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