Chile: Chilean tax reform – Where are we now? Proposed changes in light of international businesses and Chile’s tax treaties
On April 1 2014, Chile's executive branch sent a tax reform Bill to the Chilean Congress, with the aim of increasing tax revenues to finance public education. The Bill contained substantial amendments to the Chilean tax system resulting in the most significant tax debate in Chile for the past 30 years. Within the context of international businesses, the following suggested amendments brought the attention of both local and foreign practitioners: (i) gradual increase of the corporate tax rate from 20% to 25% over a four-year period; (ii) change in the basis of taxation for foreign shareholders from a cash to an attribution basis – 35% withholding tax regardless of whether effective distributions are made with a credit for the underlying 25% corporate tax paid; (iii) harmonisation of capital gains taxation in hands of foreign shareholders at a 35% rate; (iv) non-deductibility of interest expenses related to the acquisition of shares or quotas; and, (v) the introduction of a controlled foreign corporation (CFC) regime.
Even though the tax reform was approved by the House of Representatives, the discussion on the constitutionality of some proposed provisions and potential adverse tax consequences for both local and foreign investments derived into a 'protocol of agreement' signed on July 8 2014, between the executive branch and the Chilean Senate's Finance Commission including representatives of different political parties, where guidelines and areas to be amended were agreed.
The most significant change proposed by such protocol, which was a political agreement with no binding effect, was to keep the attributed mechanism as one taxing alternative and to maintain the existing integrated income tax system (where taxation at a 35% rate is applied on dividend distributions on a cash basis with the right to recognise a credit for the tax already paid at the corporate level) but with two relevant modifications: (i) the increase of the corporate tax rate from the current 20% to 27%; and (ii) to recognise only 65% of the corporate tax as a credit against the final 35% withholding tax.
This alternative mechanism, as proposed, could have adverse implications from a Chilean tax treaty perspective.
Indeed, the Chilean integrated tax system motivated Chile to negotiate for a specific clause in all of its tax treaties under which no treaty relief is granted for dividends distributed from Chile to abroad to the extent the corporate tax is fully creditable against 35% withholding tax or the effective tax rate exceeds 42% (wording may vary from treaty to treaty). If that is the case, the relevant authorities may be required to renegotiate to balance the allocation of taxing rights.
In addition, depending on the mechanics of computation, this alternative system could lead into an effective rate exceeding the mentioned 42% threshold.
The discussion on this was installed and was expected to be rectified in the new package of amendments to the tax reform Bill which was finally released on August 9 2014; where this and other important adjustments to the tax Bill were made.
In fact, the discussion on Chile's tax treaty policy fructified and the new amendments released included a full credit mechanism in the case of treaty residents. Therefore, if the law is enacted as proposed, taxation on dividends for treaty jurisdictions would become a real benefit compared with the 35% withholding tax with partial credit that would remain for non-treaty jurisdictions, resulting in an effective rate of 44.45%.
Besides the above, the harmonisation of the capital gains tax rate at 35% for foreign shareholders (now 35% or 20%) calls for a revision of the existing tax treaties Chile has in force, as in some cases a 16% maximum rate is established for substantial ownership.
Finally, it is worth mentioning that, as agreed in the protocol, the new amendments released repealed the limitation on interest deductibility. Also, CFC rules were maintained with some amendments from which we could highlight broader rules for foreign tax credit in case of treaty jurisdictions or where there is an exchange of information agreement in force with Chile. In addition the threshold for being deemed a preferential tax regime for CFC purposes was raised.
The amendments released on August 9 2014 represented a milestone in the process of approving the tax reform Bill. We will continue monitoring how discussions evolve in the Senate along with the real impact the new regulations may have for foreign investors and, in particular, for the application of Chile's tax treaties.
Mauricio Valenzuela (email@example.com)
Tel: +1 646 471 7323
Sandra Benedetto (firstname.lastname@example.org)
Tel: +562 29400155