In July this year, the Chilean government issued the indications on the tax bill aimed at modernising the existing tax system, which was originally submitted on August 2018.
In the original tax bill, a proposal was made to amend the rules applicable to the reduced withholding tax (WHT) applicable to interest paid abroad.
Currently, interest payments to a foreign entity are subject to withholding tax at a 35% rate. Nonetheless, interest is subject to a reduced WHT rate of 4%, in case of credits granted by a foreign financial institution (FFI).
It should be noted that a FFI qualification needs to comply with the requirements established by the Chilean Internal Revenue Service (IRS), which would relate to the following:
- That the foreign institution is incorporated abroad.
- Its corporate purpose or business activity is to perform financing activities or lending activities.
- Its capital and reserves are equal or greater than a quarter of the capital needed by foreign banks to be incorporated in Chile. That amount is UF 200,000 ($7.8 million).
It is important and highly advisable that Chilean regulations allow a company to be registered as a FFI in the Chilean IRS Voluntary Registry of Foreign or International Financial Institutions (FFI Registry). The registration is not mandatory, but provides certainty about the qualification and is seen as a common practice in the market.
The tax bill of August 2018 indicates that interest payments made to FFIs are able to opt for the reduced WHT rate if they are the final beneficiaries of such interest, otherwise, if the final beneficiary is a different entity, the general WHT rate of 35% applies. It is important to remark that such wording does not address the situation under which the final beneficiary is subject to a reduced WHT rate instead of the general WHT rate because of the application of the double tax agreement.
The indications complemented the original tax bill, indicating that in order to use the reduced WHT rate of 4%, the loan must not be issued through a structured agreement. Such an agreement would mean that the FFI that received the corresponding interest would end up transferring such interest to another individual or legal entity domiciled or resident abroad that originally did not have the right to use the reduced WHT if it had received directly such interest from the Chilean debtor. This could lead to complex cases under which a structured agreement is used, granting a non-FFI entity the loan but the final beneficiary of such a structure would qualify as a FFI. It is unclear whether the reduced WHT rate of 4% would still apply in this case.
In addition, the FFI has to submit to the payer of the interest a declaration that indicates that no structured agreement has taken place.
Consequently, if the effective creditor of such a loan is not a bank, nor a FFI, the reduced WHT rate of 4% is not applicable to the payment of such interest independently of its excess of indebtedness position.
This new provision would apply to interest paid, settled to an account or available for taxpayers without domicile or residence in Chile and related to credits incurred since the envisaged tax reform bill enforcement and also regarding those incurred before that date, when after that date they have been novated, transferred, or the credit amount, or interest rate are modified.
In addition, the requirements for the qualification of an entity as a FFI are expected to change, adding that: i) their income derives mostly from their principal business purpose (i.e. granting of loans, financing or other related operations); ii) such financing operations are performed periodically; and iii) that its capital and reserves are equal to or greater than the half of the capital needed by foreign banks to be incorporated in Chile.
As the indications were recently introduced, we are still expecting further development on this subject. As it is, this is without a doubt a matter to be closely monitored until the new law is enforced.