Chile seeks to modernise its tax system
Chile plans to overhaul its tax regime by amending corporate income tax provisions, capital gains tax rules, permanent establishment provisions and introduce a digital services tax. Sandra Benedetto and Gregorio Martínez of PwC Chile explain the changes.
Chile's government presented the Tax Modernisation Bill (Proyecto de Modernización Tributaria) on August 23, 2018. The bill introduces a series of modifications, seeking to simplify the Chilean income tax system and incorporate new tax regulations.
In order for the Tax Bill to be passed, Chilean law requires that it be approved by Parliament (Chamber of Representatives and Senate) and published in the Chilean Official Gazette.
The Tax Bill is set to enter into force, in general, on January 1 2019, but provides several specific entry into force rules. However, it is expected that this effective date date will be revisited with further legislative discussion.
Although there is no clear term in which the Tax Bill will be approved, it will mostly depend on the discussions held between the government and opposing parties, which were resumed on March 6. Bearing in mind that there is no common understanding on key points yet, it is expected that this will be a tangled process. The key tenants of the bill as it stands are discussed below.
Integration of the income tax regime
Previous tax reforms in Chile (Laws 20,780 and 20,899) had established two income tax regimes, with one attributed and the other partially integrated, to be applied by entities that are domiciled or resident in Chile, and their respective quota or shareholders.
The different tax regimes mostly impact:
The rate of first category tax (i.e. corporate tax) that should be applied
The moment when the income must be recognised by the quota or shareholders; and
The corporate tax credit available for quota or shareholders (fully integrated vs partially integrated).
This will amend rules under the income tax system that can impose a 44.45% effective tax rate (ETR) for quota or shareholders with no residence in Chile or residing in a country with which Chile has no double tax treaty in force, or 35%, otherwise.
The Tax Bill seeks to redesign the income tax regime and fully integrate it, creating a single tax system for all taxpayers subject to corporate income tax. Under the new regime, companies will annually pay taxes over their net taxable income at a rate of 27%. Final taxes will only apply for quota or shareholders when the distributions are paid, and the corporate tax paid by the company will be fully creditable against final taxes.
Finally, the different registries that companies must keep are simplified in order to make tax compliance easier.
As of today, individuals without domicile or residence in the country that obtains capital gains derived from the alienation or transfer of shares or quota rights of Chilean companies are subject to anadditional tax (i.e. Chilean withholding tax) at a rate of 35%, which is calculated over an accrued or perceived basis at the taxpayer election.
The Tax Bill seeks to establish a 20% sole tax over capital gains obtained by individuals without residence or domicile in the country, triggered over a perceived basis.
Companies need to reorganise their tax compliance toolkits ahead of the Chilean Tax Modernisation Bill entering into force
Deductibility of expenses
The Tax Bill seeks to update the regime established for deducting the expenses incurred by Chilean entities, and would modify the current requirements in order to incorporate the economic realities of businesses within the expense deductibility rules.
The Chilean Income Tax Law requires , among other rules, that expenses are directly linked to income generated, to be deductible. Payments that do not comply with such requirements could be considered as rejected expenses and be subject to a sole penalty tax, even if they are mandatory for the company (for example, payments for contractual fines or non-compete payments).
The latter is a consequence of a formal and strict application of the Chilean Income Tax Law provisions on expenses by Chile's Internal Revenue Service (IRS).
The government's proposal re-defines the above concept and lists the requirements in the Chilean Income Tax Law, establishing that expenses can be deducted as long as they are directly or indirectly related to the company's business, which can be ordinary, extraordinary, common, exceptional, voluntary or mandatory, provided the amount is deemed reasonable.
Deductibility of royalty payments to related parties abroad
Chilean Income Tax law also states that royalty payments made to related parties abroad can be deducted from the net taxable income, but capped at 4% of the gross revenue for sales and services in the relevant calendar year. The government's proposal seeks to eliminate such a limit.
Chilean Income Tax law does not provide a permanent establishment (PE) definition. In order to determine if a foreign entity has a PE, taxpayers must apply the guidelines provided by Chile's IRS on this matter.
The Tax Bill would incorporate a provision in line with the OECD guidelines which would consider a PE to exist in situations where a location is utilised to perform permanently or habitually all or part of a business or activity of an individual or entity without residence or domicile in Chile.
Also, a PE would be deemed to exist when a foreign individual or entity performs its activity in the country through a representative who habitually closes agreements related to the business of the foreigner, or has a key role in the closing of the agreements, or negotiates key parts of the agreements which is not modified by the foreigner.
Credits for taxes paid abroad
The Tax Bill would reorganise the provisions regarding credits for taxes paid abroad, simplifying its wording and ordering the scattered legislation in only one provision. This includes a detailed list of income which foreign taxes can be credited against in Chile, as follows:
Income for the utilisation of intangible assets:
Income for the provision of professional or technical services:
Income related to a PE of a Chilean entity;
Income derived from a controlled foreign corporation; and
Income originated in a country with which Chile has a double tax treaty.
Furthermore, the maximum credit available for treaty and non-treaty countries is matched at 35% (today it is 32% in the case of non-treaty countries).
Withholding rate on interest
The Tax Bill seeks to introduce the concept of "final beneficiary", limiting the application of the 4% reduced additional tax rate on interest payments to foreign banks, insurance companies, foreign pension funds, or foreign financial institutions in case the final beneficiary of the interest is not one of those entities, as in the case of a back-to-back loan.
Thin cap rules
If a loan is guaranteed by a third party, the interest paid is deemed as a payment to a related party, unless the loan is guaranteed by a third party that charges a market price fee for such a service. However, the Tax Bill would change this relationship rule.
The new provisions set forth that an interest payment is considered to be made to a related party when the financing is granted with a direct or indirect guarantee provided by a related party of the debtor, as long as the related-party guarantor is domiciled or a resident abroad, and is the final beneficiary of the interest.
Fixed asset VAT refunds
Chilean VAT law allows taxpayers to request a cash refund for VAT credits accumulated for six or more months that were originated due to the acquisition of fixed assets. This request must be filed before Chile's IRS, which has a 60-day term to resolve it.
The Tax Bill seeks to lower the above-mentioned term in order to make it faster for the taxpayers to obtain the VAT refund. As such, VAT credits only have to be accumulated for two months, and Chile's IRS would have only five days to issue a decision, unless it informs the taxpayer that an audit process will be started.
Also, it would be expressly recognised by law that fixed assets under construction entitle the taxpayer to request a VAT refund, a matter that has only been resolved in an administrative arena to date.
Chilean VAT law notes that payments subject to additional tax will be exempt of VAT, as long as they are not provided in Chile and are not exempt from additional tax due to a domestic law or a double tax treaty.
The above exemption benefits standardised software as Chile's IRS has understood that it is utilised in Chile, but provided abroad, which means that it is exempted from additional tax and VAT.
The Tax Bill seeks to modify this VAT exemption so that taxpayers wanting to benefit from it must be providing foreign services exclusively, thus services must not be rendered nor utilised within the country.
The latter will directly affect standardised software that would be subject to a 19% VAT rate. Business profits under a double tax treaty could also be affected by this modification.
Digital services tax
The Tax Bill seeks to introduce a digital services tax (DST) that will be applied as a specific, indirect and sole tax to digital services offered by foreign entities or individuals to Chilean individual users.
The DST will be applied at a 10% rate over the gross amount paid by the user. The Tax Bill defines digital services as:
Remunerated digital intermediation services;
Remunerated digital entertainment services;
Foreign marketing services;
Use and subscription on platforms of internet-based technological services; and
Data storage services.
Under the proposed Tax Bill, even though the foreign entity or individual will be considered as the taxpayer, the withholding agent in this case will be the electronic payment issuer.
Where services are paid in cash, the foreign entity will be obliged to inform its operations to Chile's IRS, and declare and pay the relevant tax. A registry of digital service providers will be created for the withholding agents to rely on.
Sandra Benedetto Back
Tel: +56-2 29400155
Sandra has a Bachelor's degree in law from the Universidad de Chile, and holds a Master's degree in Law and a Certificate on International Taxation (ITP) from Harvard University.
Sandra joined PwC Chile in 2005 and is currently a partner of the Firm. Previously, Sandra worked in the Chilean Internal Revenue Service at the International Taxation Department, and was involved in the negotiation of several double tax conventions.
Sandra has developed her career on tax consulting with a strong practice in international taxation. Sandra has provided tax consulting services to a broad range of foreign and domestic clients, including cross border restructuring projects, intercompany operations, day to day tax advisory, due diligence and sale/acquisition of target structures, among others.
Furthermore, she is currently president of the Chilean Branch of the International Fiscal Association. She also gives lecture at different post graduate programmes.
Gregorio Martínez Galarza
Tel: +56 2 29400633
Gregorio is a law graduate from the Universidad Católica de Chile, and has a LLM degree in tax from the Universidad de Chile.
He joined PwC in March 2013 and is currently a manager of the Tax & Legal Department, where he is involved in several tax and legal projects focusing on multinational corporations and foreign investors.
Gregorio also collaborates with the transfer pricing team of the firm, participating in the major APAs, MAPs and Corresponding Adjustment processes with the local tax authority.
He also advises local clients directly in new business organisations, the incorporation of companies, and drafting of legal documents and agreements.