Chile: Implementing the tax reform in full force
Sandra Benedetto and Jonatan Israel of PwC Chile explain why it is crucial for foreign investors to keep track of progress as Chile bids to modernise its tax system.
As COVID-19 took over the global agenda, most foreign investors in Chile were more preoccupied with the situation in their home countries, rather than continuing to focus on the impact that the latest Chilean tax reform would have on their interests in Chile. Since the tax reform was published in the Official Gazette on February 24, its timing was, to say the least, unfortunate. Therefore, and most reasonably, the obvious course of action was to put the topic on hold until the dust settled.
Bearing in mind that the general entry into force of the latest Chilean tax reform was March 1 2020, the Chilean Internal Revenue Service (Chilean IRS) has been issuing several circular letters and resolutions in order to provide general guidance and interpretation with respect to the tax and legal changes that are taking place.
As Europe and Asia are slowly transitioning back to normality, and the whole world is somehow learning to live in the post-pandemic environment, investors should pick up where they left off, and be aware of what aspects of the latest tax reform will impact their businesses in Chile; and to take action accordingly and timely. The positive note is that with the administrative guidance issued by the Chilean tax authorities, navigating through the updated provisions becomes easier in most cases.
In this article, the most relevant tax changes that affect foreign investors are highlighted: (i) the new provisional withholding for remittances to abroad; (ii) the gradual repeal of the provisional payment per absorbed profits; (iii) the transitory substitute tax on historic accumulated Fondo de Utilidades Tributarables (FUT) ledger; (iv) the transitory substitute tax for differences in the determination of tax equity, and; (v) the entry into force of the Chilean VAT on digital services. This focus will also address, where relevant, the administrative interpretation issued by the Chilean IRS.
New provisional withholding for remittances to abroad
The Chilean Income Tax Law establishes a withholding tax, the 'additional tax', which levies payments made by Chilean residents to individuals or entities without domicile nor residence in the country that derive Chilean source income (and certain foreign source income) at a general rate of 35% over the gross amount remitted to abroad. Dividends distributions to abroad are subject to a 35% additional tax rate. In general terms, the foreign taxpayer is allowed to deduct, either fully or partially, the corporate income tax paid at the level of the distributing entity.
Before 2020, the tax characterisation of the amount remitted to abroad – pursuant to dividends, remittances and withdrawals – was to be determined, in most cases, at the moment it occurred. This determination was made by applying the legal allocation order to such amount and reviewing to which tax record (i.e. taxable profits record, exempted profits record, etc.) the amount being remitted or distributed to abroad, should be allocated to.
These legal mechanics have been modified by the tax reform. In this sense, the tax characterisation of the remittance, therefore its allocation to the tax records of the company, will be determined at the end of the respective fiscal year in which it occurs. This legal change brings as a consequence, that any remittance, dividend distribution or withdrawal of funds to abroad will be considered provisional until the end of the commercial year it takes place. Therefore, no matter what amounts are registered in the tax records of the company that makes the distribution or remittance, a provisional withholding should be performed by the entity remitting the funds.
The legal mechanics also take into consideration that Chile has an integrated tax system as explained above (corporate tax paid as a credit against withholding taxes). Therefore the corporate income tax credit, the first category tax, needs to also be incorporated in determining the provisional withholding obligation. Accordingly, a restitution of the credit in the cases, the final taxpayer is only entitled to a 65% of the corporate income tax credit against its additional tax i.e. foreign taxpayer that is resident in a country without a double tax treaty in force with Chile.
In general terms, this computation of the provisional credit is done by grossing up the amount being remitted by an average equal to the rate of the corporate tax, in order to calculate the provisional withholding obligation. Another key aspect of focus is for Chilean investors who have interests abroad and allocate foreign tax credits in Chile derived from those investments. The Chilean IRS, in the draft circular letter subject to public consultation, is interpreting that in order to apply foreign tax credit to a provisional withholding, the foreign income subject to foreign taxes should already have been perceived by the Chilean taxpayer.
The bottom line, is that for foreign investors, mainly those who are resident or domiciled in a country that has not signed a double tax treaty with Chile, a cash flow analysis should be performed before any dividend distribution, remittance or withdrawal is performed at a Chilean level. This is because, since this provisional credit applies, it should be as close to the definitive one as possible to mitigate the financial impact derived from it.
Gradual repeal of the provisional payment for absorbed profits
Another aspect which has been highly commented upon is the gradual elimination of the provisional payment for absorbed profits mechanism (PPUA). The relevance of the PPUA was that Chilean tax law does not provide for a direct tax consolidation like many other jurisdictions do. Instead of that, Chilean tax law allowed for a corporate income tax refund mechanism, when profits received from subsidiaries, were absorbed by losses at the level of the recipient entity. The tax reform does not impact the allocation of its own losses nor the use of the corporate income tax credit, however, it does prevent taxpayers for obtaining a refund.
The normal way for foreign investors to structure debt financing is through a holding company in Chile, not solely because of the application of the PPUA mechanism, but also because this legal structure grants more corporate-wise flexibility.
This repeal is envisaged in phases and will be fully eliminated in 2024. Being an indirect tax consolidation mechanism, one of the core issues of this modification is that several foreign investments were structured considering these tax refund rules. However, provided that there is a four-year window in which the mechanism is reduced gradually, it is time to reassess future cashflows of Chilean investments and the financing structures that were set upon these rules, taking into account this change in the Chilean tax landscape.
The bottom line for foreign investors is to review their financial models that were designed considering the PPUA and to seek advice on whether changes can be done to address this issue.
Transitory substitute tax for accumulated profits in the FUT Ledger
Since the effective repeal of the accumulated historical taxable profits ledger (the FUT ledger) from January 1 2017, many companies have dragged in their tax records an accumulated amount of profits pending distribution that derive from previous years.
Considering the situation described above, the tax reform set forth a transitory regime to allow payers of corporate income tax to pay a single substitute tax, at a rate of 30%, over the amounts accumulated in their historical FUT ledger. The main benefit of paying this substitute tax is that once paid, the accumulated profits will be deducted from the income subject to tax ledger, and therefore, they will be considered as fully taxed. This means that these amounts can be withdrawn, remitted or distributed whenever the taxpayer deems appropriate with preference over any other amount and without considering the legal allocation order.
Moreover, these amounts are not subject to any withholding obligations set forth in Chilean tax law.
The Chilean IRS has already issued Circular Letter No. 43/2020, where it addresses the procedure for applying this benefit and provides sample calculations as a reference.
The bottom line for foreign investors is that they have three fiscal years – i.e. 2020, 2021, and 2022 (until the end of April) – to assess whether or not it is worth to pay these substitute tax and benefit from the transitory regime. The main consideration is to review whether or not the direct payment of the substitute tax, which in turn requires immediate cash, is worth the benefits attached to it. This conclusion seems to be always applicable for investors from non-double tax convention (DTC) countries since the total tax burden applicable is 44.45%.
Transitory substitute tax for differences in the determination of taxable equity
Taxable equity became a determining factor for income tax purposes when Chile opted to repeal the FUT ledger. However, the determination of the tax equity in some cases may show differences due to a number of reasons (e.g. wrong application of monetary correction, computation errors, reorganisation processes, among others).
Considering this, the tax reform included a substitute tax that allows taxpayers to address these differences voluntarily without an audit process, and therefore allows them to settle in advance. The changes mark an interesting alternative to address future contingencies and get further certainty.
The bottom line for foreign investors is that in the case that they are aware of any differences in the determination of their own taxable equity, it may be worth eliminating them by means of this substitute tax. This transitory regime is available for fiscal years 2020 and 2021, and therefore taxpayers have only one fiscal year to determine whether or not to opt for this substitute tax.
VAT rules on digital services
The Chilean IRS recently issued Circular Letter No. 42/2020 and Resolution No. 67/2020. Through both, the final guidance for the interpretation and implementation of the Chilean VAT is already available to the general public. As a brief reminder, Chilean VAT law was modified in order to include four special taxable events. These taxable events levy with Chilean VAT some services rendered by taxpayers that are not resident nor domiciled in Chile, and since some of these taxable events are targeted towards digital services, this has been called the 'new Chilean VAT on digital services'.
Rather than focusing on the description of the tax itself, a few implementation topics are reviewed below.
Chilean VAT on digital services is required to be paid to Chilean treasury either on a monthly or quarterly basis beginning from June 1 2020, at the taxpayers' election. However, the Chilean IRS stated that for the first instalment corresponding to June 2020, the payment can be exceptionally – and for one time only – be added to the quarter that includes the months of July, August and September and, therefore be paid until October 20 2020.
In respect to the administration of the tax itself, the tax reform provided for a simplified compliance mechanism that allowed foreign service providers to request a registration solely for VAT purposes. That in turn, permitted them to easily pay the VAT due when they rendered services to non-VAT taxpayers through both business-to-business (B2B) and business-to-consumer (B2C) transactions.
This simplified registry has resulted in a website where foreign taxpayers can register and pay the VAT due. The Chilean IRS recently published a list of the first 40 foreign service providers that have requested to be included in this simplified registry. The names included technology giants such as Google, Apple, Facebook, Netflix and Spotify among others, however many other big names are still missing.
The bottom line for foreign service providers is that they should assess whether or not they have the obligation to be included in the simplified registry or not, considering particularly the Chilean beneficiaries or users of their services. Alongside that, it is highly relevant to determine the Chilean direct tax implications of the services being paid from Chile, this is because Chilean withholding tax and Chilean VAT on digital services may have similar taxable events. In the past, this meant that foreign taxpayers would not be subject to Chilean tax. Today, either VAT or withholding tax (WHT) will be applicable in all cases.
As it may be noted, there are several changes that need not be overlooked by foreign investors with interest in Chile. The tax scenario has suffered deep changes and COVID-19 is no longer an excuse to postpone further review.
T: +56 2 2940 0155
Sandra Benedetto is a partner at PwC Chile. She joined the firm in 2005, having previously worked at a local law firm. Prior to that, she had worked for six years at the Chilean IRS in the international taxation department, being involved in the negotiation of several DTCs.
Sandra has developed her career mainly focused on tax consulting with a strong practice in international taxation issues. She has provided tax consulting services to a broad range of foreign and domestic clients, including on cross-border restructuring projects, inter-company operations, day-to-day tax advising, and tax and legal assistance in sale and purchase (SPA) negotiations and revisions, among others.
Sandra is a member of the International Fiscal Association (IFA), integrating its board of directors since 2005. She also gives lectures at different post graduate programmes. She holds a bachelor's degree from Universidad de Chile and holds a master's degree in law and a certificate on international taxation (ITP) from Harvard University.
Jonatan Israel Navon
T: +56 2 2940 0000
Jonatan Israel Navon is a manager at PwC Chile, who joined the firm in 2011. In 2018 and 2019, he was seconded to the international tax services team at PwC Spain, where he advised clients on both inbound and outbound taxation matters.
Jonatan has developed his career mainly focused on tax consulting with a strong practice in international taxation issues.
In addition, Jonatan has been assistant lecturer in civil and tax law at the Universidad de Chile. He holds a bachelor's and master's degree from Universidad de Chile, as well as another master's degree in taxation from the London School of Economics (LSE).