The new tax reform bill provisions would make significant changes to taxation in Chile—such as providing for an elective taxation system and a gradual increase to the corporate tax rate. The tax reform bill aims to increase tax revenue in order to fund investment in education, reduce social inequality, and prevent tax avoidance.
Current tax regime
Under the current tax regime, Chile has an integrated tax system whereby the corporate income tax (also referred to “the first category tax”) paid by a Chilean entity, is added to the foreign shareholder tax (also referred to “the additional tax”) paid by the shareholder for a combined Chilean tax burden of 35%.
Under this integrated system, profits are taxed at the corporate level at a current 20% rate. When profits are distributed to foreign shareholders, an additional 35% withholding tax applies (i.e., the foreign shareholder tax).
Nevertheless, foreign shareholders can claim the corporate income tax paid as a credit. In other words, under Chile’s integrated system, the net withholding tax (foreign shareholder tax) on dividends is 15%—i.e., the difference between the 35% (foreign shareholder tax) and the underlying credit deriving from the corporate tax paid of 20%.
Descriptions of proposed changes
The tax reform bill provides the following significant changes:
1. Election to be taxed under “attribution regime” or “alternative regime”
Effective 1 January 2017, taxpayers would be able to elect to be taxed under one of two different regimes—the “attribution regime” or the “alternative regime.”
- Attribution regime - Under the attribution regime, the foreign shareholder would be fully taxed at 35% on profits obtained in Chile. However, unlike the current foreign shareholder tax, this tax would be assessed whether those earnings are actually distributed or not. In any event, the taxpayer would receive a credit of 100% of the underlying corporate income tax paid by the subsidiary to offset this tax. In other words, profits, withdrawals, and actual distributions by the Chilean entity would be attributed to the foreign shareholder on a current basis.
- Alternative regime - Under the alternative regime (which is similar to the current regime), the foreign shareholder would be taxed when business profits are distributed. The main difference between the alternative regime and the current regime is that the foreign shareholder would have a 100% credit for the corporate income tax paid (at the rate of tax in effect when the profits are distributed) but, at the same time, would have to reimburse as a fiscal debit, an amount equal to a 35% of the credit amount. This would result in an aggregate effective tax rate of 44.45%. The reimbursement of the 35% amount would not apply in the case of a non-Chilean resident that is a resident in a country that has an income tax treaty for the avoidance of double taxation in force with Chile. Accordingly, the effective total tax burden would be 35% for investors that are residents in countries with an income tax treaty in force; for the rest of the foreign investors, the effective total tax burden would be 44.45%.
It is important to note that under either regime, the accumulated profits generated before the legislation is enacted may be grandfathered and would remain subject to the existing rules and, thus, taxed pursuant to the foreign shareholder tax only if distributed to the foreign shareholder.
2. Gradual increase to the corporate income tax rate
As proposed, the corporate income tax rate for taxpayers electing to be taxed under the attribution regime would increase gradually from 20% to 25%.
For taxpayers electing the alternative regime, the corporate income tax rate would be increased to 27%.
The phase-in of the corporate income tax rate increase is proposed as follows:
- 21% in 2014
- 22.5% in 2015
- 24% in 2016
- 25% (attribution regime) or 25.5% (alternative regime) in 2017
- 25% (attribution regime) or 27% (alternative regime) in 2018 and later
3. Thin cap rules
The draft bill would modify the thin capitalization rules, to further severely restrict the ability to fund investments in Chile with related-party loans.
Unlike thin capitalization rules in other jurisdictions, the Chilean thin capitalization rules do not aim to characterize interest as dividends or to disallow the deduction of interest expense at the level of the debtor. Under current rules, interest paid to a foreign lender generally is subject to a 35% withholding tax or 4% in case of foreign banks or financial institutions.
If in a given tax year, any portion of the interest that is attributed to “excessive indebtedness” is subject under the Chilean thin capitalization rules to tax at a 31% entity-level income tax borne by the Chilean borrower, in addition to the 4% non-resident income tax withholding that is borne by the foreign creditor.
The additional 31% entity-level income tax is not withheld at source; instead, this tax is borne by the Chilean borrower and constitutes a deductible expense for purposes of corporate income tax.
For these purposes, “excessive indebtedness” is defined as that which exceeds three times the debtor’s adjusted tax equity in the year it was incurred (3-to-1 debt-to-equity ratio). Only related-party loans subject to the reduced withholding tax rate of 4% are counted towards the “excessive indebtedness” computation.
According to the tax reform proposals, in order to determine if there is excess of indebtedness, all debt would have to be considered regardless of whether or not it is held by related parties in Chile or abroad, without prejudice of the taxation in the event of excess of indebtedness being applicable only with regards to related-party loans from abroad subject to the 4% rate or exempted.
Under the proposals, the 3:1 debt-to-equity limit would be tested annually, in lieu of the one-time test that is currently applied upon disbursement of each loan.
The new rules would apply from 1 January 2015 and would apply only to loans obtained after 1 January 2015.
4. Tax avoidance rules
The bill also attempts to align Chilean tax legislation to the Base Erosion and Profit Shifting (BEPS) standards and would introduce the following:
- General anti-avoidance rules applicable to agreements, structures or other activities performed by companies when such activities are carried out for the sole or principal purpose of avoiding taxes
- Controlled foreign corporation (CFC) rules
- Modifications to the rules regarding deductions with foreign entities
- Adjustments to the existing transfer pricing
Given the anticipated September action on the proposals, multinational companies with Chilean operations need to:
- Understand the proposed changes and anticipate their potential impact
- Consider the modeling of the potential tax (both in Chile and in the country of residence, such as the United States) of the proposed changes
- Consider what necessary, potential steps/actions need to be taken now
For more information, contact a KPMG tax professional with:
U.S. Latin America Markets, Tax
Devon M. Bodoh, Principal in Charge
+1 202 533 5681
Alfonso A-Pallete, COO
+1 305 913 2789
+1 305 341 6424
KPMG in Chile
Francisco Lyon, Partner
Rodrigo Stein, Partner
Mauricio Lopez, Partner