Chile – Tax reform implications for foreign investors
The enacted tax reform legislation introduces significant changes to Chile’s tax regime with measures that, among other items, are intended to increase tax revenue.
Foreign shareholders will want to consider the effect of making certain elections (described below) and of making adjustments to their current structures, to address the potential Tax reform implications of the tax reform to their operations in Chile.
Prior tax law
Under the prior tax regime, Chile had an integrated tax system whereby the corporate income tax (also referred to as the “first category tax”) paid by the Chilean entity was added to the foreign shareholder tax (also referred to the “additional tax”) paid by the shareholder, for a combined Chilean tax burden of 35%.
This integrated system imposed tax on profits at the corporate level, at a rate of 22.5%. When profits were distributed to foreign shareholders, an additional 35% withholding tax applied (i.e., the foreign shareholder tax).
However, foreign shareholders could 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 was made at a rate of 12.5%—i.e., the difference between the 35% foreign shareholder tax and the underlying credit deriving from the corporate tax paid of 22.5%.
Tax reform provisions
The tax reform legislation (enacted in autumn 2014) allows taxpayers to elect to be taxed either under an attribution or under alternative regime. Certain provisions have an effective date of 1 January 2015, but the regime elections described below are effective 1 January 2017.
Effective 1 January 2017, taxpayers can elect to be taxed under two different regimes—the “attribution regime” or the “alternative regime.”
- Attribution regimeUnder the attribution regime, a foreign shareholder is fully taxed at 35% on profits obtained in Chile. However, unlike the prior foreign shareholder tax, this tax will be assessed whether earnings are actually distributed or not.
In any event, the taxpayer will 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 of the Chilean entity will be attributed to the foreign shareholder on a current basis.
- Alternative regimeUnder the alternative regime (similar to the prior tax regime), the foreign shareholder is taxed when business profits are distributed.
The main difference between the alternative regime and the prior regime is that the foreign shareholder will have 100% credit for the corporate income tax paid (at the rate in effect when the profits are distributed), but at the same time, will have to reimburse as a fiscal debit, an amount equal to a 35% of the credit amount. This results in an aggregate effective tax rate of 44.45%.
The reimbursement of the 35% will not apply for non-Chilean residents that are residents in countries that have an income tax treaty for the avoidance of double taxation in force with Chile. Accordingly, the effective total tax burden will be 35% for investors that are residents in countries with an income tax treaty and 44.45% for the remainder of foreign investors.
Under either regime, the accumulated profits generated before the tax reform bill was enacted may be grandfathered, and will remain subject to the existing rules and subject to tax as foreign shareholder tax only if distributed to a foreign shareholder.
Gradual increase to the corporate income tax rate
The corporate income tax rate for taxpayers electing to be taxed under the “attribution regime” (described above) will increase gradually from 20% to 25%.
For taxpayers electing the alternative regime, the corporate income tax rate will increase to 27%.
The phased-in increase of the corporate income tax rate is to be made according to the following schedule:
- 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
Thin capitalization rules
Effective 1 January 2015, the tax reform legislation also modifies the thin capitalization rules, so as to limit (severely restrict) the ability to fund investments in Chile with related-party loans.
Under the previous “thin cap” rules, interest paid to a foreign lender generally was subject to a 35% withholding tax (4% in instances involving foreign banks or financial institutions).
Beginning in 2015, in a given tax year, any portion of the interest is attributed to “excessive indebtedness,” the Chilean thin capitalization rules subject such interest to tax, with 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—a 3-to-1 debt-to-equity ratio. Only related-party loans subject to the 4% reduced withholding tax are counted towards the “excessive indebtedness” computation.
Under the tax reform provisions, to determine if there is excessive indebtedness, all debts must be considered—regardless whether or not the indebtedness is held with related parties—in Chile or abroad, and without prejudice of the taxation in the event of excess indebtedness being applied only with regards to related-party loans, made from abroad, and subject to the 4% rate or exempted.
The 3:1 debt-to-equity limit is tested annually (instead of the one-time test applied under prior law, on disbursement of each loan).
The revised thin capitalization rules apply only for loans issued after 1 January 2015.
Tax avoidance rules
The tax reform legislation also attempts to align Chilean tax law to the base erosion and profit shifting (BEPS) standards and introduces the following concepts:
- 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
KPMG’s America Markets Team