Chile imposes a non-resident capital gain tax applicable to indirect transfers of shares or equity-type interest in Chilean entities (ICGT) when any of the three legally-envisaged thresholds is met, which are related to the Chilean entity’s fair market value and the interest percentage in the foreign entity being sold as well as the residence of the latter if domiciled in a preferential tax regime.
The Chilean Income Tax Law establishes two methods to compute the capital gains: the foreign tax basis and the Chilean tax basis, at the election of the seller, being its final tax liability a 35% sole tax over the determined net capital gain as a general rule.
The acquirer, on the other hand, has withholding obligations. Nonetheless, when the seller pays the tax within the month following the transaction, no withholding is required.
Prior to Tax Modernization Law No. 21,210, of February 24 2020, acquirers had two options to comply with their withholding obligation, both applicable only if the taxable income was determined according to the Chilean tax basis method:
- To withhold at a provisional 20% rate over such taxable income, calculated as per the Chilean tax basis method. The transferor, on the other hand, had to file its annual tax return in April of the year following the transfer and the tax withheld was creditable against its final tax liability; or
- The acquirer could opt to withhold 35%, as general rule, calculated as per the Chilean tax basis method as well. In case the 35% withholding was made, the transferor was not required to file its annual tax return as the payment of the indirect transfer tax would be satisfied.
Therefore, there was no obligation to withhold any amount when the seller chose the foreign tax basis, as asserted by the Chilean Internal Revenue Service (IRS) in its annual tax supplements.
The Tax Modernization Law modified the first withholding option for the acquirer, maintaining the second. The 20% provisional withholding rate over the capital gain determined under the Chilean tax basis method was replaced with the same rate but over the amount put at disposal instead, without any deductions.
Accordingly, this withholding operates on a perceived sum basis. Due to the withholding being provisional, the seller will still have to file its annual tax return in April of the year following the transfer and is entitled to use the tax withheld by the acquirer as a credit.
Circular Letter No. 56 of 2020 by the Chilean IRS stated that the amendment sought to acknowledge that the acquirer does not usually have enough information to estimate the capital gain arising from the operation.
Nonetheless, even though it is not mentioned in the pronouncement, the provision entails that if the foreign tax basis method is chosen by the seller to calculate the capital gain, the 20% provisional withholding obligation would arise for the acquirer, as opposed to the situation prior to the Tax Modernization Law.
Consequently, according to the letter of the law, even if a loss in the operation is verified, regardless of the method elected to estimate the taxable base, the 20% withholding would still apply, as it only hinges on the amounts put at disposal, irrespective of the existence of a capital gain.
Moreover, if the seller’s decision were to use the Chilean tax cost method, the Chilean IRS could argue that the option to withhold 35% only applies over the ‘taxable income,’ and since there is no such option in case of losses, the 20% withholding provision would prevail.
The acquirer’s withholding in case of tax losses generates economic fallouts for the seller, as a refund would need to be claimed later. It might be advisable to calculate the taxable base under both methods to assess the most suitable option.
In conclusion, the Tax Modernization Law introduced modifications to the withholding obligations for the purchasers in offshore indirect transfers. As per the provisions, a withholding obligation arises when the seller chooses to estimate the taxable base under the foreign tax basis, be it a profit or a loss.
The same could be argued by the Chilean IRS when the Chilean tax basis method calculation results in a loss. Economic hurdles stem for the seller when the 20% provisional withholding is carried out despite a negative taxable income, as a refund would need to be claimed later.
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