Chile's current FUT (Fondo de Utilidades Tributables or Taxable Profits Fund Ledger) mechanism promotes reinvestment in Chile by deferring shareholder-level taxation (effectively 15% to 18%) where profits are reinvested in Chile rather than being distributed to shareholders.
Under the current system, a company's taxable profits are subject to corporate income tax at 20% (17% for years prior to 2011). When profits are distributed, shareholders pay tax at 35% on the distribution, subject to a credit for underlying corporate taxes. Thus, shareholders should only be subject to tax at an effective rate of 15% or 18%, depending on whether the underlying profits were subject to tax at 20% or 17% (note it is not possible to reduce the shareholder-level tax under any of Chile's tax treaties). The FUT is a special ledger that tracks retained profits and the corresponding tax credit.
The FUT regime will be eliminated as part of the proposed reforms, resulting in all profits being immediately taxable at 35% effective 2017. This change reduces the incentive for international groups to reinvest in Chile. It is expected that the elimination of the FUT mechanism, together with the proposed reforms set out below, will affect Chilean companies in one or more of the following ways: decreased cash flow and profitability; pressure on dividend policies; increased working capital needs; potential weakening of debt structure; rising borrowing costs; and discouraging investments in projects.
The key corporate income tax proposals:
- Incrementally increase the corporate income tax rate to 25% (from 20%) by 2017.
- Introduce a 35% accrual tax for shareholders on corporate earnings, with a credit for underlying corporate taxes, effective 2017. This effectively increases the tax rate on all income to 35%, whether or not distributed. Consequently, retaining or reinvesting earnings in Chile will no longer result in a tax deferral.
- Maintain the existing regime for taxable income earned before the accrual regime comes into effect. Distributions will be deemed paid first from post-2016 taxable income; shareholder-level tax on pre-2017 income will continue to be deferred until distributed.
- Eliminate the current deductibility of interest and other financing costs associated with the direct or indirect acquisition of shares, equity rights, bonds or any other securities. These costs will instead be added to the tax basis of the assets acquired. This change effectively precludes any immediate tax relief for borrowing costs related to corporate acquisitions or takeovers, and therefore will impact the after-tax cost of M&A transactions.
- Limit the deduction by corporations of accrued amounts owed to foreign related parties. These amounts will have to be paid, and the withholding taxes remitted, before a deduction is allowed.
- Introduce a general anti-avoidance rule to disallow benefits from transactions that are "abusive, contrived, or aggressive", including penalties for both taxpayers and their advisors.
- Increase the maximum stamp tax rate to 0.8% (from 0.4%) effective January 1, 2016.
- Discontinue entering into agreements with foreign investors under Decree Law No. 600 to suspend foreign exchange controls or provide any other benefits to these investors effective January 1, 2016. However, Chile will honour its existing agreements.
- Increase the tax rate on capital gains on certain share dispositions by non-residents from 20% to 35%. The 20% rate currently applies to shares held long term and sold to unrelated parties. Under the proposals, such dispositions will be subject to a 35% tax rate regardless of how long the shares were held. The proposals increase the tax cost of shares held by non-residents by their proportionate share of corporate retained earnings (since this amount will already be taxed at 35% under the new regime).
Overall, the proposed tax reforms will substantially increase the tax cost of foreign investment into Chile at all stages of the investment cycle, including:
- Acquisition: denial of relief for acquisition financing costs, and an increase in stamp taxes on any acquisition loans
- Generation and reinvestment of earnings: effective tax increase to 35% (from 20%) on reinvested earnings (by accelerating the tax on undistributed earnings)
- Exit: increase in the effective capital gains tax rate to 35% (from 20%). This change must be considered in light of Chile's comprehensive rules for taxing "indirect" disposals (i.e., sale of the shares of offshore holding companies), enacted in 2012, which taxes transfer of a significant interest in a Chilean corporation.
For more information, contact your KPMG adviser.
Information is current to May 13, 2014. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500