Chilean tax reform and the effects of the change of domicile of foreign investors
Roberto Carlos Rivas and Josefina Casals of PwC Chile assess the Chilean Government’s progress in implementing the 2014 tax reform package, reflecting on how certain provisions are impacting foreign investors and looking ahead to see how these measures will sit alongside the implementation of base erosion and profit shifting (BEPS) related measures
In 2014, the Chilean Parliament began the enactment of an ambitious tax reform that changes the features of the country's taxation structure. Among other aspects, this reform eliminates the existing taxation method, establishing two co-existing income tax regimes; gradually increases the corporate tax (first category tax (FCT)) rate (from 20% to up to 27% in 2018); and incorporates the controlled foreign corporation (CFC) rules, a general anti-avoidance rule (GAAR), and new thin capitalisation rules into legislation.
Until the end of 2016, Chilean taxation will be governed by the integrated tax system, where final taxpayers pay income tax upon distribution of profits materially received from the respective companies, with a full credit for the corporate tax paid at such level. However, starting on January 1 2017 two new tax systems will replace it:
a) Attributed income method, which automatically attributes certain type of income generated at the company level (with a full corporate tax credit if available) to the final taxpayer, regardless of an actual distribution of profits, and;
b) Partially-integrated system, similar to the current tax situation, that is, using the distribution-based method, but with a credit of only 65% of the corporate tax paid by the company.
This limitation is not applicable to taxpayers domiciled in a country with a double tax convention in force with Chile under certain conditions described below (article 63, Income Tax Law); should those requirements be fulfilled the income tax rate will remain at 35%, whereas for other foreign taxpayers the effective rate will increase to 44.45% in 2018.
The complexity of this tax reform has caused the local Internal Revenue Service to issue several –and often controversial – rulings to construe a formal interpretation of some of its aspects, increasing the sense of uncertainty among the local industry, tax advisers, and foreign investors. For this reason, the government already announced a new Bill to clarify and simplify key features of the reform before they come into force.
What is clear at this point is that from 2017 onwards it will be different tax treatments for foreign taxpayers under the partially-integrated system, depending on the jurisdiction of residence for tax purposes.
Requirements under the partially-integrated system for the preferred Additional Tax rate
According to article 63 of the Income Tax Law, the limitation set forth in the new partially-integrated system will not apply if:
a) Chile has a double tax convention in force with the respective country, whereby the contracting states have agreed the full application of the Chilean Additional Tax (AT) rate over dividends distributed by local companies as long as the corporate tax remains deductible from the former tax.
To date, every tax treaty signed by Chile contains the so called 'Chile Clause', which allows the application of the AT at its full rate upon distribution of dividends as long as the FCT is fully creditable from it.
b) The shareholder recipient of the distribution of dividends from the Chilean company is a resident of the respective country.
There is no special definition of the term 'resident' for the purposes of article 63 of the Income Tax Law. We understand that as long as the foreigner is considered as a resident according to the provisions of the relevant double tax convention, this requirement should be satisfied. Generally speaking, Chile's tax treaty network determines the residence status if the involved person is liable to tax by reason of its domicile or residence under the laws of the contracting state.
Effects of the change of domicile of a foreign corporation in Chile
In broad terms, changing the domicile of a corporation implies the cancellation of the registry in one country and a new registration in another foreign jurisdiction.
Our legislation does not provide for any specific legal or tax treatment in connection to the change of domicile of a foreign company that holds shares of a Chilean entity, either regarding the relocation of the place of incorporation, or the migration of the place of effective management and control.
From an administrative standpoint, the change of domicile has been accepted by the Chilean Internal Revenue Service, which has considered the new country of residence of a corporation as its tax domicile (Ruling No. 3531/2012); in this case, the new tax domicile of a second-tier subsidiary of a Chilean parent company was recognised for the purpose of using the foreign tax credit in our country.
However, recently the tax authority has stated its position about the change of tax residence of a foreign taxpayer for the specific application of the preferred AT rate provided in new article 63 of the Income Tax Law. In Ruling 1985/2015 the Chilean regulator accepts that if a company incorporated in a country that has no tax treaty with Chile changes its domicile to a jurisdiction with an in-force double tax convention, and it is considered a resident under the relevant treaty, the requirements set forth in article 63 should be satisfied. This is certainly positive news for the international community.
Regarding the Chilean tax effects of the change of domicile, the tax authority has considered that when a corporation is liquidated, and its shareholders receive assets located in Chile as a consequence of such liquidation, any capital gain derived from this transaction may be subject to taxes in our country. Therefore, the tax consequences in Chile would depend on the particular effects of the cancellation of the registration according to the relevant foreign jurisdiction, in terms of liquidation of the company and transfer of shares or interest of Chilean entities.
In the case of the migration of the place of effective management, our opinion is that such event would not trigger any taxable event in Chile, since no liquidation of the foreign corporation takes place.
It should be noted that some of the tax treaties signed by Chile contain a main purpose test rule that denies access to the benefits set forth in the convention if the main purpose or one of the main purposes is taking advantage of the preferred rates set forth in the corresponding treaty.
Moreover, the recent tax reform package incorporates a general anti-avoidance rule (GAAR) into the Chilean legislation, which allows the Internal Revenue Service to challenge acts performed by taxpayers if the authorities consider that they have entered into them to avoid taxable events under the domestic law, by means of abuse or simulation.
The existence of the abuse must be declared by a Tax Court upon the request of the Internal Revenue Service. If such a declaration is made, the taxpayer is obliged to pay the taxes that should have been paid in case the abuse or simulation has not taken place, plus interest and fines.
The GAAR applies to facts, acts, or business performed or concluded after September 30 2015. The tax authority unilaterally extended the application of this provision to such transactions that, though formally performed or concluded as acts, have not fully produced their tax effects, such as a lease contract, or a reorganisation process.
In consequence, the scope of application of the preferred rates of article 63 will require a detailed and careful analysis including other provisions under domestic law or tax treaties signed by our country.
Commentaries on Action 6 of the BEPS project
The base erosion and profit shifting (BEPS) project is led by the Organisation for Economic Co-operation and Development (OECD) and the G20 and is intended to ensure the allocation of profits generated by multinational enterprises in the jurisdiction of origin. For this purpose, there is a 15-point action plan established by the OECD which is aimed to be implemented in two years.
Action 6´s objective is to prevent the granting of treaty benefits in inappropriate circumstances, addressing treaty shopping and other treaty abuse cases, through the inclusion of certain anti-avoidance clauses in the OECD Double Tax Convention Model. Draft versions of Action 6 have been released for discussion, with the final document expected to be published in October 2015. Among other recommendations, the report includes clauses on limitation on benefits (LoB), principal purpose test (PPT), and on tie-breaker rules for dual resident corporations.
Implementation of these clauses into in-force tax treaties would be performed through a multilateral convention as provided in Action 15. However, it is not clear whether all the participating countries would agree on the wording of the referred anti-avoidance clauses as suggested in the Action 6 deliverable. In case of disagreement with Action 6 clause drafting, the implementation should be made under a bilateral basis. In any case, it is difficult to predict how long the execution of these changes would take.
Special attention should be given to the impact of the LoB clause and PPT in connection with the change of domicile of foreign corporations.
An LoB clause is already found in tax treaties concluded by the US, India, and Japan. According to the proposed LoB clause, although a person is considered a tax resident according to the relevant treaty, it may not be entitled to the benefits provided therein unless it is also considered as a 'qualified person'. The character of qualified person must be determined at the time the benefit would be accorded.
The proposed draft considered that a resident is a qualified person if it is: i) an individual; ii) a company listed in a recognised stock exchange of the relevant jurisdiction; iii) unlisted companies if at least 50% of their voting shares is held by qualified persons; iv) non-profit organisations; and v) a contracting state or a political subdivision, among others.
PPT limits the application of some benefits of the corresponding convention, if the only, or one of the main, objectives of a transaction was to take advantage of such treaty.
What is relevant here is that the drafting of Action 6 specifically addresses cases when a company engages in certain transactions to become a resident of a country with a double tax convention in order to obtain the benefits included in it. Though compliance with the requirements of article 63 of the Income Tax Law is a matter of the application of domestic law, it will be necessary to conduct a deeper analysis when both rules come into force, and once our tax regulator issues an official interpretation in this regard.
Domestic reforms and multilateral developments; the need for harmonisation
Access to the preferred tax treatment under the new partially-integrated system would depend not only on the fulfillment of the requirements set forth in the new article 63 of the Income Tax Law but also on its interaction with other provisions under Chilean domestic law and signed treaties. The harmonisation of this rule with the upcoming changes in the international tax arena through the BEPS project, and its interpretation by the Chilean Internal Revenue Service will, of course, be highly relevant and taxpayers will need to look at the potential need to realign structures for continuing compliance.
Roberto Carlos Rivas
Tel: +562 2940 0151
Roberto Carlos Rivas is a partner of the Tax and Legal Services department of PricewaterhouseCoopers Chile.
During 2001 and 2002 he obtained a master's degree in law, specialising in international taxation, from Leiden University, the Netherlands.
During 2002 and 2003 he was attached on a secondment to the International Taxation department of PricewaterhouseCoopers, Rotterdam, the Netherlands, taking active part in international tax planning projects concerning investments between Europe and Latin America.
He joined PricewaterhouseCoopers in April 1993 and he has also been assigned to PwC Buenos Aires. He is a transfer pricing expert.
Roberto is a member of the International Fiscal Association in Chile and he has written many articles on international tax matters. He has lectured on topics of international taxation at seminars taking place in Rotterdam, Amsterdam, Barcelona, Buenos Aires, Punta del Este and Santiago.
Tel: +56-2 2940 0152
Josefina is a supervisor at PwC Chile, with more than seven years of experience with the firm. Her tax practice includes consulting services in tax planning and reorganisations, financing structures, cross-border transactions, and analysis of corporate tax, customs and VAT issues.
In the legal field, Josefina has participated in due diligences of public and private companies, contract analysis and drafting, corporate secretarial affairs, and legal compliance for local and foreign clients. In the past, Josefina also held the position of in-house legal counsel, providing assistance in legal and corporate affairs, global governance, and regulatory matters within the firm.
Josefina holds a master's degree in law from New York University, USA (2013), and a bachelor's degree in law from Pontificia Universidad Catolica de Chile (2006). She also followed studies in tax planning and analysis at Pontificia Universidad Catolica de Chile (2011) and Universidad del Desarrollo (2010), Chile.