The Private Wealth & Private Client Review: Chile
Chile is a democracy with a president elected by popular vote. Legislative power is exercised by a bicameral congress, which is also elected by popular vote. The election process of authorities has been democratic throughout the past 30 years, with successive transitions between left and centre-right governments. After several riots starting in October 2019, Chile's Congress reached an agreement for a democratic process to reform the country's constitution. A national referendum was scheduled for April 2020 to determine whether citizens would agree to initiate a constitutional process, but it was postponed until October 2020 because of the covid-19 outbreak.
Chile's political economy is considered stable. Its primary industries are related to the export of natural resources such as minerals and metals (mostly copper), produce, lumber and forestry by-products, and fish.
From a tax perspective, Chile and Colombia are currently the only members of the Organisation for Economic Co-operation and Development (OECD) in South America. At the time of writing, Chile has double taxation treaties in force with the following countries: Argentina, Australia, Austria, Belgium, Brazil, Canada, China, Colombia, Croatia, the Czech Republic, Denmark, Ecuador, France, Ireland, Italy, Japan, Korea, Malaysia, Mexico, Norway, New Zealand, Paraguay, Peru, Poland, Portugal, Russia, South Africa, Spain, Sweden, Switzerland, Thailand, the United Kingdom and Uruguay. A double taxation treaty has been signed but is not yet in force with the following countries: United States, United Arab Emirates and India. In addition, Chile has signed the OECD's Convention on Mutual Administrative Assistance in Tax Matters.
In recent years, a number of tax reforms have been introduced that are in line with OECD regulations. In 2012, indirect transfer and transfer pricing regulations were incorporated in the Income Tax Law (ITL). In 2014, Law No. 20,780 and subsequent Law No. 20,899 (which simplifies aspects of Law No. 20,780) were enacted (hereafter, the 2014 Tax Reform). These two pieces of law introduced significant changes to Chilean tax legislation, and entered into force progressively until complete effectiveness on 1 January 2017. After almost two years of legislative discussion, in February 2020, Law No. 21,210 was published, with the objective of correcting and modernising Chile's tax legislation (hereafter, the 2020 Tax Reform).
In the context of this tax reforms, the Chilean Internal Revenue Service (SII) has been issuing numerous regulations and opinions in the form of Official Letters, Instructions and Rulings, clarifying the practical application of the recent tax modifications.
i Individuals taxation
In general terms, individuals domiciled or resident in Chile and legal entities incorporated in Chile are subject to taxation on their worldwide income. On the contrary, non-resident and non-domiciled individuals or legal entities are subject to taxation on their Chilean source income.
Taxpayers domiciled or resident in Chile are subject to second category tax or global aggregate tax depending on the nature of the income obtained. Employment income obtained from the exercise of liberal professions (independent or dependent workers) is subject to second category tax, ranging from 0 to 40 per cent (progressive tax) monthly.
On the other hand, any income other than employment (i.e., interests, dividends and capital gains, among others) that an individual receives is subject to global aggregate tax at the same rate as second category tax, but annually.
ii Foreign taxpayers
Taxpayers that are not domiciled or resident in Chile are subject to additional tax or withholding tax on their Chilean source income at a general rate of 35 per cent.
The above rate may be reduced (or even exempt) depending on the type of income or circumstances surrounding the transaction, such as the application of a double taxation treaty.
iii Corporate taxation
In general, the net taxable income of a corporation is calculated annually by deducting from the year's gross revenues all deductible expenses. The 2020 Tax Reform substantially changed the concept of deductible expenses, expanding the concept to include those expenses that have the ability to generate income, regardless of whether they generate income in the future; and, including expenses that are related to the interest, development or maintenance of the business and that have not been imputed as a cost.
In accordance with the provisions of Law No. 21,210 that modernises the tax legislation, as of January 2020, three new tax regimes are in effect for companies to determine their corporate income tax (first category tax, FCT): General Regime, Pro-Small and Medium Enterprises Regime (hereafter, the Pro-SMEs Regime) and the Transparent Pro-Small and Medium Enterprises Regime (hereafter, the Transparent Pro-SMEs Regime).
In general terms, SMEs are entities that annually accrue gross income that do not exceed approximately US$2.7 million. Relation rules are applicable for the purposes of preventing tax avoidance using multiple legal entities.
Under this regime, shareholders or partners are only taxed on the effective distribution of dividends or profits by the legal entity.
In general terms, taxable income generated by a SME will be subject to 25 per cent FCT. Additionally, shareholders or partners are able to use the FCT paid by the legal entity as a credit against additional tax or global aggregate tax.
In addition, the Pro-SMEs Regime has other additional benefits such as the option of keeping simplified accounting records, release from monetary correction rules and application of instant depreciation rules.
Transparent Pro-SMEs Regime
In general terms, the Transparent Pro-SMEs Regime is an option for those SMEs owned only by individuals. In this case, the company will not pay income tax and its owners will pay personal tax directly on the company's income. As a result, these companies are not subject to Corporate Tax.
In addition, the Transparent Pro-SMEs Regime has other additional benefits such as the option of not keeping accounting records, the ability to determine its tax basis over the entities' cash flows, they are not subject to rejected expense rules, release from monetary correction rules and application of instant depreciation rules.
Under the General Regime, also called the Partially Integrated Regime, shareholders or partners are only taxed on the effective distribution of dividends or profits by the legal entity.
The FCT rate for the Partially Integrated Regime is 27 per cent. Additionally, shareholders or partners are only able to use 65 per cent of FCT paid by the legal entity as a credit against additional tax or global aggregate tax. Under this regime, final taxpayers are required to reimburse 35 per cent of FCT credit available. This results in FCT credit being limited to 65 per cent of FCT paid at the legal entity's level.
Taxpayers under this regime, whether local individuals or foreign shareholders or partners, are subject to a maximum overall taxation of 44.45 per cent over distributed income (despite being in the global aggregate tax rate of 40 per cent).
An exception to the 35 per cent FCT credit reimbursement applies to foreign shareholders or partners who are domiciled in a country that has a double taxation treaty with Chile,2 making the total tax under a treaty scenario return to a 35 per cent rate over the effective distribution of dividends or profits.
While double taxation treaties signed by Chile provide different rates for dividend and profit distributions, these dispositions do not apply to distributions made from Chile. In fact, Chile has made a reserve regarding the application of dividend distribution reduced rates (the Chile Clause) as long as FCT is creditable against additional tax. Thus, all dividend distributions made to a foreign taxpayer domiciled in a treaty country would still be subject to additional tax at a rate of 35 per cent.
Dividend or profit distributions within Chilean legal entities are not subject to tax.
Companies that meet the SME requirements can choose the tax regime applicable when they file for their initiation of activities with the SII. Taxpayers that do not exercise their option within the terms stated in the law will be subject to their default regime as determined by the ITL.
iv Real estate taxation for individuals
In general terms, capital gain generated by individuals domiciled or resident in Chile for the sale of one or more real estate assets is subject to global aggregate tax.
Notwithstanding the above, a single and substitutive tax of 10 per cent, and a non-taxable gain of 8,000 units of account (UF)3 may apply if the sale is to an unrelated party and is carried out after one or four years have elapsed from the acquisition (depending on the type of real estate sold). This capital gain is determined by the difference between the tax basis for the asset, calculated as the acquisition price adjusted by local inflation (by the Chilean Consumer Price Index), and its sale price.
In relation to the sale price, the Chilean Tax Code requires that the sale price be at fair market value (FMV). If this is not the case, the SII will have the power to assess the transaction and collect the taxes that would have applied if the transaction had been executed at FMV (as determined by the SII). However, if the real estate was acquired by the individual before 31 December 2003, the sale may not be subject to tax.
From a value added tax (VAT) perspective, the 2014 Tax Reform included the alienation of real estate property in the concept of 'sale', provided it is carried out by taxpayers that have the nature of sellers (and therefore deemed as habitual).
The sale of real estate property and other special transactions assimilated to sales, as long as they are made by sellers, is liable to VAT at the rate of 19 per cent. In the application of VAT to these transactions, the value of the land is excluded from the VAT-taxable base. In this sense, the sale of land is not subject to VAT.
v Direct capital gain taxation for individuals
The ITL states that income related to goods located or activities developed in the country are deemed as Chilean source income. In this sense, shares of a company incorporated in Chile are deemed as Chilean source income. Therefore, the gain generated in the sale of shares of an entity incorporated in Chile is considered as Chilean source income and is subject to tax regardless of whether the taxpayer is foreign or not.
The capital gain is equal to the positive difference between the tax basis calculated as the acquisition value of the shares duly adjusted by inflation (by the Consumer Price Index), and its sale price.
In relation to the sale price, and as already mentioned regarding real estate, the Chilean Tax Code requires that the sale is executed at FMV.
The capital gain obtained as a result of the disposition of shares will be subject to the general tax regime stated in the ITL; that is, FCT at the rate of 25 or 27 per cent (depending on the regime) if the transferor is a Chilean-incorporated company, or global aggregate tax if the taxpayer is an individual domiciled or resident in Chile. In the latter case, if the sale is to an unrelated party, the individual may choose to consider that the capital gain has been accrued during the period of years that the shares have been in his or her possession, up to a maximum of 10 years. For these purposes, global aggregate tax shall be recalculated for each corresponding year.
The capital gain obtained by a foreign taxpayer should be subject to withholding tax (WHT) at the rate of 35 per cent. Under a double taxation treaty scenario, the rate may be reduced.
Finally, the sale of shares of corporations with a Chilean stock market presence that fulfils the requirements of Article 107 of the ITL is not subject to tax.
vi Indirect transfer
Another relevant rule to be taken into account is the regulation of indirect transfer of Chilean underlying assets through the sale of foreign entities, enacted in 2012.
In general terms, indirect transfer rules apply if 10 per cent or more of a foreign entity is sold, at least 20 per cent of the total market value of the shares, quotas and titles of foreign rights is represented by the Chilean underlying assets, and the Chilean underlying assets have an FMV greater than 210,000 annual tax units (UTA).4 Indirect transfer rules would apply, regardless of the percentage sold, if the foreign entity being transferred is located in a tax-haven jurisdiction and certain requirements set by the law are met.
vii Transfer pricing
In 2012, Article 41E on transfer pricing was introduced to the ITL. This regulation defines terms as 'related parties', 'applicable methods', and the declaration obligations and transfer pricing adjustments.
Taxpayers who carry out cross-border transactions governed by this regulation must have and keep a transfer pricing study that supports the methods applied to their transactions, available for the relevant tax authority.
Chilean regulations include methods in line with the OECD regulations, such as comparable uncontrolled price, resale price, cost-plus margin, profit-split and transactional net margin. The regulation also considers the use of any other method if it is the most appropriate, considering the advantages and disadvantages of each one.
Regarding tax compliance, a transfer pricing's affidavit must be annually submitted on the last business day of the month of June. It must be submitted by medium or large companies that have carried out transactions with foreign related parties for amounts exceeding 500 million Chilean pesos; and by taxpayers who have carried out transactions with persons domiciled or residing in a country or territory considered a jurisdiction with a preferential tax regime. If the Chilean company qualifies as a large taxpayer, transfer pricing regulations will apply regardless of the amount of the transaction.
According to this regulation, if the affidavit is not submitted or is submitted with errors, incomplete or late, a fine of 10 to 50 UTA should apply.
viii Withholding tax
Under Chile's general tax regime, interests and services paid abroad are subject to a tax rate of 35 per cent. For royalties, the WHT rate is 30 per cent. In some cases, such rates may be reduced under local regulation or under a double taxation treaty scenario.
In the case of interests, any amount paid or made available to a foreign creditor as interest derived from credits granted by foreign or international banks or foreign financial institutions may be subject to a final 4 per cent WHT, given some requirements are met.
ix Foreign tax credit
In terms of foreign tax credit (FTC), the ITL makes a distinction between treaty and non-treaty countries. Under a non-treaty scenario, foreign taxes are only creditable in Chile in relation to dividend income, income derived by permanent establishments, royalties, employment and independent professional services, and remunerations for technical assistance or similar services. Taxes charged overseas on any other income cannot be used as tax credit. Under a treaty scenario, all income taxes included in the respective treaty can be creditable in Chile.
In general terms, the tax credit available for taxes charged overseas is capped at 35 per cent. Note that the excess of FTC may be carried forward.
x Foreign exchange regulations
Chile does not limit the entry or repatriation of funds. Nevertheless, all transactions exceeding US$10,000 must be informed to the Chilean Central Bank.
xi Regulation on controlled foreign corporations
The 2014 Tax Reform incorporated into Chilean legislation regulations on controlled foreign corporations (CFCs). This regulation represents an exception to the general rule of recognition of income from a foreign source on a cash basis.
In general terms, this regulation establishes that, if certain control hypotheses are met, the Chilean taxpayer must recognise income generated by a foreign controlled entity on an accrual basis. This regulation is only applicable to the passive income obtained by the foreign controlled entity, and therefore it does not include income generated by foreign controlled entities that carry out an active business.
In 2018, the SII confirmed that – for CFC purposes – there is no relationship between an individual and their spouse or their relatives, but there is between any of them and the respective company. This interpretation may be useful when evaluating a structure. However, there are multiple factors, exceptions and legal assumptions that must be considered when attempting to create a structure with a Chilean holding company that holds investments abroad.
xii General anti-avoidance rules
The 2014 Tax Reform incorporated Articles 4-bis, 4-ter and 4-quater of the Tax Code, establishing the general anti-avoidance rules (GAAR).
The purpose of these regulations is to prevent Chilean taxpayers from evading tax regulations through abuse or simulation. These rules are of an exceptional nature and will not apply if there is a special anti-avoidance rule to prevent avoidance (such as transfer pricing regulations or rejected expenses penalty tax, among others).
In addition, these rules recognise the principle of good faith in tax matters, the effects that arise from the acts or contracts celebrated and the legitimate option of the taxpayer to choose among the various mechanisms provided by the law.
GAAR regulations define abuse and simulation. Abuse is understood to exist when there is a taxable event that may be totally or partially avoided or diminished, or when the generation of the tax obligation is postponed or deferred. Those transactions, analysed as a whole, shall be considered abusive if they solely intend to cause tax effects and do not produce relevant economic or legal effects. On the other hand, simulation would be deemed to exist in those acts that conceal the configuration of a taxable event, simulate the nature of its elements, the true amount of the tax obligation or the date of the same.
If the tax authority considers that abuse or simulation exists, the taxpayer must first be challenged by the Director of the SII to subsequently follow a judicial procedure before the Tax and Customs Courts.
In addition, GAAR regulations state that individuals or legal entities who have contributed in the planning of the acts, contracts or businesses that are considered abusive or elusive by the authority shall be subject to a fine of up to 100 per cent of all taxes that should have been paid according to the tax authority's criteria if the abusive or elusive conduct had not been carried out (this fine is capped at 250 UTA).
Although GAAR regulations were enacted in 2015, there has not yet been any practical application by the SII.
Wealth structuring and regulation
Currently, the use of foreign foundations or trusts by Chilean taxpayers has diminished, in part owing to the enactment of CFC regulations.
On the other hand, Chilean taxpayers with existing foreign structures that were not in compliance with local regulations took advantage of the temporary tax amnesty included in the 2014 Tax Reform.
This special tax amnesty allowed the disclosure and recognition of previously undeclared foreign source income at a flat 8 per cent tax rate. The funds that were subject to this alternative tax are considered to have fully complied with their final taxation; hence, taxpayers can freely repatriate or invest these funds abroad without further taxation. However, the return obtained over these funds will be subject to taxation under the general rules.
In recent years, partnerships with their equity divided by shares (SpAs) have been one of the most common corporate structures in Chile. This legal form has attributes from both partnerships and corporations, it has limited liability for its shareholders and it allows flexibility in its administration without the need to establish a board of directors or hold shareholders' meetings regularly.
In this sense, the legislator gave freedom to the shareholders to include particular regulations in the by-laws with few limitations. One of its particularities is that its shares can be owned by a sole shareholder without triggering its absorption or dissolution (as would be the case for a corporation or partnership that requires at least two shareholders or partners).
High net worth individuals and families have made the signing of family protocols and shareholder agreements frequent. These instruments seek to regulate the operation, administration and eventual sale of family businesses, seeking to achieve harmonious transitions through family generations and allow the efficient use of resources.
These protocols and agreements are made separately from, or are often incorporated directly into, the by-laws of SpAs, generating a single document that regulates relationships between family members efficiently.
Common clauses include, among others, the creation of different classes of shares with preferential economic or political rights, veto powers, and first offer, drag-along or tag-along clauses.
Outlook and conclusions
Chile is a stable country with a broad treaty network and a strong financial system, making it a good alternative for foreign investors that look for a Latin American holding company or investment platform.
From a tax standpoint, Chile has in recent years undergone a series of tax reforms that have introduced new Tax Regimes, CFC, transfer pricing and GAAR regulations, and digital taxes, among others.
1 Pablo Chechilnitzky R is a partner at Recabarren & Asociados.
2 Law No. 21.210 makes this exception applicable to countries that have signed double taxation treaties with Chile before 1 January 2020, but are not yet in force (United States). This exception applies until 31 December 2026.
3 A reference monetary unit used in Chile.
4 A reference monetary unit used in Chile.