Reforms Relevant to Foreign Investors
INTEGRATION OF THE CORPORATE TAXES AND THE DIVIDEND WITHHOLDING TAX
Foreign investors resident in a jurisdiction that has not entered into a tax treaty with Chile can only credit 65% of the corporate income tax towards the dividend withholding tax. Under the proposed tax reform, these investors would benefit from a full corporate income-tax credit towards the dividend withholding. In practice, this may imply up-to a 945 bps reduction (9,45%) in the aggregate tax burden in Chile.
Now, this full integration is not necesarilly good news for foreign investors resident in a jurisdiction that has entered into a tax treaty with Chile. These investors already benefit from full integration, and as a result of the proposed tax reform, will likely suffer a reduction of the tax credits that they can claim towards the dividend withholding tax. Indeed, under the new fully-integrated regime, the corporate-tax credit will be determined as the average of accumulated credits. In most cases, this average may be significantly lower than the 27% credit that such investors are allowed to credit under existing rules.
No significant changes have been proposed to imputation rules. In other words, dividend distributions will be subject to withholding tax to the extent that the company has retained taxable or financial earnings.
CAPITAL GAINS TAX
No changes were proposed to the rules that govern the taxation of capital gains on the direct or indirect transfer of Chilean entities. A reduced capital-gains tax rate of 20% has been proposed, but it only benefits Chilean resident individuals.
The bill proposes the ability to deduct from the corporate tax basis, 50% of any new or imported fixed assets acquired as part of a new investment project (broadly defined), provided such investment is made during the 24-months following the enactment of the tax reform. The remaining 50% may be amortized pursuant to the general rules (normal or accelerated depreciation).
GENERAL ANTI-AVOIDANCE RULE (GAAR)
The proposed amendments to the Chilean GAAR are likely to draw significant discussion in Congress. The reform bill tries to correct the vagueness and ambiguities of the GAAR. The discussion in Congress will focus on whether the proposed amendments, in making the rule more specific, narrow its scope of application.
Concretely, abuse of form, which is one of the potential conducts that are captured by the GAAR, would need to be “notoriously artificial.” Moreover, form would not be abused if, compared to the eluded action, the steps taken by the taxpayer have any different economic or legal consequence (other than tax consequences). Currently, such economic or legal consequences must also be “relevant.”
35% WITHHOLDING TAX ON BACK-TO-BACK LOANS
Foreign loans obtained by Chilean borrowers from foreign banks, international financial institutions, insurance companies and certain foreign pension funds qualify for a reduced 4% withholding tax rate on interest payments (the standard rate is 35%). Currently, back-to-back loans are eligible for the reduced 4% rate, provided they satisfy the thin-capitalization rules applicable to related-party debt.
The tax reform would disqualify back-to-back loans from the reduced 4% rate altogether. Foreign banks, financial institutions, insurance companies and pension funds would need to be the final beneficiaries of the interest payments to qualify for the 4% rate.
THIN CAPITALIZATION RULES
Under current rules, third-party financing that is guaranteed by a group entity is considered related-party debt of the Chilean debtor, thus subject to the thin capitalization rules. The reform would require that the related-party guarantor also be the final beneficiary of the interest payments under the loans to consider it as related-party debt.
In addition, the current exception from the thin-cap rules applicable to project financing loans is expanded. Under the proposed amendment, loans for the development, expansion or improvement of one or more projects in Chile would be exempted from the thin-cap rules if the majority of the lenders are unrelated to the borrower, and the terms of the financing satisfy the arms’ length principle.
Currently, the test for deductibility of expenses requires that the expense be “necessary” for the production of taxable income. This “necessity test” has been narrowly interpreted by the tax administration and the courts, requiring that each expense be indispensable and strictly obligatory. As a result, on audit, the tax administration has attempted to substitute its business judgment for that of the business, rejecting expenses that in foresight, did not produce taxable income.
The tax reform proposes a new test for the deductibility of expenses. The new test requires that expenses be directly or indirectly associated with the business activities, including ordinary, extraordinary, regular, exceptional, voluntary or obligatory expenses, provided they are reasonable given the circumstances.
In addition, the tax reform expressly regulates the deduction of certain expenses that have been disputed under the existing rules, including the deductibility of certain (i) bad debt, (ii) environmental mitigation expenses that are established as a condition, or voluntarily assumed, in the environmental approval process, (iii) expenses linked to a reorganization process, (iv) contractual penalties and indemnities.