHAN

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