Chile Tax Reform Overview
Chile’s President Michelle Bachelet has sent a major tax reform bill to congress that sets out to raise corporate taxes to finance better education. It is expected to be approved by Congress with no key changes and to be enacted before September of the current year. The goal of the reform is to raise additional tax revenue equivalent to 3 percentage points of GDP during Bachelet’s term in office, with 2.5pp coming from tax rate changes and 0.5pp from measures to reduce tax evasion.
Harris Gomez Group has outlined some of the key areas of the tax reform bill. It is currently being debated so there will be changes as it passes through the legislative process. We will keep our clients updated over the next few months, as more information is made available.
Core structure of the tax reform: Elimination of the Taxable Profit Ledger/Fund (FUT). What does this imply?
Since 1984 Chile has embraced an integrated tax system based on the fact that the corporate tax is burden upon accrual basis and then, once profit is withdrawn or paid abroad to partners or shareholders, income is taxed on a second level equivalent to personal taxation either with Withholding Additional Tax or Global Complementary Tax (supplementary tax or surtax) upon a distributed or cash basis profit. Therefore, the income that has being accrued but has not yet been paid to the owners of companies is taxable only by the corporate tax (First Category Tax) at a current rate of 20%.
The tax paid by the company may be used as a credit against the tax liability of the shareholders/partners once the income is withdrawn or distributed (keeping the record in an account ledger, known as “FUT,” used to track retained profits and the relevant tax credits). Under this feature the tax basis for company owners is upon cash flow and the corporate tax is creditable against withdraws or distributions.
The tax reform will not change the integrated tax system but will change the tax basis to an equal accrual basis (“attributed income”) for both companies and individuals.
This major adjustment will mean the end of the FUT.
Under this scheme the annual profits/income of a company would be deemed to be automatically distributed to its shareholders/partners at the calendar year-end, and companies that “attribute income” to their resident shareholders/partners will have to withhold 10% of their income “attributed”. Taxpayers (other than public trade corporations) would not be subject to the withholding obligation if their shareholders/partners or co-owners include only individuals domiciled or resident in Chile. Attributions (distribution) to non resident taxpayers would be subject to a 35% withholding tax, although this rate could be offset by a credit for the corporate tax paid on the “attributed income” maintaining the foundation of the integrated system.
Corporate income tax increases to 25%. Overall taxation adds up to 35%.
The corporate income-tax rate will increase to 25% in a four year period, as follows: 21% in 2014, 22.5% in 2015, 24% in 2016 and 25% in 2017.
In addition, the increase of 10% as a mandatory withholding tax on “attributed income” will burden shareholder on account of their final taxes. Taxpayers (other than public traded corporations) would not be subject to the withholding obligation if their shareholders/partners or co-owners include only individuals domiciled or resident in Chile, subject to Global Complementary Tax (supplementary tax or surtax).
As a result of the latter, the overall corporate tax burden will increase up to a 35% on dividends paid to non-resident shareholders. At the same time, since the integrated system will remain intact, the corporate tax will be still creditable against the withholding tax; therefore this final tax may not mean a further burden on the overall taxation of non-residents income withdrawn or distributed from Chile (withholding tax will remain with a 35% rate).
These novel rules will enter in force from year 2017.
Relief on Personal income tax
The top marginal rate of the personal income tax (and payroll tax) for a Chilean-resident individual is currently in a 40% rate. The tax reform proposes a reduction to 35% within this threshold.
The reduction of the rate of the payroll tax will be effective on the month following the publication of the law. The personal income tax rate will enter in force in 2017, although both reductions will face the examination of Congress and may not be approved on these terms.
Anti avoidance rules
General anti-avoidance rule (GAAR). Chile has just a few anti-avoidance rules and only recently and not without legal criticism, Chilean courts have adopted the “business purpose” and “economic substance” doctrines in aggressive tax planning, thus overcoming the lack of a GAAR. The tax reform will establish a wide variety of doctrines and methods gathered by the new bill to challenge agreements, contracts, structures or activities of companies carried out for the sole or main purpose of avoiding tax payment. The tax authorities will be able to deny tax benefits obtained through tax-avoidance planning and penalize the taxpayer, as well as its tax adviser who participated in the design of the legal and accounting structure.
In addition, “abuse” in compliance of the law will be deemed to exist in mergers, transformations and other conducts of business reorganizations. Under these terms, taxpayers will be able to challenge the submission of the GAAR before courts; nevertheless, there seems to be a wide margin of legal uncertainty that suggests restudying the appliance of the GAAR rules to specific cases.
The GAAR will become effective one year after the publication of the bill.
CFC rules. So far Chile is lacking of a proper control on foreign companies. On this behalf, the bill intends to prevent the deferral of tax on foreign-source profit in regard to passive income defined this latter as dividends, withdrawals of profits, interest, capital gains and royalties, among others. These incomes would be recognized on accrual basis by the Chilean resident controlling shareholder.
The CFC rules would become effective from 1 January 2015.
Thin capitalization rules. The bill maintains the ratio 3:1 debt to equity, nonetheless the rules that impose a 4% tax rate on interest will be modified and more strict norms will be incorporated to determine there is an excess of indebtedness. On these terms, the new provision would affect interest and any other expenses relevant to financing, such as commissions and remuneration.
These rules will enter in force in commercial year 2015.
Tax haven definition. Chile has a close list of tax heavens applying several rules to prevent tax avoidance through profit shifting or tax base erosion.
On this regard, the bill will characterize and establish an “open list” of tax heavens jurisdictions defining them as those that (i) tax foreign source income with less than 17.5%, (ii) have not entered into an information exchange agreement with Chile, (iii) do not have relevant transfer pricing rules, (iv) are identified as a preferential tax regime by the OECD, or (v) only taxes local source income.
This rule would be effective from 2015.
Transfer pricing rules (TPR). The bill incorporates to TPR export of assets or activities. In addition, the penalty tax composed of disallowed expenses and differences determined by transfer pricing adjustments would be increased from 35% to 40%.
The House of Representative has recently approved article 1 and 2 that contain the core structure of the tax reform commented above. Currently the bill is at the Senate in discussion but there are no major setbacks foreseen since the administration has enough votes for its approval. Nevertheless, political and technical issues should be still in debate for a few months and important adjustment may be done at the Senate before the bill is enacted and finally published.
Miguel Guerrero Fuentealba
Miguel recently joined our Santiago team as an Associate. His focus will be on advising clients on taxation, legal structures, labour law and other commercial matters. Miguel worked for Deloitte Chile where he was an International Tax Lawyer. He has an extensive amount of experience advising multinational clients on tax matters related to domestic legal compliance, tax planning, repatriation of capital and due diligence reports on tax and legal compliance.