In general, in the absence of a specific distributive rule dealing with services rendered by an enterprise, service fees fall into article 7 of the DTCs and are taxed accordingly (taxation solely in the residence state, unless services are performed through a permanent establishment in state of source).

In Ruling 191, issued on January 29 2010, the Chilean IRS analysed a situation where a Mexican company undertook to perform database services to a Chilean company. The Mexican company did not have sufficient human and material means to perform the services, reason why, they were subcontracted to a Colombian company. The activities performed by the Mexican company were limited to lower importance coordination, supervision, reporting and invoicing activities.

In the mentioned ruling, the IRS interpreted that the payments made to the Mexican company could not be considered business profits, as it did not have material or human means to perform database services, restricting the application of article 7 to the payments made in connection with the services effectively performed by it.

Accordingly, the IRS understood that the fees related to database services being subcontracted should be taxable in Chile without limitations, either because they were subject to article 21 of the relevant DTC (article 21 of the Chilean DTCs deviate from the OECD model, allowing unrestricted source taxation) or because they should be considered income derived by a resident of Colombia (at that opportunity, the Chile-Colombia DTC was not yet in force). To the moment, no other rulings have been issued by the IRS in the matter; reason why the principle established in 2010 seems to remain unchanged.

It is not clear from the ruling if such position should also be applicable to cases where only a small part of the services is being subcontracted. If one understands the ruling in a straight forward manner, it could be concluded that article 7 will never apply to income referring to subcontracted services, even if the major part of the services is performed by the contractor. However, it could be considered that the position adopted by the IRS was motivated by the factual situation analysed in the ruling, where the activities performed by the Mexican company were irrelevant in the context of the service being provided. In this regard, it is possible that a more flexible criterion is established upon the analysis of situations where the contractor has a more active participation in the performance of the service.

From these authors' point of view, there are arguments to discuss the criterion adopted by the IRS. Firstly, it appears that the IRS is applying a type of beneficial ownership requirement to article 7 even if none of the DTCs signed by Chile (nor the OECD model) provide for such a requirement. This is made clear when the ruling mentions that, either article 21 of Chile-Mexico DTC should be applied or it should be understood that the income is derived by a resident of Colombia. Secondly, the OECD seems to have accepted that business profits include income from subcontracted activities in its commentaries to the OECD model (comm. 19 to article 5(3)), which determine that the period spent by a subcontractor in the building site shall be considered as time spent by the general contractor, for the purposes of configuration of a project permanent establishment.

Astrid Schudeck (astrid.schudeck@cl.pwc.com) & Adriana Zaidan (adriana.zaidan@cl.pwc.com)
PwC
Tel: +56 2 940 0155
Fax: +56 2 940 0588
Website: www.pwc.com/cl