Chile: Tax treatment of capital reductions by the recipient entity

Loreto Pelegrí		Rodrigo Winter

Article 17(7) of the Corporate Income Tax Law, provides a special allocation and tax regime for capital reductions, establishing that, as general rule, these distributions are considered a non–taxable income for the recipient shareholders.

However, this general rule has two exceptions:

• When the amounts returned correspond to taxable profits (capitalised or not) that have not been paid the corresponding final income tax; and
• When the amounts returned to the shareholders correspond to financial profits in excess of taxable profits.

Before the issuance of Ruling No. 2145 and No. 2146 of 2013 by the Chilean Internal Revenue Service (Chilean IRS), there was no certainty on how a capital reduction should be registered by the recipient entity.

In fact, there was a criterion under which capital reductions were treated as a non-taxable income at the receiving shareholder provided that it could be effectively allocated to the paid in capital and its corresponding readjustments. Under this interpretation, the subsequent distributions of those amounts were not subject to withholding tax since it was allocated to non-taxable profits.

The other criterion was to treat this capital reduction as a lower cost basis at the level of the investor which cannot be treated as non-taxable profit.

For purposes of clarifying this uncertainty, the Chilean IRS issued in October 2013 Revenue Rulings No. 2145 and No. 2146, which establish the criterion regarding the registration of these non–taxable profits in the accounting records of the receiving shareholder, when the latter is an entity or a person that needs to keep full accounting records for tax purposes.

These rulings provide that capital reductions, allocated to paid-in capital, must be registered by the beneficiary as a lower cost basis at the level of the investor but cannot increase the beneficiary's non-taxable fund ledger.

The criterion contained in these rulings clarify the way in which capital returns must be registered in the tax accounting records of the receiving shareholder and change the interpretation in which capital returns had been registered in Chile for decades.

Loreto Pelegrí (loreto.pelegri@cl.pwc.com) and Rodrigo Winter (rodrigo.winter@cl.pwc.com)
PwC
Tel: (+56 2) 29400588
Website: www.pwc.com/cl

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