Chilean tax reform includes VAT exemption modification

On August 23 2018, the Chilean government presented a tax modernisation bill, which aims to introduce a series of modifications seeking to simplify the Chilean income tax system and incorporate new tax regulations. Among the proposed VAT modifications, there is one that could affect standardised software taxation. At the time of writing, the tax bill is under discussion in Parliament.

Since 2012, an additional tax (i.e. Chilean withholding tax) exemption is available for payments made to a non-resident in consideration of standardised software, which has been defined as: "those where the rights granted (to the lessee) are limited to the necessary to allow the use of such software, not allowing its commercial exploitation, reproduction, or modification with any other ends than to make it able to be used". On the other hand, non-standardised software is subject to additional tax at a 15% rate.

Regarding VAT, although the lease of software is, in principle, taxed as it is considered a VAT service, Chilean law provides an exemption regarding payments that are made to non-residents, unless the payment is for a service rendered in Chile and it is not levied with additional tax.

The Chilean IRS confirmed, through several rulings, that even though the payments for standardised software to non-residents is exempted from additional tax and utilised in Chile, it must be understood to be rendered where the intellectual property (IP) is registered, which is generally abroad, allowing the application of the said exemption to the relevant payments.

The above-mentioned criteria, sustained by the Chilean IRS, means that payments made abroad in consideration of standardised software are not subject to additional tax or VAT.

If the tax bill under discussion is approved without amendments, the above-mentioned taxation would change. The new rule would state that, in order to benefit from the said exemption, the services must not be rendered or utilised in Chile.

As a consequence of the proposed tax bill, payments made abroad in consideration of standardised software would be exempt from additional tax, but subject to VAT at a flat rate of 19% over the agreed price, particularly considering that the Chilean IRS has stated that software licenses must be understood to be utilised in Chile.

This is very relevant, since it will put standardised software in a worse situation than non-standardised software, as the 19% VAT rate is actually higher than the 15% additional tax rate (or even less in cases where a double tax treaty is applicable).

Considering the proposed changes, if the tax reform is enacted, it will be important to review business structures in place in order to determine the impact the mentioned modification could have.

This article was written by Nicolas Foppiano and Gregorio Martinez.