Chilean 2020 tax reform: Modernising the tax system
The Chilean government is embarking on a new tax reform in its latest bid to modernise the tax system. PwC Partner Loreto Pelegrí and PwC Tax Manager Bernardita Parodi explore the plans.
President Sebastian Piñera presented his last tax reform bill to the Chilean Congress in August 2018. The tax bill aimed to modernise the tax system, which had been significantly amended in 2014 and 2016, with the enactment of the 2014 tax reform and its simplification on 2016.
This bill included substantial changes to the domestic corporate tax regime and other important local tax rules, as well as significant tax changes to the Chilean international tax rules. The main purpose was achieving tax efficiency.
This bill was immediately questioned by the opposition political parties. Thus, its discussion in Congress was controversial and continuously delayed, consequently triggering several amendments.
By mid-October 2019, social demands, that in general terms aim to reach a greater equity among Chile's population, began to manifest with a surprising greater force, significantly changing the Chilean economic, social and political scenarios.
Due to these social manifestations, one of the first issues that the Chilean government addressed after October 18 was the tax reform to improve investment, protect and strengthen small- and medium-sized enterprises (SMEs), boost entrepreneurship and finance social demands.
In December 2019, the Piñera government and the Senate's Finance Committee reached a tax agreement which led to the approval of the tax reform by Congress on January 29 2020, and finally enacted as law on February 24 2020 (Law N° 21.210).
Law 21.210 does not contain several rules included in the initial bill that were controversial, such as tax-free international reorganisations, but does focus on SMEs and fund raising.
This new tax scenario that domestic and foreign taxpayers face needs to be carefully reviewed. It may be necessary to revise and adapt business structures and decisions according to this new tax framework.
Amendments and new rules
Income tax law
Corporate income tax
A unique corporate tax regime is established for large enterprises, repealing the attributed income tax system introduced by the 2014 tax reform. This tax regime, in force as of January 1 2020, is a partially integrated system that levies corporate income tax at a 27% rate.
It is known as the partially integrated system because it is possible to credit against final income taxes (global complementary tax and additional withholding tax). This means that only 65% of the corporate tax is paid at the entity level, unless the final taxpayer is resident in a country with which Chile has a double tax treaty (DTA), in which case the corporate tax may fully be credited against the final income taxes. Final taxes are applied on a cash basis.
Therefore, the Chilean total income tax burden for Chilean individuals or foreign investors not domiciled or resident in treaty countries is 44.45%. Meanwhile, foreign investors resident in treaty countries are subject to a total income tax burden of 35%.
The reason for this difference is the so-called 'Chilean clause' included in all tax treaties signed by Chile, which provides that if the corporate tax is not fully creditable and/or the total income tax burden exceeds 42%, the tax treaty needs to be revised by both contracting states or the reduced rate for dividends contained in the tax treaty becomes fully applicable.
The same treatment will apply to residents of countries with which Chile has a signed but not yet in force DTT, such as the US and the UAE, until 2026.
On the other hand, SMEs, which are those entities whose sales do not exceed $2.5 million approximately, are able to take advantage of a fully integrated system, being able to credit 100% of the corporate tax against final taxes, and their fully creditable corporate income tax rate is 25%. Relation rules are applicable for purposes of preventing tax avoidance using different corporate structures.
Tax rebates are gradually decreased and entirely repealed by 2024 under the tax reform. Normally, in Chile, corporate structures involve a holding company that holds operative companies and absorbs their tax losses, via the tax rebate system, which will be no longer available as of 2024.
Certain capital gain taxation issues that had not been established by law, but ruled by administrative regulations and jurisprudence, are now expressly provided in the law, and in force as of January 1 2020. For example:
Financial instruments' short sale – i.e. transfer within a repurchase agreement – is not considered as sale or exchange;
Stock options regulated in employment agreements and collective agreements will not be considered as income when granted or when the option is exercised. Taxation is applicable only when the shares are sold after the exercise of the option. On the contrary, when the stock option is not contained in an employment agreement, the granting of the option is not considered income, but its exercise is; and
A residual rule is established for the alienation of any other unregulated assets, thereby being applicable to the same rules as those that determine capital gains taxation in the sale or exchange of shares and quotas (social rights).
Concept of deductible expense
The concept of deductible expenses has remained almost immovable for more than 15 years. However, Law N° 21.210 revises this concept, including those expenses that have the 'ability' to generate income, regardless of whether the expense generates income in the future or not; and the expenses must relate to the business' interest, development or maintenance. Before, in order to be deductible, expenses had to generate income related to the business activities.
Review of certain expenses
Law 21.210 also revises a few specific expenses and eliminates or adds requirements to the corresponding expense. Summarising, the most relevant revised expenses are as follows:
Expenses in supermarkets and other similar markets: elimination of certain restrictions;
Interest arising from loans not related to the assets that could generate income: they are deductible if they comply with general deductible expense requirements;
Non-tradable merchandise costs may be deducted if it is delivered to non-for-profit entities;
Bad debt rules are made more flexible when the debtor is non-related and the debt has been due for more than 365 days, in which case the debt may be written off and deducted. This is the opposite of former rules, which were very strict and difficult to comply with;
Tax deduction of shareholder's remuneration who work for the company is allowed, to the extent reasonable. In addition, remunerations paid to the shareholder's spouse or civil partner or his/her children, will be deductible, if the same requirements are met;
Voluntary environmental expenses are deductible if they are established by the competent authority and with certain limits;
Disbursements or discounts imposed by the authority to compensate damage to customers or users, in a strict liability scenario, will be considered as expenses; and
Disbursements in judicial or extrajudicial transactions will also be deductible in an unrelated party scenario. This would include penalty clauses.
Individual income tax rates
The tax rate on taxes that are levied on individuals, i.e. employment tax and global complementary tax, has been revised and a new bracket of 40% is established for final taxes and employment tax, applicable to an annual income greater than UTA 310 ($216,000) and greater than UTM 310 ($18,000) monthly, respectively.
Actively traded securities
Due to taxpayer malpractices, the 'actively traded' concept established for certain securities has been reviewed and is now exclusively granted to a 'market maker' contract (i.e. a contract that ensures the existence of daily buying/selling operations), and capital gains derived from the sale of securities would not be subject to tax, only for one year from the first public offering.
International tax rules and other rules that are relevant for international considerations
An individual who remains in Chile for a period that in total exceeds 183 days within any 12-month term will be considered as a Chilean resident.
Definition of permanent establishment
Before the enactment of Law 21.210, permanent establishments were defined by Circular Letter N° 57 of 2017 and administrative jurisprudence. Now, the concept is contained in the income tax law, following the OECD's guidelines, establishing the hypothesis of a fixed place of business, the independent agent test, and excluding preparatory or auxiliary activities.
Foreign tax credit
The foreign tax credit's limit is equalised for treaty and non-treaty countries at a 35%.
Also, when a Chilean entity holds shares in another Chilean entity, through a foreign company, the withholding tax paid by the Chilean entity will be creditable.
Financing of investment and development of project rules
In this regard, according to Law 21.210, excess of indebtedness rules will not apply to financing that is guaranteed by a related third-party, if this is required by the creditor. Therefore, the tax rate could be reduced from 35% to 4% in these cases.
In addition, withholding tax on interest at a 4% rate is limited only to those cases in which the effective beneficiary is a bank or financial institution, limiting the application of the back-to-back structures.
In order to enhance this, new requirements have been established to qualify as a foreign financial institution by the Chilean Internal Revenue Service (IRS).
Separately, royalties on research and development (R&D) projects are not considered as passive income for controlled foreign corporation (CFC) rules purposes, if approved by the Corporación de Fomento de la Producción (CORFO), which is a public-sector organisation dedicated to promoting entrepreneurship, innovation and growth in Chile.
VAT on digital services
Digital services are now considered as subject to VAT at a rate of 19%.
The term digital services includes:
The intermediation of services provided in Chile, whatever its nature, or sales made in Chile or abroad, if they give rise to an import; and
The supply or delivery of digital entertainment content, such as videos, music, games or other similar content, through downloads, streaming or other technology, including for this purpose, texts, magazines, newspapers and books;
The provision of software, storage, platforms or IT infrastructure; and
Advertising, regardless of the means by which it is delivered, materialised or executed.
For purposes of applying these new rules, territoriality of services and reverse charge mechanism rules have been modified.
The Chilean Tax Code was also subject to numerous amendments:
An administrative complaint was introduced in case taxpayer's rights are infringed.
The concept of a business group and relation have been incorporated, following the rules of the Securities Market Law; and
Extrajudicial agreements between the Chilean IRS have been incorporated and regulated.
Substitute tax for the balance kept in the historical taxable profits ledger (FUT)
For purposes of raising funds by the Chilean Treasury, a sole tax that substitutes final taxes (global complementary tax or additional withholding tax) has been introduced and will be available until the last business day of April 2022.
Taxpayers who choose to apply this regime to the balance they keep of taxable profits generated until December 31 2016 will be able to enjoy a 30% tax on all or part of their FUT, being able to credit the corporate income tax paid for such profits, against this withholding tax.
It is not mandatory to withdraw the profits levied with this tax from the entity that generated them but they do have preference upon the withdrawal of funds.
Other significant introductions to the Chilean tax system include:
Municipal tax on investment: in order to avoid questioning investment companies receiving passive income to determine whether they are subject to this tax, Law 21.210 expressly states that they indeed are subject to municipal tax; and
Contribution for regional development: investment projects exceeding $10 million, which require authorisation from the Environmental Impact Assessment Service, as on the first fiscal year during which the project generates revenue, will need to pay a single amount of 1% of the cost value of the fixed assets involved in the project, on the amount that exceeds the aforementioned $10 million. However, projects destined to health development, educational, scientific, research or technological development activities among others, declared as such by the Finance Ministry, shall be exempt from this contribution.
In conclusion, the Chilean tax system has been reformed one more time, which will require taxpayers to review their situation and make decisions and changes to their business model, if necessary, to adjust their tax efficiency to this new tax framework.
Partner, tax consulting
T: +56 2 2940 0113
Loreto Pelegrí is a tax partner at PwC Chile, Santiago office. She is an admitted lawyer from the Pontifical Catholic University of Chile and gained a Master of Business Administration (MBA) qualification from the same university. She later studied at the School of Economics and Management, at Tsinghua University, in Beijing, China.
Loreto has more than 20 years of experience advising and consulting on tax and corporate matters to local, international and multinational companies, being part of the Chilean M&A group and international tax services.
She advises multinational companies investments in Chile and other countries with respect to tax advice, acquisitions, and tax operations in general.
Loreto has vast experience advising clients in diverse tax matters, including very important tax due diligence projects for a large number of companies in various sectors, as well as leading the development and implementation of international tax and legal structures.
She speaks fluent English and Spanish.
Manager – tax
T: +56 2 2940 0689
Bernardita Parodi is an admitted lawyer from Pontifical Catholic University of Chile and has a Master of Laws in international taxation from the University of Florida, US.
She is part of the tax and legal service department at PwC Chile, Santiago office.
Bernardita has more than 10 years of experience in tax and legal consulting services, assisting local, international and multinational clients on domestic and foreign tax and corporate matters.
She is fluent in English and Spanish.