Technology Brings Hacienda into the 21st Century
When it comes to having the latest technological tools, it’s no secret to anyone that the Puerto Rico Treasury Department, known locally as Hacienda, has for years been stuck in a time warp.
No one knows this better than Treasury Secretary Juan Zaragoza. When Zaragoza stepped in as Treasury secretary in late 2014, he essentially found the same computer systems with black screens and green letters that he used at the agency back in the late 1980s when he was deputy secretary.
For years, Hacienda has been notorious for the numerous complaints from taxpayers about long lines, delays, mistakes with addresses and tax information, outdated tax records as well as the infamous “mathematical error” notices in the mail regarding the processing of tax returns.
Over time, this has created distrust and a lack of respect for the agency among taxpayers.
Time to act
In his second stint at the agency, Zaragoza was intent on transforming Hacienda, as the timing could not be more pressing.
A shrinking tax base, a lingering economic downturn now in its 10th year, low sales & use tax (IVU by its Spanish acronym) collection rates, and an escalating fiscal & debt crisis as taxpayers and businesses have been carrying the burden of more than $2 billion in new taxes on their shoulders made the task to overhaul the agency even more difficult.
Needless to say, the agency’s biggest roadblock to leap into the 21st century was basically lack of funding.
“Only 3% of Hacienda’s total budget was destined for technological improvements,” Zaragoza told Caribbean Business during an interview last year. “This cries out in front of God. Large tax agencies like those in the Dominican Republic, Chile and Spain have spent big bucks on administration. You can’t do an efficient job with sweat and tears alone; you also need technology.”
As Zaragoza outlined his transformational plan for Hacienda based on the overhaul of four main areas—human resources, management, technology and organizational structure—in March 2015 he recruited Víctor Pizarro to be the agency’s wingman as deputy secretary of internal revenue.
Ironically, Pizarro occupies the same position Zaragoza had at the agency back in the 1980s.
Securing the funds
“To address Hacienda’s lack of funding for the much-needed technological upgrades, we were able to allocate $37 million over a four-year period. It was $3.5 million the first fiscal year, with the amount increasing over the following years. I believe there were $5 million allocated for the second year,” Pizarro commented to Caribbean Business.
Most of the $37 million went into developing SURI, the Spanish acronym for the Internal Revenue Unified System. SURI is a new Windows-based system that integrates and manages, in a single platform, nearly 20 types of taxes paid by businesses and individual taxpayers. It became operational in April.
In essence, Pizarro said SURI will replace Prida, Hacienda’s archaic tax administration system that dates back to the 1980s. Prida is made up of several different modules with little or no communication between them, causing problems not only for Hacienda, but also for taxpayers as well when confronted with tax issues.
Eventually all tax modules will fully migrate to SURI, starting with the IVU in October, followed by the excise tax, corporate income tax and the individual income tax.
Hacienda estimates that SURI, slated to be fully implemented by 2018, should bring in an additional $150 million a year in tax revenues to the agency.
PICO, IVU-Loto and tax stamps
The first step in overhauling Hacienda’s tax collection efforts through technology came nearly two years ago when the agency implemented the Integrated Merchant Portal, a new computerized system known as PICO by its Spanish acronym.
Through PICO, importers and merchants at the ports are able to make their IVU payments and file their monthly statements. While PICO was originally designed for the proposed value-added tax system, now dead, it will continue to process the IVU at the ports, Pizarro indicated.
When Pizarro began working at Hacienda last year, he found unprocessed IVU tax forms that were filed by hand. So, when the agency finished processing all those IVU tax forms, it transitioned to the compulsory electronic tax forms through PICO.
“That brought in efficiencies, as it reduced the money we were investing in processing the IVU tax forms by hand,” Pizarro indicated. “This also helped us keep our records up-to-date and become more efficient.”
Late last year the agency eliminated the IVU-Loto, a free lotto drawing printed on the merchants’ receipts, aimed at increasing IVU compliance and collections.
The idea behind the IVU-Loto—implemented during the Luis Fortuño administration—was to get shoppers to ask for their receipts with the hope of winning the free lottery and at the same time, ensure merchants were both collecting and remitting the IVU tax to Treasury.
“In the aggregate, we were paying $30 million a year for the IVU-Loto terminals and the software and telecommunications companies. We eliminated that service, leaving only the terminals, saving $10 million annually. The efficiencies generated were used to make investments in other areas we understood were more important than the IVU-Loto,” Pizarro said. “There wasn’t much that we could do with the very little information the IVU-Loto was generating.”
Another area in which the agency was able to generate efficiencies and cost savings was through the conversion of the tax-stamp payment method from paper to electronic form. Now that the system is electronic, Pizarro said there is more transparency and visibility as to how many stamps are sold versus the revenue these generated.
“Previously, we didn’t know how many tax stamps were sold, and the money from these didn’t arrive to Hacienda immediately. There was a third party, a provider that managed the system that charged between 3% and 5%, which kept the sales money and didn’t remit it until several weeks or a month later,” the deputy Treasury secretary said. “Now we have more visibility and it costs us less, which is another savings we redirected to other more effective activities in the agency.”
Doing more with less
Hacienda, like other government agencies, has not been exempt from the impact of legislation enacted over the past several years to lay off, freeze vacant positions and offer early retirement packages to public employees.
As a consequence, Treasury has had to learn to do “more with less,” having to become more efficient, Pizarro indicated, adding he would love to have more staff at the agency.
One example of doing more with less is the agency’s move from paper to electronic individual income-tax filing this year, which unlike being voluntary in the past, is now mandatory for most taxpayers.
For tax year 2015, which was due April 15 of this year, Hacienda received a total of 908,932 individual income tax forms, of which 875,540, or 96.43%, were filed electronically, while another 33,392 were filed on paper, or just 3.57% of the total.
“We estimate this year we are saving 1 million [work]-hours just by transitioning from paper to electronic individual income-tax filing. With the transition, the average processing time of an individual income-tax return went down from 73 days to three,” Pizarro pointed out.
However, given the government’s dire fiscal situation, taxpayers will not get their tax refunds right away, as it will be dependent on the government’s cash-flow situation, he stressed.
As of June 3, Hacienda had so far paid out 96,914 individual income-tax returns, amounting to more than $7.9 million.
“Many individual income-tax returns are ready for issuing the tax-return checks, but we are waiting for the funds to come available. The vast majority of the individual income-tax forms have been processed, but some have a mathematical error situation or are waiting for some type of additional information to corroborate a charitable contribution or other tax credit,” Pizarro said.
Mathematical errors to increase significantly
While it may sound contradictory, Pizarro indicated that with the electronic filing of the individual income-tax returns, the number of mathematical errors should increase significantly.
“A mathematical error can occur for two main reasons. The first is the typical one, where the taxpayer or tax preparer made a mistake entering the data. Those can cause a mathematical error,” he noted.
The second reason for errors has to do with the informative
returns, which began to be filed electronically for the first time last year. The informative returns’ information can now be matched with the information on the taxpayers’ electronic tax form.
“Informative returns from conduit entities such as special societies, LLCs and trusts, as well as those from mortgage interest are now filed electronically. This allows us to do a match against the taxpayers’ income-tax form and if there’s some unreported income, we will know immediately, as this sends a notice of a mathematical error,” Pizarro explained.
A mathematical error does not necessarily mean there is a problem with the electronic tax-form software or with the sum; it just means an unreported income, Pizarro said.
Eventually, Hacienda hopes the system auto-populates the information received from the taxpayer’s employer, bank or any other entity that has issued an informative return and matches it against his or her tax form. Pizarro estimates that should happen in the next tax cycles.
“Now that we receive the information from the informative returns electronically, we are going to investigate better what the taxpayer filed in the system. So every time there’s an unreported income, we will notify a mathematical error,” he commented.
Last year, Hacienda began to digitalize the informative returns, and this year with the electronic individual income-tax forms, Pizarro said the agency has experienced a greater volume of mathematical errors, but he sees it as a good thing because all taxpayers now know the agency is on the lookout to make sure they include all their income in the income-tax forms.
Through Hacienda’s colecturía virtual, or virtual tax center, located on the agency’s main webpage, hacienda.gobierno.pr, taxpayers can now access all their informative returns and therefore can avoid the so-called mathematical errors, Pizarro noted.
Purging Hacienda’s database, dealing with wrong addresses
For years, one of the biggest complaints from taxpayers has been Hacienda’s inaccuracies with its records, especially those having to do with tax debts.
“When I started working at Hacienda last year, I noticed there was no area or division in charge of purging or cleaning up our tax-debt records. That’s why we saw the debt records kept increasing at the agency, and no one was checking if that growing debt was real,” Pizarro recalled. “We created a new debt purging division, which is constantly cleaning up the information to update tax records.”
The division has a staff of seven employees, and while they started working not too long ago, Pizarro insists it is already bearing fruit. In fact, a few days after the division’s staff began working, he sat down with them, and the group was able to write off $150 million in debt from the agency’s books in about three hours.
“There were errors in processing payments that were in the system, but applied erroneously, creating a debt that didn’t exist. Certainly this is a project that has barely started and there’s a debt that has been accumulating for decades, but we will be refreshing and shrinking that number,” Pizarro said.
Another complaint from both Hacienda and taxpayers has been the errors with mailing addresses, which in many cases hinder communications efforts, causing the agency to delay or not deliver a tax-return check, a debt or mathematical error notification, he said.
“We acquired the same software program the U.S. Postal Service uses, and when someone writes or enters an address incorrectly, the system reorganizes it in the format used by the post office. That process takes days, not weeks, until the address is corrected,” Pizarro said.
As for other types of human errors when entering information such as Social Security numbers or adding totals when filing the individual income-tax form, those mistakes should become less frequent with the electronic filing, the deputy Treasury secretary said.
Embargoes of businesses getting results
When Zaragoza began duties as Treasury secretary in late 2014, he was adamant about boosting the agency’s tax-collection efforts, given the government’s dire fiscal and debt situation.
Last November, Zaragoza began a series of embargoes on local businesses that charged and collected the IVU from customers, but did not remit the funds to the agency.
As of June 3, Hacienda has delivered embargo notices to a total of 109 businesses, of which 60% had filed for Chapter 11 (reorganization) bankruptcy protection. The businesses have 30 days to pay the due tax, or risk having their properties seized and sold.
At the same time, Zaragoza has publicly stated the agency will be going after churches and other nonprofit organizations, to make sure they are not evading taxes by taking advantage of their tax-exempt status.
“The business embargoes have been conducted on a constant basis, every week, since they began in November. I believe it’s the most invasive action by Hacienda, and we invite all taxpayers owing taxes to come forward and identify whatever tools are available to them to comply with their responsibility and avoid the embargo,” Pizarro indicated.
As for those who claim the embargoes hurt the economy, the deputy Treasury secretary said that in this recessionary economy, you cannot have two businesses competing in the same market with vastly different conditions.
“You can’t have a restaurant that does not forward the IVU collections, competing in the same market with a restaurant that does, because that’s an unfair business advantage. In that sense, what we want is for everyone to comply with their tax responsibilities and compete on a level playing field,” Pizarro said. “This bodes well for a healthy business environment.”
In his view, the embargoes have been effective because many businesses that owe the IVU collections to Hacienda have come forward voluntarily to pay their tax debt in its entirety, to avoid being embargoed.
Treasury, using a new methodology the agency claims is more accurate, has calculated that the IVU’s overall collection rate has improved to 63.7% in 2015.
The tax-collection rate in the merchandise sector was 74.3%, while the service sector only registered a 43.5% rate. Taking into account Treasury’s goal to achieve an 80% capture level, the agency estimated the government loses around $300 million a year in tax revenues.
In 2012, the overall level of IVU collections in Puerto Rico was 55.6%. The collection rate for merchandise was 63.3%, while the level in the services area was 41.6%.
Moving in the right direction
Kenneth Rivera, former Society of CPAs president and partner at local accounting firm FPV & Galíndez PSC, said that most people like the idea of using more technology to process tax returns and it appears the agency is taking the steps in the right direction.
“From the statements they have made regarding the new system,
it will take a few years for the new system to be fully operational. The first obstacle is that future administrations must recognize the importance of this initiative and that it is properly finished,” Rivera told Caribbean Business.
In the end, he said the system should completely integrate the processing of all returns that Treasury handles (income tax, payroll, IVU, excise, beverages, estate taxes and gift taxes), including all relevant financial information.
“The level of service the agency delivers to residents must be
improved, particularly speeding up the processing of returns and making them easier to file, as well as having fewer incorrect tax deficiencies and providing the capability to follow up on requests,” Rivera said.
Treasury is one of the government agencies that collects the most economic information on the island, and such intelligence is very valuable in making political and fiscal decisions. However, the current system is not robust enough in gathering and analyzing such data, he noted.
“This information could be used at the government level to make decisions such as granting exemptions or tax credits. In addition, the information could be made available for a fee to the private sector, obviously in a way that protects the confidentiality of taxpayers,” Rivera indicated.
More needs to be done to curb tax loopholes
While Hacienda’s recent initiatives to modernize its operations are all welcome and way overdue, local economist José Joaquín Villamil, chairman of Estudios Técnicos Inc., said some issues still need to be addressed that go beyond these measures.
“The fiscal problem won’t be resolved by improving technology or by going after small fry that evade taxes, although they, as all businesses, have to comply with the law,” Villamil told Caribbean Business. “When dealing with taxes and shortfalls in collections there are two major concerns. One is, of course, evasion such as has been in the news lately with Hacienda’s business embargo media campaign.”
In his view there is not much to be gained in terms of collections with the business embargo approach, as Zaragoza has indicated the main purpose of the campaign is to stimulate firms to come forward and pay up.
“The main problem and where there is a much greater amount of uncollected taxes isn’t evasion, but avoidance, that is, finding loopholes in tax laws that permit firms to get away legally with not paying taxes. Finding these loopholes and minimizing taxes paid by their clients is what tax lawyers and accountants do, nothing illegal or unethical in this, but the state has the responsibility of closing these loopholes. The reason is that, to the extent they exist, the burden of paying for government services is distributed among a smaller group of taxpayers,” Villamil said, adding one of those tax loopholes is transfer pricing.
There are other mechanisms for profit shifting and avoiding taxes in a specific jurisdiction, such as “home office charges” and other means of shifting profits through accounting practices, he added.
“It’s important to mention that economic or tax incentives are a useful economic development tools, but constant monitoring is necessary to assure that the benefit-cost relationship is positive for the country or region. What is patently wrong is to offer tax or other incentives to activities that don’t generate economic development or displace other providers of similar goods or services. In a zero-sum economy like ours, this applies to the big box and chain retailers,” Villamil commented.