US embassy cable - 03TEGUCIGALPA865

UNCLAS SECTION 01 OF 03 TEGUCIGALPA 000865 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR WHA/CEN, WHA/ESPC, DRL/IL, AND EB/IFD/OMA 
STATE PASS AID FOR LAC/CEN 
STATE PASS USTR FOR ANDREA GASH DURKIN 
TREASURY FOR JOHN JENKINS 
DOL FOR ILAB 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, PGOV, EAID, ETRD, ELAB, HO 
SUBJECT: Honduran Congress Adopts New Fiscal Package; 
Emphasis on Eliminating Corporate Exemptions and Loopholes 
 
Ref: (A) Tegucigalpa 826 
 
     (B) Tegucigalpa 494 and previous 
 
1. (SBU) Summary.  On April 2, the Honduran Congress 
considered and adopted in one reading a second fiscal 
package (the first was adopted in May 2002) designed to 
broaden the tax base, help reduce chronic budget deficits 
and move the government on the road to an IMF agreement. 
Congress modified several of the government-proposed 
provisions in order to lessen the impact on low and medium 
income Hondurans (the majority) and to avoid political 
backfire from influential unionized public sector workers 
(particularly teachers).  Increased taxes on tobacco and 
alcohol were added in order to compensate for lost revenues. 
The government and the IMF are working together to develop 
projections of the effect of the final tax proposals on the 
government's annual revenues.  The target had been an annual 
increase of 3.5 billion lempiras, (USD 200 million) - of 
which about 2 billion lempiras (USD 118 million) would be 
collected in the remaining months of 2003 - but IMF sources 
are concerned that the final result will be lower.  The GOH 
has continued with its planned austerity measures and work 
to strengthen the financial sector.  The most problematic 
issue remains: getting the public sector wage bill under 
control for the medium and long term.  The GOH is engaged in 
negotiations with striking doctors on a needed change to the 
law on mandated salaries for medical personnel (if 
successful, the "estatuto" for teachers will be tackled 
next).  The GOH also continues to promise to introduce a new 
civil service framework law that provides the GOH with 
control over wage policy for the majority of public sector 
workers.  End Summary. 
 
2. (SBU) After two months of negotiation and fine-tuning, 
the Honduran government submitted to Congress a package of 
tax measures (called the Law of Tax Equity) designed to 
broaden the tax base and eliminate a number of special tax 
exemptions.  To ease its quick passage, the bill had already 
been watered down from an initial proposal discussed with 
the IMF, but Congress modified it further during the 
marathon legislative session on April 2.  The key measures 
include: 
 
-- Reduction of the income tax exemption for bonuses and 
representation expenses for individuals with income above 
600,000 lempiras (USD 35,294) annually.  Taxation of 
insurance premiums paid by companies and executives. 
Application of the income tax to capital gains from the sale 
of securities and property.  Application of the income tax 
to rental income (for executives and professionals).  The 
first 90,000 lempiras (USD 5,294) will be exempt from income 
tax. 
 
-- Application of the income tax to the "14th month" salary 
(a bonus paid to employees in June of each year) and other 
benefits such as vacation, for taxpayers with annual income 
greater than 225,000 lempiras (USD 13,235).   The "13th 
month" Christmas bonus remains exempt from income tax. 
 
-- Corporate income tax was unified at a rate of 25 percent 
of net taxable income. 
 
-- A "temporary solidarity tax" of five percent was 
established for corporate taxpayers with taxable income 
greater than one million lempiras (USD 58,824).  It will be 
applied to tax bills for the 2002, 2003 and 2004 tax years. 
Hotels and companies working under special export regimes 
are exempted from this measure. 
 
-- Tobacco products and alcoholic beverages will be subject 
to a 15 percent sales tax.  An internal tax on cigarettes 
was increased from 32.25 percent to 45 percent, aligning  it 
with practice in the rest of Central America.  The 
calculation of sales tax on beer, soft drinks and alcoholic 
beverages was modified. 
 
-- Establishment of withholding taxes to ensure more 
corporate taxpayer compliance.  The law requires a payment 
of 12.5 percent of wholesale transactions that will be 
applied against corporate income tax bills.  Similarly, 
companies and self-employed individuals will pay withholding 
taxes of 2.5 percent of net taxable income. 
 
-- Elimination of tax exemptions for nongovernmental 
organizations, cooperatives, churches and nonprofit 
organizations.  Exemptions remain for activities by NGOs 
related to health, education and charity.  Rules on the 
exemptions from customs duties on automobiles imported by 
NGOs are also tightened up.  These provisions are designed 
to stop tax avoidance by Honduran companies.  USAID is in 
discussions with the GOH on the need to avoid taxing U.S. 
assistance provided through NGOs. 
 
-- The number of products exempt from sales tax was reduced 
from 800 to about 200 (mostly foodstuffs, pharmaceuticals, 
books and publications and school supplies). 
 
-- Creation of a one percent tax on the value of net assets 
for companies involved in wholesale or retail trade. 
 
-- Elimination of the tax exemption for fuels used in the 
generation of electricity.  Power generation firms may 
present their invoices to the state-owned electricity 
company ENEE for reimbursement of these taxes and customs 
duties.  (Note: this measure was taken to control widespread 
abuses of the tax exemption, in which bunker and diesel fuel 
were imported supposedly for power generation but in fact 
sold on the market.  End Note.) 
 
-- Reinstatement of the ten percent consumption tax on cars 
including "luxury pickups". 
 
-- Tightening up of the rules on free trade zones and 
special warehouses.  Only true export operations will be 
eligible for related tax breaks. 
 
-- Tightening up of methods to measure inventory and 
corporate expenses routinely deducted to calculate net 
taxable corporate income. 
 
-- Procedural changes to improve sales and income tax 
compliance, including the control of receipts, electronic 
filing and channeling payments through credit card 
companies. 
 
3. (SBU) The fiscal package also contained the following 
expenditure measures: 
 
-- Cancellation of 60 percent of government positions that 
were vacant on December 31, except in education, health and 
security.  Overtime pay is limited. 
 
-- Wage freeze for public employees not covered by 
collective bargaining agreements. 
 
-- Instruction to proceed with retirement for all employees 
not meeting legal requirements (generally age). 
 
-- Austerity measures such as limitation of monthly use of 
cellular phones by public officials and establishment of 
caps on overtime hours. 
 
4. (SBU) The IMF is working with the GOH to develop 
projections of the effect of the final tax proposals on the 
government's annual revenues.  The target had been an annual 
increase of 3.5 billion lempiras (USD 200 million) - of 
which about 2 billion lempiras (USD 118 million) would be 
collected in the remaining months of 2003 - but IMF sources 
are concerned that the final result could be significantly 
lower.  The Congress rejected three important tax measures 
in the original government proposal: taxation of the 
Christmas and June bonuses for a much larger group of 
taxpayers; elimination of the exemption from income tax for 
secondary school teachers and university professors (primary 
teachers have a tax exemption written into the 
Constitution), and taxation of electricity for the largest 
residential users and for commercial users.  The increase in 
the sales tax for tobacco and alcohol was added to 
compensate for these cutbacks. 
 
5. (SBU) The GOH has continued with its planned austerity 
measures and work to strengthen the financial sector.  The 
most problematic issue remains: getting the public sector 
wage bill under control.  The GOH is currently in 
negotiations with the doctors over changes to the special 
law, or estatuto, which governs pay for medical personnel. 
GOH negotiators have distributed results of their analysis 
of the Honduran medical establishment's comparability with 
other countries in the region.  By any measure, Honduran 
doctors are the highest paid in the region, while medical 
indicators for the country are some of the worst in Latin 
America.  The result of the negotiation (which has the 
possibility of turning into a labor confrontation and a 
doctor's strike) will set the stage for attacking the 
bigger, although not quite as egregious, problem of the 
growth in the wage bill for teachers.  (See ref A for more 
on the GOH's dispute with the doctors.) 
 
6. (SBU) Comment: From the IMF's point of view, the fiscal 
package was watered down from the original proposal, bowing 
unduly to political pressure.  The Fund is concerned that 
(1) teachers and other unionized public sector workers will 
continue as privileged groups, and (2) widespread tax 
exemptions distorting the economy and reducing potential tax 
income will continue.  To the GOH's credit, however, the 
fiscal measures do attack some notable tax loopholes that 
have allowed Honduran companies and wealthy individuals to 
pay very little in taxes over the years.  The question 
remains to be answered if the measures will deliver the 
hoped-for tax revenues.  President Maduro has requested a 
meeting with the Managing Director of the IMF  during his 
April 9-11 visit to Washington to review the progress made 
to date.  Embassy is tracking the progress of GOH-IMF 
negotiations closely.  If no agreement is reached, Honduras 
will need to pay certain overdue payments on DOD loans by 
July and September of this year or risk triggering Brooke 
Amendment sanctions.  End Comment. 
 
Palmer