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Proposed anti-deferral tax raises economic questions for Chile

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Rodrigo Winter Salgado of PwC Chile reports on the submission of an ambitious tax reform bill to the Chilean Congress that proposes the creation of a tax on retained taxable profits.

In 1984 a new tax system was created in Chile. Under the reform of the corporate income tax rules, if taxable profits were distributed to Chilean individuals or foreign residents, they were subject to final taxes: surtax in the case of Chilean individuals and withholding tax in the case of foreigners. Against these final taxes, the taxpayers were able to use a tax credit for the corporate income tax paid by the distributing company. This was known as the ‘fully integrated tax system’.

The rationale of the system was that the income tax rate was rather low, but the withdrawal of profits was subject to high personal taxes. Thus, there was an incentive to reinvest those profits in the company and defer final taxation.

2014 tax reform

In 2014 Michelle Bachelet was elected as the Chilean president. As part of her programme, she declared that she wanted to eliminate the integrated tax system and replace it with a system that levies undistributed earnings on an accrual basis since the integrated Chilean tax system implied the deferral of final taxes.

For several reasons, the taxation of accrued undistributed taxable earnings was finally discarded as a sole regime. Since the goal was to tax accrued undistributed taxable earnings, Andrés Velasco, a finance minister of Michelle Bachelet in her first presidential period (2006–10), proposed the creation of an ‘anti-deferral tax’ applicable to retained undistributed earnings not yet taxed with final taxes. The rationale was that companies using retained earnings are being financed with cash that has not been fully taxed and thus this new tax should be similar to an interest rate applicable to such deferral.

However, Andrés Velasco´s idea was not considered and the fully integrated tax system was replaced by a partially integrated tax system that still allows the deferral of retained untaxed earnings without an extra tax burden.

The partially integrated tax system implies that dividend income received by Chilean individuals or foreigners will be subject to final taxes but only 65% of the corporate income tax paid could be used as a credit. For tax treaty reasons, dividends paid to treaty country residents are entitled to 100% corporate income tax credit.

2022 tax reform bill

In March 2022 Gabriel Boric became president and in June a very ambitious tax reform bill was presented to the Congress. Amendments to the original bill were made in October.

Among the topics included in the bill, an anti-deferral tax is proposed, which shares the same rationale as deemed interest. In summary, an anti-deferral tax applies provided that the following joint requirements are met:

  • The company is characterised as a big taxpayer; and

  • More than 50% of the gross taxable income derives from passive income.

The proposed anti-deferral sole tax rate is equal to 2.5% over 22% (0.55% effective burden) annually applicable over the undistributed untaxed retained earnings.

Many economists argue that Chile’s economic growth during the past three decades was partly due to the incentive of not taxing the deferral of retained earnings. If this anti-deferral tax is approved, the incentive will not be the same.

It is a fact that the proposed anti-deferral tax will be a new source of tax collection; however, it is yet to be seen if it will produce some other unexpected economic effects.

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