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Chile: A new concept of deductible expenses

A mere change in profitability will not, of itself, justify an exit charge

The tax authority under a formal and strict application of such criterion has rejected expenses that were perfectly reasonable from a business perspective.

In August, the Chilean government submitted to Congress a new Bill aimed at modernising the existing tax system.

One of the proposals is to amend the general requirements for an expense to be considered as tax deductible, and to introduce the new concept of special tax deductible expenses cases.

As per legislation already in force, an expense will be tax deductible provided that:

  • it is related to the business of the company;

  • it is necessary to produce taxable income;

  • it has not been deducted as part of the direct cost of goods or services of the company;

  • it is actually incurred in the relevant taxable period; and

  • it is adequately supported with appropriate documentation.

Expenses that fail to comply with the above requirements would be subject in principle to a 40% fine tax (rejected expense tax).

Even though the requirements for an expense to be tax deductible are included in the law, the practical implications of that provision derived mainly from the Chilean Internal Revenue Service (Chilean IRS) and the Chilean courts through their jurisprudence. For instance, the tax authority has construed that in order for an expense to be considered as 'necessary to produce income', it must be directly linked with the production of income, in the sense that it is mandatory/indispensable and that it cannot be avoided by the company.

The tax authority under a formal and strict application of such criterion has rejected expenses that were perfectly reasonable from a business perspective. For instance, the tax authority has defined that contractual fines would not be tax deductible as they are not indispensable or mandatory to produce income (even though they could be legally binding under a contractual arrangement) and could be avoided if the taxpayer properly complied with its contractual obligations.

Indeed, an update of Chilean tax legislation on this matter is urgently needed to provide a much clearer and reasonable legal framework for the deductibility of expenses.

The new Bill opens up discussion around this issue. According to the new requirements, an expense will be tax deductible provided it:

  • Is directly or indirectly linked to the business, including ordinary, extraordinary, habitual, exceptional, voluntary or obligatory expenses;

  • Is reasonable with respect to its amount;

  • Has not been deducted as cost;

  • Was actually incurred in the relevant taxable period;

  • Has a lawful cause and did not originate in malicious behaviour; and

  • Is adequately supported with appropriate documentation.

It will be interesting to see the Chilean Congress' position on this proposal. Furthermore, if passed in such terms, it will also be interesting to observe the tax authority's interpretation of the new requirements, particularly in reference to lawful cause or malicious behaviour concepts, which are more related to civil and criminal law and are not properly adapted for tax purposes.

The Bill is still in its early stages in Congress, and we expect an important discussion to be held around this and other topics covered therein. It is without a doubt a matter to be closely monitored in the following months.

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