Chilean Congress passes major tax reform to overhaul education

January 21, 2013

On 5 September 2012, the Chilean Congress approved the Tax Reform Bill that was presented by the executive last July, itself the second, reduced version of a bill originally submitted in April 2012. Most of the provisions will be effective as of January 2013.

This article was first published in the Ernst & Young Global Tax Policy and Controversy Briefing, Issue 11, December 2012 (pdf, 4.26 MB)

The bill was designed to increase corporate tax revenues (and to decrease personal income tax rates), with the revenue from corporate increases used to finance an overhaul of the Chilean education system, long a thorn in the side of the government and the source of riots in the Chilean capital in August 2011. Opposition members stated that the reform is “not enough” to satisfy the country’s needs, though the bill successfully passed through Congress.

The bill, which contains a raise in the corporate income tax rate, a whole new set of transfer pricing regulations and a new indirect transfer rule, among others, is primarily intended to raise revenue in order to finance several reforms in education, as well as modernizing the Chilean tax system bringing it closer to international OECD standards.

The main changes include:

  1. A rise in the statutory corporate tax rate: from 18.5% to 20%, effective as of January 2013.
  2. Changes to the regulations on disallowed expenses: when such expenses somehow benefit a company’s shareholders or partners, current regulations deem them as profit distributions (which trigger a tax credit at the individual’s level for paid corporate taxes). Under the new rule, the disallowed expense is not considered a profit distribution (and thus is taxed directly with no tax credit). Furthermore, the resulting payable tax is increased by 10% of the amount of the disallowed expense.
  3. Transfer of stock and other participation rights are assimilated: current regulations contain different sets of rules for the transfer of stock and other participation rights, respectively. The bill assimilates all transfers under the regime applicable to stock (which, for example, allows for a different tax regime depending on different factors surrounding the operation).
  4. Regulations on tax “goodwill” and “badwill”: the tax amortization of the goodwill embedded in the acquisition of a local entity through the merger of the acquired entity into the acquirer (calculated as the difference of tax basis of the shares against tax equity of the entity being absorbed) was only administratively regulated before the reform. The bill thus adopts the administrative criteria, with a few changes regarding the manner in which the amortization can be implemented, thereby providing legal certainty on the subject (which is a major issue for tax planning purposes).
  5. Changes in indirect transfer rules: the bill introduces substantial changes in this subject. Whereas current regulation encompasses only indirect transfer of participation rights when the acquirer is a Chilean resident, the bill virtually extends the indirect transfer rule to any kind of Chilean asset that is indirectly transferred abroad, albeit introducing materiality thresholds and exceptions.

The new rules cover all indirect transfers where:

  • At least 20% of the transferor’s ownership of the object of the transaction (e.g., a company, fund, permanent establishment) is represented by Chilean assets (at market value) and at least 10% of the foreign entity is transferred
  • The market value of the underlying Chilean assets equals or surpasses the amount of approximately USD 211,000, and at least 10% of the foreign entity is transferred
  • The assets that are transferred abroad were issued or are located in a tax haven (for Chilean purposes, which may differ from the OECD tax haven list), unless the taxpayer can prove that (1) no Chilean resident ultimately owns 5% or more of the transferred foreign entity, and (2) ultimate owners are all resident in non-tax haven countries

Notwithstanding, if the operation abroad corresponds to part of a reorganization process, and no revenue is generated thereof, indirect transfer rules shall not apply.

  1. Transfer pricing: the bill contains a whole new set of transfer pricing rules that have been more closely aligned to OECD recommendations, thereby establishing more familiar and more modern rules for foreign investors.
  2. Permanent establishments (PE): the bill upgrades PE rules, establishing that the same must determine its results based on full accounts (as if it were a regular company), thereby considering its foreign income. The new rules set out a mechanism to determine a PE’s taxable income when its effective revenue fails to be determined by the taxpayer.
  3. Withholding tax (WHT) administration: though the WHT rate remains untouched (35% in general, with specific, differentiated rates for certain operations), the withholding procedure, which takes place when Chilean source income is remitted abroad, has been modified by the bill.
  4. WHT exemption for standard software: payment of standard software licenses (as defined by the bill) is now exempt from WHT.
  5. Value Added Tax (VAT) exemption: many remittances made abroad are currently VAT-exempt, insofar as they are also subject to WHT. The bill removes this exemption when by virtue of a double taxation treaty (or a legal exemption) the WHT rate is reduced or no WHT applies at all.
  6. Stamp tax: the bill reduces stamp tax rates. The current 0.05% rate for each month or fraction of month between disbursement and maturity of the debt (with a maximum rate of 0.6%) is reduced to one-twelfth of 0.04% (with a maximum rate of 0.4%). In case of immediately payable operations, the stamp tax rate is reduced from 0.25% to one-sixth of 1%.
  7. Final taxes rate reduction: all progressive rates applicable to the taxation of individuals (including employees) have been reduced, with the exemption of the top tier (of the eight current tiers).

The effects of the above modifications could significantly affect several companies, particularly foreign ones.

While there has been special concern in regard to the indirect transfer rules (which undoubtedly increases their reach, raising questions about the tax administration’s effective capability to enforce them) and transfer pricing, within which their further alignment to OECD standards has been mostly welcomed by specialists, we encourage taxpayers to carefully examine all modifications introduced by the bill in regard to each business’ specific context.

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