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Tax Reform Bill seeks to revamp the Chilean income tax system

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Nicolas Foppiano and Juan Pablo Marambio of PwC Chile explain why foreign and domestic taxpayers should pay close attention to a tax reform proposal that would create a capital income tax in Chile.

On July 7 2022, the new Chilean government presented a Tax Reform Bill for discussion in the Chilean Congress. The proposal follows several tax reforms in the past decade, including those passed in 2014, 2016, and 2020.

One of the most important modifications proposed under this latest Tax Reform Bill is the full 'disintegration' of the Chilean income tax system. This change is proposed for all companies except those owned by residents in a country with which Chile has a double tax treaty in force.

The aforementioned implies a paradigm shift in the Chilean income tax system, which is traditionally based on the integration of both corporate and final taxes through a credit mechanism. Note, though, that such a paradigm was already weakened due to the partial disintegration of the Chilean income tax system introduced by the tax reform of 2014.

In such a context, the Tax Reform Bill proposes to introduce a new capital income tax, which will apply to dividends or withdrawals made from a company without granting any kind of corporate income tax credit.

The current tax system for capital income

At present, common taxation rules apply to dividend distributions or withdrawals made from a company to its shareholders. Accordingly, corporate income tax applies at a 27% rate at corporate level, and, at the shareholders’ level, the relevant final tax will apply, which is global complementary tax (progressive rates on individual residents in Chile) or additional tax (35% withholding on foreign residents). Final shareholders will then have the right to use – totally or partially – as credit the corporate income tax already paid by the entity paying the dividend or making the profit distribution.

The reform bill proposal for capital income

If the Tax Reform Bill is approved as originally proposed, final shareholders will be subject to a new tax, the so-called capital income tax, at a 22% rate on the shareholders’ withdrawals, remittances, or distributions, on the net amount being distributed.

In such regard, taxpayers resident in Chile will have to pay the new capital income tax, at a 22% rate, which will be withheld by the paying entity on a net basis and will not grant any credit to be deducted from such amount. The latter would lead to a 43% total burden in the case of the highest marginal tax rate.

On the other hand, a dual system will apply on the taxation of foreign taxpayers. For those foreign taxpayers resident in jurisdictions without a double tax treaty in force with Chile, the same taxation described above for final taxpayers will apply, resulting in a compound rate of 43%.

Nevertheless, for taxpayers resident in countries with which Chile has a double tax treaty in force, the current fully integrated system is retained, which means that the total tax burden is maintained at a 35% rate, since the corporate income tax credit will be fully creditable against additional tax.

What comes next?

The Tax Reform Bill set forth that the capital income tax will enter into force as of January 1 2025 and is to be applied on income paid or accrued from that date. That is, of course, provided the bill is passed by the Congress as it is now. However, there is still a long way to go, and bearing in mind that the Chilean government coalition does not have a majority in the Congress, amendments are expected in order to move forward with the discussion.

In a nutshell, for those foreign taxpayers resident in countries with which Chile does not have a double tax treaty in place, the new tax reform would imply a full disintegration of the Chilean corporate tax system, and represent a paradigm shift from the current Chilean income tax system. Hence, the parliamentary discussion should be closely monitored by foreign and domestic taxpayers, who may need to take action to adapt to these changes.

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