Chile: Additional withholding tax applicable to the forgiveness of interest
According to Article 59 No 1 of the Chilean Income Tax Law (ITL), interest remitted abroad is subject to additional withholding tax.
As withholding tax, the ITL states that this tax is accrued once the income is paid, credited to an account, accounted as an expense by the debtor, distributed, withdrawn, remitted or put at the creditor's disposal. Any of these events that occur first will determine the moment when the tax liability arises, the applicable tax rate, and its amount.
Since the taxpayer is a non-resident company, it is the Chilean payer who is held responsible for withholding, declaring and paying the withholding tax to the Chilean Treasury. Pursuant to article 74 No 4 of the ITL, the withholding should be done once the income has been paid, credited to an account, or when the income is distributed, withdrawn, remitted abroad, or put at the creditor's disposal. Thus, the sole accounting as an expense in the debtor's registers does not by itself trigger the obligation to withhold the tax.
The Chilean Internal Revenue Service (IRS) has interpreted that in case the obligation to pay interest abroad was also fulfilled by a means of extinguishing an obligation other than by payment, the additional withholding tax is triggered and must be withheld and paid by the Chilean debtor on behalf of the foreign creditor.
These interpretations were based on Article 2 No 3 of the ITL, which provides that an accrued income shall be understood as "earned", in case the obligation was extinguished by a means different from "payment".
Due to this provision, the IRS has argued that an income is "earned" not only when the obligation is materially paid, but also when it is offset, forgiven, substituted by another obligation, in case the parties of an obligation are merged in a sole person (confusion), or when it is extinguished as a consequence of the statute of limitations.
This criterion was usually applied by the Chilean IRS in case of capitalisation of interest, where the foreign creditor exchanged its credit for shares or quotas in the debtor's share capital. In these cases, it has been considered that there is a set-off of the obligation which is equivalent to a payment, and thus the creditor has to recognise a Chilean-sourced income subject to additional withholding tax.
We consider that the IRS had been interpreting this provision in terms that were too broad, since the above mentioned statute only states that an income should be deemed as earned once the obligation is fulfilled by a means different to a payment. However, the administrative jurisprudence has included some means of extinguishing obligations which do not truly entail the fulfillment of the obligation, as the case of forgiveness and the application of the statute of limitations.
More recently, the Chilean IRS, through Ruling No 1953, dated August 25 2011, has restricted the above mentioned interpretation, stating that in case of forgiveness of interest, which has been registered as an expense in the debtor's registers, the liability to withhold and pay the additional withholding tax is not applicable, since such exoneration cannot be considered as being equivalent to an effective payment for purposes of Article 74 No 4 of the ITL.
Moreover, the mentioned ruling considers that it should be understood that there is payment, not only when consideration is given as agreed, but also when the obligation is fulfilled by any alternative means to payment, such as offsetting, novation, confusion, or settlement.
Although this ruling was issued regarding a case of forgiveness of interest, in our opinion, the referred interpretation should equally be applicable to other obligations that are extinguished through means which do not imply an effective fulfillment of the obligation, e.g., as in the case of the statute of limitations.
In such a case, even though the liability is extinguished, there is no consideration that can imply that income has actually been earned by the creditor. In these cases, only the debtor will have to recognise an income.
Loreto Pelegrí Haro & Trinidad Fernández Gurruchaga
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