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Chile: Further details regarding forthcoming tax reform legislation

Chile: Details regarding tax reform legislation

Chile’s president previously announced intentions for tax reform legislation that eventually would be presented to Congress.

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The legislation would introduce changes to modernize and simplify the Chilean tax system in an effort to promote investment, economic growth, and employment. Read TaxNewsFlash

Legislative text of the tax reform bill on 23 August 2018 was submitted to Congress—thereby giving a first look at the proposals that would affect income tax, value added tax (VAT), international tax regime, the taxation of capital gains, and the rules concerning the tax treatment of reorganizations, among others.

KPMG observation

The proposed tax reform would have implications for foreign non-treaty jurisdiction investors by reducing the current effective tax rate to 35% (from a maximum possible rate of 44.45%). U.S. investors in Chile could be most affected, given that the Chile-United States income tax treaty has not yet been ratified.

Details of the tax reform proposals

For foreign investors, the tax reform bill would have the following implications. 

Simplification of corporate tax system (full imputation credit against non-resident dividend withholding tax)

The proposed measures would provide substantially similar treatment for treaty and non-treaty investors  (currently the corporate tax could be different for treaty versus non-treaty investors), by allowing all investors to claim a credit equal to 100% of the corporate tax paid by the company (i.e., the imputation credit) against the 35% non-resident dividend withholding tax.

The proposed changes thus could provide all non-resident shareholders with an effective tax rate of 35% (reduced from 44.45% under the current rules). 

KPMG observation 

This reduction in the tax rate could be particularly relevant for U.S. investors in Chile, given that the status of the pending tax treaty. The United States is benefiting from a “transitory rule” until 31 December 2021 that is applicable with respect to countries with income tax treaties pending ratification.

Taxation of capital gains 

The legislation would introduce a reduced 20% rate for capital gains, only for resident and non-resident individuals.  In addition, the draft bill would eliminate joint liability for Chilean domestic entities for the collection of capital gain taxes on indirect dispositions of stock and other underlying assets located in Chile. 

Permanent establishments

The proposed legislation would align the Chilean domestic law definition of “permanent establishment” with the OECD definition, with some minor differences.

The new definition would offer greater certainty for treatment as a permanent establishment if the taxpayer develops its activity in Chile in a permanent or recurrent manner through an office, agent, installation, construction project, or branch. 

The legislation would clarify that only a dependent agent could result in a permanent establishment and that preparatory and auxiliary activities would not give rise to a permanent establishment. 

International reorganizations

The legislative proposals would provide rules allowing for tax-free treatment for non-Chilean mergers or spin-offs that involve assets located or registered in Chile, provided that the legal implications of such reorganizations are similar to the legal consequences of a purely domestic reorganization. 

The same treatment would apply to a cross-border merger involving a Chilean resident company, provided that the Chilean company survives the reorganization process. 

Withholding taxes on interest from back-to-back loans

The legislative text provides that the current reduced withholding tax (a rate of 4%) on interest paid would only apply when the ultimate beneficiaries are banks, financial entities, insurance companies, and pension funds (under the current rules, back-to-back structures could benefit from the 4% reduced rate).

The proposed legislation does not provide a definition of “ultimate beneficiary,” however; the preamble of the draft legislative text establishes a 35% withholding tax rate for all other situations not included in the above list (unless a lower rate could be applicable under existing double tax treaty).

Thin capitalization rules

Under current law, thin capitalization rules apply to loans from related parties and to loans from unrelated parties when the loan is guaranteed by a third party. 

The legislation would change the guarantee rules so that they would only apply if such guarantee is provided by a non-Chilean resident related party that is final beneficiary of the interest. The legislation would also expand the exemption from the thin capitalization rules to “project finance”—broadly defined as funding for the development, expansion or improvement of one or more projects in Chile. Under the proposed measures, such loans would not be treated as related-party loans if the taxpayer could show that the majority of the lenders are not related to the borrower and that the terms and conditions of the funding are consistent with the arm’s length standard.

Taxation of digital services

The legislation would provide a 10% flat tax on digital services provided to Chilean resident individuals by non-resident service providers. The tax would be expected to be collected through credit card charges at the time of payment for the services.  The draft bill does not include any changes to the current rules applicable to payments for digital services provided to non-resident providers made by resident entities.

Deductible expenses

Taxpayers would be allowed to deduct the following items under measures in the tax reform draft legislation:

  • 50% of the investment in new or imported capital assets, which can be expensed immediately, for investments made during the 24-month period after enactment of the legislation; the remaining 50% could be expensed under general tax depreciation rules 
  • Deductions of certain other expenses—such as bad debts, environmental mitigation expenses, expenses related to certain reorganizations, and contractual and court imposed penalties). Under current law, the deduction of these expenses has often been challenged by the tax administration and in the courts.

Taxation of stock-based compensation plans

The legislation would introduce rules for taxation of stock-based compensation plans—distinguishing the tax treatment of the compensation upon granting, vesting, and exercise, as well as the transfer of the option.

VAT-related reforms

The legislation would reduce the refund period from six months to two months, for value added tax (VAT) credit balances in the purchase or construction of capital assets. The period established for the tax administration to resolve the application would also be reduced—from 60 days to five days.  

 

For more information, contact a tax professional with KPMG’s Latin America Markets Tax practice or with the KPMG member firm in Chile:

Devon M. Bodoh | +1 (202) 533-5681 | dbodoh@kpmg.com

Alfonso A-Pallete | +1 (305) 913-2789 | apallete@kpmg.com

Francisco Lyon | +56 229 971 400 | flyon@kpmg.com

Rodrigo Stein | +56 229 971 341 | rodrigostein@kpmg.com

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