Businesses generally adopt a corporate form in Chile in order to limit liabilities and ensure they can deduct expenses and costs from their tax base.
The most common corporate structures are:
From a tax perspective, all companies are taxed as separate entities and there are no key differences in terms of taxation.
Corporations and limited liability partnerships require at least two shareholders/partners, while stock corporations can be wholly owned entities.
From a management standpoint, corporations are managed by a board of directors, while limited liability partnerships appoint one or more managers that represent the company. In the case of stock corporations, the by-laws can regulate how the company will be managed. In the absence of a particular provision, the rules of corporations apply.
Shares in corporations and stock corporations can be freely transferred, while quotas in limited liability partnerships require the unanimous approval of partners.
Branches of foreign companies can also be incorporated. Although branches have the same legal personality as the parent company, they are separate taxpayers.
From 2020, Chile does not have tax transparent entities per se. An exception is the transparent regime for small companies with sales below USD2 million, where profits are allocated directly to shareholders, who must be Chilean resident individuals.
Branches that, from a legal standpoint, are the same entity as their foreign parent companies are considered as separate taxpayers subject to the same tax regime as Chilean companies.
Foreign companies that are considered transparent for tax purposes under local regulations are treated as separate entities in Chile. Exceptions may apply under certain treaties.
Chilean legislation recognises entities that are not subject to income taxes, provided certain requirements are met, such as private investment, mutual or public funds. These vehicles do not have legal personality; however, they are considered as separate from their quotaholders, not attributing or allocating revenue without effective distributions.
Residence for incorporated businesses in Chile is determined by the country of incorporation.
Chile has an integrated system, therefore taxation would be as follows.
Small Businesses (Transparent)
No corporate tax; shareholders – who must be Chilean resident individuals – are subject to individual tax (Impuesto Global Complementario), with a progressive rate from 0% to 40%.
Medium-Sized Business Regime (PYME)
Corporate tax at a 25% rate (reduced to 10% for COVID-19 incentives for 2020, 2021 and 2022). Upon dividend distribution, shareholders are taxed as follows, depending on their nature:
Corporate tax at a 27% rate. Upon dividend distributions, shareholders are taxed as follows, depending on their nature.
Corporate taxpayers are taxed on a worldwide basis. Chilean-source income is recognised on an accrual or receipt basis. Foreign-source income is generally taxed on a receipt basis, with the exemption of permanent establishment (PE) or controlled foreign corporation (CFC) income, which is taxed on an accrual basis.
Taxable income results from adjustments made to the accounting profits. Some of the most relevant adjustments are as follows.
There are no special regimes for technology investment.
Individual creators of intellectual property are exempt from capital gains tax upon sale to non-related parties.
A 35% credit could be granted against the corporate tax for certain R&D expenses. The credit requires the government's prior approval and has a cap of USD1 million.
Small businesses that have agriculture, mining or transport activities may be taxed on a presumptive profit, based on the value of the assets associated with the operation.
The acquisition of a fixed asset results in a credit against corporate tax that cannot exceed 4–6% of the asset value, with certain caps. The VAT credit associated with these acquisitions is refundable after a two-month period.
The importation of fixed assets can be exempt from VAT if they are related to investment projects exceeding USD5 million.
Subject to certain requirements, investments in fixed assets can be depreciated, either immediately or in an accelerated manner (see 2.1 Calculation for Taxable Profits)
Funds are generally exempt from corporate tax.
Sales of shares in publicly traded companies and bonds issued in the Chilean market are not subject to income taxes. Special requirements in terms of acquisition and disposal mechanisms and characteristics of the assets must be met.
All exemptions are currently under review by a special commission mandated by the government.
Losses can be carried forward with no limit on time or amount. Carry-back has been recently eliminated from Chilean legislation.
Corporate tax losses can be offset against dividends from local subsidiaries. As a result of the imputation, the corporate tax paid by the subsidiary on profits subject to distribution could be refunded to the holding company. The benefit corresponds to 90% for dividends paid in 2020, 80% for dividends paid in 2021, 70% for dividends paid in 2022 and 50% for dividends paid in 2023, until complete elimination of the benefit from 2024.
For capital gains relief, see 2.7 Capital Gains Taxation.
There are no interest deduction limitations, provided that interest relates to the generation of income. However, interest exceeding transfer pricing rules or thin capitalisation rules is subject to a separate taxation regime. See 4.6 Comparing Local Transfer Pricing Rules and/or Enforcement and OECD Standards and 5.7 Constraints on Related-Party Borrowing.
There are no consolidated tax grouping rules in Chile.
Chilean parent companies that have net operating losses and receive dividends from their subsidiaries can request a refund of the corporate tax paid by their subsidiaries. This benefit will be available only until 2023.
Capital gains on fixed assets, shares in subsidiaries and other assets generated by corporate taxpayers are considered as general income not subject to particular exemptions or reliefs, therefore the income or loss can be offset against other income subject to the general regime.
Sales of shares in publicly traded companies or companies acquired before 1984 are exempt from taxes, provided some requirements are met.
If financing is obtained, stamp tax is levied on the loan transaction, with a cap of 0.8% over the principal amount of the loan.
VAT (19%) could be borne upon the disposal of assets or certain operations. Interests are not subject to VAT.
Mining companies are subject to a particular royalty tax, from 0.5% to 14%.
Companies must annually pay municipal tax on their tax equity, with a rate that ranges from 0.25% to 0.5% depending on the municipality.
Land tax applies to the owners of real estate. A surtax is imposed on businesses that own real estate assets that exceed a certain value.
It is a common practice for businesses to be incorporated as stock corporations or limited liability partnerships, since incorporation thereof is fairly straightforward, which makes it possible to deduct expenses and offset credit and debit for VAT purposes.
As individual tax rates are progressive, the effective tax rate may be higher than the corporate rate, depending on the level of income.
There are no particular provisions prohibiting individual professionals from being incorporated as corporate taxpayers.
However, as Chile has an integrated system (see 1.4 Tax Rates), even if individual professionals are structured as corporate taxpayers, the income will be subject to individual tax at the time dividends are paid. Also, any expenditure not related to the business (ie, school, car or housing) or even the loans granted by the company to its shareholders will be treated as a deemed dividend.
There are no restrictions on corporations accumulating earnings for investment purposes.
If profits are accumulated through structures intended to grant shareholders access to those profits, such as loans to shareholders or use of assets of the company for a purpose other than the business purpose, deemed dividend provisions could apply.
CFC rules may also apply on profits accumulated in foreign-controlled subsidiaries that generate passive income.
Dividends or income derived from the sale of shares in closely held corporations are subject to the general individual tax regime, with rates ranging from 0% to 40%, depending on the level of income.
Capital gains may be divided in up to ten years or the number of years those shares have been held if less than ten, and added as an income for each year subject to individual tax in order to apply a lower tax bracket.
Sales of shares in corporations acquired before 1984 are exempt from taxes, if other requirements are met.
Dividends allow individuals to use as credit the corporate tax paid against individual tax. For further information, see 1.4 Tax Rates.
Dividends allow individuals to use as a credit the corporate tax paid against individual tax. For further information, see 1.4 Tax Rates.
Regarding capital gains, Article 107 of the Chilean Income Tax Law provides an exemption, regardless of whether the seller is an individual or corporate taxpayer, when the following requirements are fulfilled.
Interest is generally subject to a 35% withholding tax. Interest on bonds and debentures is subject to a 4% withholding tax.
The 4% rate also applies on interest from loans granted by foreign banks, financial institutions, insurance companies and qualified investors.
For dividends WHT, see 1.4 Tax Rates.
Royalty payments are generally subject to a 30% withholding tax. This rate is reduced in the following scenarios:
It should be noted that the conventions for the avoidance of double taxation subscribed to by Chile do not provide for any tax relief regarding dividend distributions from Chile (the so-called Chile Clause), as long as the corporate tax paid by the Chilean company is a credit against the dividend WHT. For further information on dividend taxation, see 1.4 Tax Rates.
Considering there is no dividend relief, the main benefit granted to foreign investors relates to capital gains taxation.
Foreign investors acquiring corporate stock are more likely to structure Spanish or Portuguese parent companies, since treaties with those countries provide for a reduced 16% capital gains tax on the sale of controlling interests in Chilean entities.
In turn, foreign investors acquiring corporate debt have a different type of tax relief regarding interest income (10%) and capital gains on the disposal of receivables (exemption). The most common tax treaties are with:
From a technical perspective, the Chilean IRS is entitled to challenge the use of channel companies that lack the substance to use treaty benefits based on the beneficial owner concept.
From a practical perspective, the Chilean IRS rarely challenges cross-border transactions for lack of substance, since the taxing authorities have difficulties in sustaining this kind of claim.
However, the Chilean IRS, in line with BEPS, is adjusting its audit focus, therefore we should expect challenges in the near future, also in line with the OECD parameters.
The biggest transfer pricing issues for foreign investors are:
Limited risk distribution arrangements regarding the sale of goods are commonly used in Chile; they have been reviewed and accepted by the Chilean IRS, provided they fulfil the functional analysis test in terms of the risk allocation to each entity.
The issue is how to achieve the proper margin of the Chilean distributor, which requires an adjustment of the value of goods acquired from related parties.
Limited risk distribution arrangements for the provision of services or technology are currently subject to review, particularly with respect to tech industry operations in Chile. As no transfers of goods exist and because of the 40% penalty risk, achieving the target margin requires the implementation of alternatives that result in withholding tax and expense deduction considerations.
In general, Chilean transfer pricing rules and regulations follow most of the OECD standards.
The main difference relates to the effects of transfer pricing adjustments that do not result in an income basis adjustment (by recognising a lower expense or a higher income), but instead the adjustment is subject to a substitutive 40% penalty tax (cash tax), which does not modify the taxable base for corporate tax purposes.
The 40% penalty tax could be increased by 5% to an overall penalty of 45% under some circumstances.
Proper transfer pricing rules have been enacted in Chile for the past decade; however, their implementation is in constant development.
Mutual agreement procedures have been utilised by taxpayers and the Chilean IRS, mostly in relation to the interpretation of the tax treaty provisions (WHT reduction and residence, among others).
Transfer pricing disputes have been mostly limited to administrative or court discussion but not through international arrangements between tax authorities. In this respect, advance pricing agreements have also been limited between the Chilean IRS and Chilean corporate taxpayers.
Compensating adjustments are only allowed if the counterparty is a treaty country resident. The nature and amount of the adjustment must be previously approved by the Chilean IRS.
Difficulties in Connection with the Process
A taxpayer has a five-year period to apply for the adjustment authorisation, which could be a problem, since tax refunds have a three-year limitation.
The IRS could deny the authorisation if it considers the adjustment to be against Chilean Income Tax Law provisions. A negative decision issued by the IRS cannot be appealed by the taxpayer.
Branches and local subsidiaries of non-local corporations are corporate taxpayers that are subject to taxes on their worldwide income. The taxable income of the branch could also be determined using indirect methods. Branches may not have access to Chilean treaty benefits as they are not Chilean tax residents. Some permanent establishments of treaty-country taxpayers can decide to be taxed on a gross basis.
Capital Gains Tax on Direct Transfer
Capital gains on the direct transfer of Chilean stock by non-resident shareholders are subject to a 35% tax. If the shareholder has signed a DL 600 contract that remains in force, capital gains will be subject to a 42% rate.
There are exemptions for shares acquired before 1984, if other conditions are met. Also, capital gains on shares acquired and sold on the Chilean Stock Exchange or under other regulated mechanisms are not subject to income taxes. The exemption also requires a minimum market presence to operate. These exemptions are under review by the government.
Some tax treaties provide for reduced rates on capital gains taxes. The rates could be 20%, 17% or 16%, depending on the nature of the underlying assets (real estate or not), percentage of ownership and holding period.
Capital Gains Tax on Indirect Transfer
Capital gains on the indirect transfer of Chilean stock or other assets by a non-resident shareholder are subject to a 35% tax.
The capital gains tax on indirect transfers applies in two cases:
The seller has the right to apply the capital gains regime directly in indirect transfers. In that case, if the direct shareholder is a treaty country resident, the provisions of the relevant treaty will apply.
Some tax treaties allow that capital gains on indirect transfers would not apply to sellers that are tax residents of those treaty countries. This interpretation must be analysed on a case-by-case basis as the Chilean tax authorities might not share this view.
Any change of control that triggers the direct transfer of shares in a Chilean company is subject to capital gains taxation.
Capital gains resulting from an indirect transfer of a Chilean asset (company) is subject to a 35% tax, provided one of the following requirements is met:
In order to apply this tax, at least 10% of the foreign entity should be transferred.
For taxable gains determination and the rate, see 5.3 Capital Gains of Non-residents.
The indirect transfer regulations allow intragroup reorganisations (any type of alienation, such as a sale) without triggering any tax consequences in Chile, provided that no gains are triggered by the alienation. That is to say, the transfer should be materialised at tax basis. Also, in the case of mergers/accretions or spin-offs that have the same legal effects as in Chile (see above), no taxation should be triggered.
Foreign-owned local subsidiaries must determine their income based on the same rules as a company owned by Chilean shareholders. This means their taxable income is determined based on accounting books, with tax-related adjustments.
In the case of local branches or other types of permanent establishments of foreign companies, the Chilean IRS has the authority to apply indirect methods based on assets or revenues if the accounting books do not present evidence of the annual result.
The deduction of payments to foreign-related parties for management, administrative and other technical or professional services is subject to the same requirements as other expenses, especially in connection with their ability to produce income.
These payments can only be deducted on a cash basis (the general rule is deduction on an accrual basis) and after the withholding tax is filed and paid.
If disbursements are not necessary or able to produce income, a 40% penalty tax borne by the Chilean company applies, regardless of their deduction as expenses.
The deduction of royalty payments to related parties is limited to 4% of the payer’s annual revenues. This limitation does not apply in the case of payments to treaty-country residents or when the income is subject to a rate of 30% or higher in the country of the recipient.
Article 41 F of the Income Tax Law limits related-party borrowing to a 3 to 1 debt-to-equity ratio (thin capitalisation rule). For purposes of determining the ratio, all debts (related and non-related) must be taken into account.
Interest and other financial expenses exceeding such ratio and paid to foreign-related parties would be subject to a 35% tax borne by the Chilean debtor. The Chilean debtor can use the withholding tax effectively paid as a credit against the penalty tax.
For these purposes, creditors will be related or deemed to be related in the following cases:
Thin capitalisation provisions are not applicable if guarantees are granted with respect to project finance, provided that the transaction is performed at arm’s length.
Net foreign income of local corporations is subject to corporate tax on a cash basis.
In the case of foreign branches or other types of permanent establishment of local corporations, the positive or negative tax result of the permanent establishment is recognised and taxed in Chile on an accrual basis.
As per the Chilean CFC rules, the passive income generated by foreign-controlled entities must be recognised in Chile every year on an accrual basis, if certain thresholds are met.
This is not applicable in this jurisdiction.
Net dividends from foreign subsidiaries paid to local corporations are subject to tax on a cash basis. Foreign tax credit is available.
If the foreign entity generates passive income previously recognised under CFC rules, the dividends from that entity will be exempt from income taxes.
Intangibles developed by local corporations can only be used by non-local subsidiaries under a licence or similar agreements, or as a result of a transfer of ownership subject to corporate tax. The difference between the acquisition value and the fair value of the intangible is subject to income taxes upon transfer.
Subject to specific rules and limitations, passive income generated by controlled foreign entities should be recognised on an accrual basis. In the case of non-local branches, their annual tax results should be recognised in Chile, even if such result is a loss and regardless of the nature (passive or not) of the activities or assets that generate the income.
Chile does not have specific rules regarding the substance of non-local affiliates. As a consequence, all foreign entities are recognised and taxed equally.
A gain on the sale of shares in non-local affiliates is subject to income taxes under general rules, on a cash basis and for the net amount of the gain. Foreign tax credits are available only for treaty countries.
If the shares are assigned to a foreign permanent establishment or if those shares qualify as passive income-generating assets, tax consolidation or CFC rules, respectively, will apply.
Since 2015, Chile has had a general anti-avoidance clause (GAAC) that allows the Chilean tax authorities to discard the forms adopted by the taxpayers in order to assess the tax results that would have been applied according to the economic substance of the same acts.
The Chilean GAAR requires that a previous and regulated process is followed in order to declare the existence of a simulated or abusive act in order to operate.
Chile has a regular routine audit cycle, which begins with processing the information gathered by the tax authorities from the tax returns and sworn statements filed by taxpayers and third parties.
A formal audit process is initiated by sending a notice intended to request the taxpayer for additional information.
If the taxpayer does not file the requested information or the tax authorities consider taxes may be due, a summons (citation) will be issued to the taxpayer to formally answer the issues raised by the IRS. The summons overrules the statute of limitations, which is extended to three additional months.
If the taxpayer does not respond to the summons, or if the response does not solve the differences, an assessment (liquidation) or resolution with a payment order or the denial of a benefit or refund request will be issued. These acts may interrupt the statute of limitations.
Against the assessment or resolution, the taxpayer could file a tax claim (Reclama Tributaries). The tax claim initiates a tax trial.
The law and regulations allow for intermediate instances to settle tax differences detected in the context of the audit cycle.
Chile has adopted a number of the BEPS recommended changes. Some of the most important changes are:
Chile has also ratified the Multilateral Instrument and the Convention on Mutual Administrative Assistance in Tax Matters.
As part of the OECD, the Chilean government is aligned with the implementation of BEPS-related measures. The government has a special focus on reducing tax avoidance and increasing transparency and tax responsibility, resulting in higher tax collection.
Chilean regulations are strongly influenced by international tax-related measures. As a result of this and the participation of Chile in the OECD forum, the country has adopted most of the BEPS recommendations.
Chile has a competitive tax policy. The recently approved tax reform (enacted in February 2020) is a clear demonstration of this objective. The government and the tax authorities consider that, given the international context, the introduction of BEPS-related measures is in line with tax competitiveness.
The corporate tax system and the taxation of shareholders under the integrated system – where the corporate tax is a credit against the income tax that affects dividends – has become more complex with time.
The complexity is even greater considering the number of changes and transitory dispositions applicable to different taxpayers, by separating incomes and credits depending on the year they were generated and the fact that some rules that were necessary in the context of an integrated regime have been modified. An example of this is the rule that allows a holding company to offset losses against dividend income has been repealed effective from 2023 onwards.
Chile still maintains formal and outdated taxes, such as inheritance and donations tax, stamp tax, land tax and municipal tax.
The main element that has made the competitive system vulnerable is the legislative process itself. This process has resulted in a set of rules that is not necessarily consistent between them, and also in uncertainty, such as the proposal of technically deficient tax rules and a constant review of the tax system that will probably result in the fifth tax reform in ten years.
No changes have been introduced or proposed in terms of hybrid instruments. Given the upcoming discussions on the evaluation of the Chilean tax system, it is expected that the treatment of hybrid instruments will be one of the topics to be addressed.
Chile does not have a territorial tax regime. In fact, even permanent establishments of foreign entities are taxed on a worldwide basis.
The combination of taxation on worldwide income and the foreign tax credit regulations makes debt financing inefficient.
Not having a proper holding company regime affects foreign investment more than interest deductibility limitations.
According to the Chilean CFC regulations, offshore investments in preferential tax regimes are deemed to be foreign-controlled investments that generate passive income subject to taxation.
Taxpayers have the right to prove their foreign investments are not covered by the CFC rules.
The DTC limitation of benefit rules will require a complete review of all the structures previously implemented, as some of them may not qualify for treaty benefits.
The DTC limitation of benefit and anti-avoidance rules demand a new approach in terms of tax structuring and risk assessment, where tax sustainability may have a relevant role.
The taxation of profits from intellectual property is a particular source of difficulty and controversy, mainly due to the lack of specific regulations.
No substantial changes have been proposed in terms of taxation or transfer pricing regulations on intellectual property, other than those related to increased transparency.
Chile has already adopted the country-by-country reporting and other transparency-related measures.
The evaluation of these measures depends on the approach of the Chilean tax authorities in terms of audits and on how susceptible the authorities are to the requests made by other tax administrations.
A key point is understanding the right of any multinational enterprise to organise its business under a tax-efficient structure, by complying with the rules adopted by each country in which it operates.
In February 2020, a new digital tax, in the form of VAT, was introduced to the Chilean legislation.
As of 2020, Chile incorporated a tax on digital services in the form of VAT.
The VAT on digital services has been a simple and direct way to collect taxes from this type of activity.
The most relevant actors of the industry have also contributed by adopting high compliance standards.
It is also important to highlight that the Chilean tax authorities have adopted a practical and open approach, by having a direct line with the industry intended to solve any issue the implementation of this new tax has raised.
The country has not introduced specific changes with regard to the taxation of intellectual property deployed within Chile.
Payments abroad for the use of intellectual property are generally subject to a 30% withholding tax, which is reduced to 15% in some cases. The withholding tax reduction does not apply in the case that the owner or licensor of the intellectual property is a resident of a jurisdiction qualified as a preferential regime.
Under the existing tax treaties, intellectual property payments made to the beneficial owner of the income are subject to a 10–15% withholding tax rate. Exemptions are available for payments for the right to use standard software.
Intellectual property payments made to foreign-related parties that are non-treaty country residents can only be deducted up to 4% of the annual revenues of the payer. This limitation may not apply if the income is subject to a 30% or higher rate in the country of the licensor.
Tax Reform in Full Force
On 24 February 2020, the latest Chilean tax reform, enacted by Law No 21.210 (the "Tax Reform"), was published in the Official Gazette, concluding an extended process in the Congress, marked by the negotiations performed by the government and the political parties due to the social unrest after October 2019.
The Tax Reform had 1 March 2020 as a date of general entry into force, but it set forth several specific entry-into-force dates on different matters.
The Tax Reform was comprehensive and involved several legislative changes to the Chilean Tax Code, Chilean VAT law and Chilean income tax law, among others. With respect to income tax, the Tax Reform eliminated the duality of income tax regimes and established the Partially Integrated Income Tax system (PIS) as the general income tax regime.
Besides the above, the Tax Reform introduced several changes to corporate taxation that impact Chilean investors as well as foreigners. Considering the broadness and the complexity of some of these changes, the Chilean Internal Revenue Service (the "Chilean IRS") has issued several pronouncements, including circular letters and resolutions, in order to provide guidance to tax officials and taxpayers in navigating the tax and legal changes that are taking place.
Along with the matters that were modified by the Tax Reform, there are other developments in the Chilean tax scene that are worth noting. Firstly, the Chilean IRS has recently issued its 2020 version of the tax schemes catalogue, which includes a series of situations and transactions that are considered to produce tax non-compliance situations. Another relevant development is that the Chilean government entrusted an expert commission to analyse all the special regimes and exemptions that currently exist in Chilean tax law. The referred-to commission recently issued its report containing the analysis and recommendations.
On top of that, the Chilean tax policy discussions have been influenced by the constitutional debate that has surged in Chile since October 2019, and these developments should be closely monitored by investors as it is likely that tax provisions will be included in the new Constitution that is expected to be drafted.
Partially Integrated System as the General Tax Regime
As previously noted, one of the main changes to the Chilean income tax system was the elimination of the Attributed Income Tax system. As a consequence, the Tax Reform established the PIS as the general income tax rule.
The Chilean income tax system is based on an integrated mechanism, according to which, First Category Tax (FCT) paid at the operative company level can be offset against taxes to be paid by final taxpayers (ie, Global Complementary Tax for individuals resident in Chile and Additional Tax for non-residents).
The Attributed Income Tax system aimed to tax, on a yearly basis, income derived at the corporate level irrespective of its effective distribution to final taxpayers by means of attributing such income to them (attributed basis). Under that system, FCT was fully accreditable against final taxes.
On the contrary, under the PIS, final taxes will only be accrued at the moment at which the amounts are effectively distributed to the final taxpayers (cash basis). It is called partially integrated because, as a rule, there is an obligation to reinstate 35% of the Chilean FCT credit. Therefore, only 65% of the Chilean FCT already paid on profits being distributed can be used as credit against final taxes. This results in a total tax to be paid, in the case of foreign residents, of 44.45%, considering both FCT and Additional Tax.
Nevertheless, there are two exceptions where such reinstatement is not required and, thus, the FCT can be fully used as a credit against final taxes. Firstly, for those taxpayers in the small and medium enterprises tax regime. Secondly, in the case of final taxpayers that are resident in a country with which Chile has a double tax treaty (DTT) in force, in which case, the total tax burden remains at 35%.
In this second case, the Tax Reform also provided for a transitory rule that grants full FCT credit until 2026 for taxpayers that are resident in a country with which Chile has a signed (ie, before 1 January 2020), but not yet in force, DTT. Cases that fall under the transitory rule are the DTTs signed by Chile and the USA, as well as Chile and the United Arab Emirates. Thus, dividend distributions made to residents of such countries will bear, broadly speaking, a total tax of 35% up to December 2026.
New Rules on the Provisional Withholding for Remittances Abroad
As a rule, Additional Tax levies the Chilean-source income derived by non-resident taxpayers (and certain foreign-source income) at a general rate of 35%. Additional Tax is applied over the gross amount remitted abroad and works, in most cases, under a withholding mechanism in order to ensure its collection.
Dividend or profit distributions abroad are subject to Additional Tax at a 35% rate. As noted in the previous section, the foreign taxpayer can deduct, either fully or partially, the FCT credit for the First Category Tax paid on those profits at the corporate level.
Before the Tax Reform, the tax characterisation of the amount remitted abroad – pursuant to dividends, remittances, withdrawals and capital returns – was determined, in most cases, at the moment it occurred. This determination was made by applying the tax allocation order to such amount and reviewing to which of the tax records (ie, taxable profits record, exempted profits record, etc) kept by the distributing company the amount being remitted or distributed abroad should be allocated. This is crucial in order to determine effective FCT credit available and Additional Tax to be paid. Indeed, if there were no amounts pending of taxation in such records, the taxpayer could treat such withdrawal as a capital return, being subject to no further taxation.
The Tax Reform changed the legal mechanism described above. Now, the tax characterisation of the remittance and, accordingly, its allocation to the tax records of the company will be determined at the end of the respective fiscal year in which it was made.
The main effect of this change is that any remittance, dividend distribution, withdrawal or even capital reduction abroad will be considered as provisional until the end of the calendar year when it takes place, since only then will its tax characterisation be determined for certain. Hence, no matter what is noted in the tax records of the company that makes the distribution or remittance abroad, a provisional credit should be considered by the entity remitting the funds.
If, as a consequence, it is determined at the end of the calendar year that the provisory credit granted was higher than the actual one, then the Chilean company must pay such difference in its annual Income Tax return, and has the right to request the foreign taxpayer to repay such amount.
On the other hand, if, at the end of the commercial year, it is determined that the provisory credit granted was lower than the actual one, then the foreign shareholder is allowed to request a refund through an administrative procedure before the Chilean IRS, request a refund through its annual income tax return, or increase the accumulated credit ledger of the company.
Considering the latter, all foreign investors should carry out a cash-flow analysis before any dividend distribution, remittance, withdrawal or capital reduction is performed at a Chilean level to mitigate the financial impact derived from it. This recommendation is particularly relevant for those who are resident or domiciled in a country that has no DTT with Chile.
Financing Structures for Investments in Chile
The Tax Reform introduced several legal modifications that impact both current financing structures, which shall be reviewed and adapted accordingly, as well as potential financing structures. The most relevant are commented on below.
Changes to Additional Tax applicable to interest payments to foreign financial institutions
In the case of interest payments abroad, even though the general rule is that Additional Tax applies at 35%, if the interest is paid to a bank or a foreign financial institution (FFI), such income benefits from a reduced 4% Additional Tax rate.
Before the Tax Reform, Chilean income tax law did not provide the requirements to qualify as an FFI, thus the Chilean IRS established them through its administrative interpretations. In addition, the Chilean IRS maintains a voluntary registry of FFIs aimed to grant certainty for an FFI to be qualified as such. This registration should be updated before the Chilean IRS on a yearly basis.
The Tax Reform incorporated a new definition of a FFI and set forth the requirements to be considered thus. In this regard, the minimum capital threshold to be an FFI was augmented to half of that needed to be registered as a foreign bank in Chile, and its main activities alongside its corporate purpose should be the granting of credit or financing.
This increase in the legal requirements to be considered as an FFI created a situation where some entities that prior to the Tax Reform were considered FFIs and were duly registered as such and had provided credits that benefit from this 4% Additional Tax on their interest see a change in the thresholds and therefore may now be subject to a 35% rate. In this sense, a grandfathering rule was set forth for credits that were granted before 1 March 2020, as long as such credits have not been novated, transferred or the amount of the credit or interest rate has not been modified after such date.
Alongside these changes to FFI regulations, a specific anti-avoidance rule was included to prevent the benefit of the reduced 4% rate to those credits that were granted through structured arrangements where the FFI that receives the interest cannot dispose of them and must transfer them to another entity that would not be entitled to benefit from the reduced 4% rate.
FFIs are commonly involved in financing structures of long-term investment projects such as mining or infrastructure. Therefore, it is relevant to review the conditions of the financing of these kinds of projects that were provided prior to the Tax Reform.
Gradual repeal of the provisional payment for absorbed profits
Another aspect that impacts financing structures is the gradual elimination of the provisional payment for absorbed profits mechanism (PPUA). The relevance of the PPUA was that Chilean tax law does not provide for a direct tax consolidation mechanism like many other jurisdictions do. Instead of that, Chilean income tax law allowed for an FCT refund mechanism, whereby profits received from subsidiaries were absorbed by losses at the level of the recipient entity. The Tax Reform does not impact the allocation of own losses nor the use of the corporate income tax credit; however, it does prevent taxpayers from obtaining a refund.
The normal way for foreign investors to structure debt financing used to be through a holding company in Chile, not solely because of the application of the PPUA mechanism, but also because this legal structure grants more corporate-wise flexibility.
The PPUA repeal is envisaged gradually: for 2020, 90%; for 2021, 80%; for 2022, 70%; for 2023, 50%; and, finally, it is expected to be fully repealed by 2024.
One of the core issues of this legal change is that several foreign investments were structured considering PPUA tax refunds within their flow estimations. However, due to the fact that it is being gradually abrogated, it is time for investors to reassess future cash flows of Chilean interests and the financing structures that were created based upon these rules.
Changes to the Tax-Deductible Expense Concept
Another relevant change in corporate taxation in Chile was the modification that involved tax-deductible expenditure. Prior to the Tax Reform, a company’s taxable income was determined by deducting those expenses that were necessary to produce such income.
The concept of "necessary" expense was not defined in Chilean income tax law and was therefore construed in a very restricted manner by the Chilean IRS. Before the legislative change, an expense was considered necessary if it was unavoidable and mandatory, and directly connected with the generation of income. This restricted interpretation caused a series of problems in expense deductibility; for example, payments for some labour benefits granted to employees were deemed as rejected expenses as they were not directly connected to any generation of income, or indemnities in regard of contract breaches were also deemed as such.
The Tax Reform stated that a necessary expense is that which has the "ability" to generate income, in the same or future periods, and it is associated with the business purposes of the company. With this, the narrow concept of necessary expense is much broadened and therefore companies will need to reassess such expenses that were not tax deductible in previous years and adjust accordingly.
Besides the general concept of tax-deductible expense, Chilean income tax law also contains specific examples of expenses that, provided certain requirements are met, are considered necessary expenses. These specific rules were also adjusted by the Tax Reform considering changes to the requirements for bad debts, remuneration of partners and owners of a company, and expenses derived from torts, among others.
Latest Developments and What's Coming Next
As mentioned above, there have been some other relevant developments in the Chilean tax scene recently. The issuance of the 2020 tax schemes catalogue by the Chilean IRS and the review of the special regimes and exemptions in Chilean tax law are two of the most relevant highlights.
Since 2016, the Chilean IRS has issued on a yearly basis a series of cases and situations that, in its view, may configure situations of abuse or tax non-compliance. The new catalogue includes ten new cases (five domestic and five international) and keeps 45 of the previous cases gradually added since 2016, totalling 55 cases.
The issuance of this yearly update follows the developments since the addition of a General Anti-Avoidance Rule (GAAR) to the Chilean Tax Code. The GAAR has not featured in a decision by the Chilean tax courts. However, there have been cases analysed under the GAAR by the Chilean IRS. The tax schemes catalogue states that the Chilean IRS has analysed 33 binding and 23 non-binding consultations referring to the application of the GAAR to specific cases.
Another significant development has been the review of the special regimes and exemptions in Chilean tax law. This task was an aim of the Chilean government since it was agreed upon in the legislative process that led to the approval of the Tax Reform in early 2020.
To perform the review, an expert commission – all of its members were economists and not a single tax practitioner was invited – was tasked to perform a full review of the matter. The experts worked on the basis of a report that was prepared for Chile by the International Monetary Fund and the OECD. In broad terms, the expert commission’s report goes over the special regimes and exemptions, assessing their fiscal impact and whether or not a review, change or elimination should be performed. It is expected that the outcome of this report, or at least some portion of it, will be addressed in a new tax reform bill to be considered in the near future.
Also, the developments in the political scene in Chile are likely to touch upon tax matters and tax policy. The process of drafting a new Constitution will be something to watch closely alongside the presidential election at the end of 2021.
As may be observed, the past years have been prolific in terms of new legislation and tax developments in Chile. Investors and taxpayers need to keep up to date with the latest modifications, not only to avoid non-compliance situations or falling into abuse scenarios such as the ones in the tax schemes catalogue, but most importantly to be in line with the changes taking place. These challenges, that come at a time when the Chilean IRS is very active in its assessment programmes, may be faced appropriately if they are foreseen and addressed under specialist advice.