By Tomás Kovacevic, Senior Associate, Barros y Errázuriz Abogados, Santiago
The Chilean tax agency has clarified the application of the amended foreign tax credit rules enacted in Chile’s 2020 tax reform through guidance issued on May 19 in regulation N° 31/2021. With an aim of promoting Chile as an investment hub, the amended rules simplified both the determination of the foreign tax credit and the procedure for claiming it.
Rationale behind foreign tax credit rules
Chilean residents are subject to income tax on worldwide source income. Accordingly, when income obtained by residents is taxed abroad, international double taxation would result if foreign tax credit rules did not allow taxpayers to offset taxes paid abroad against Chilean income tax.
To prevent such double taxation, the Chilean Income Tax Law (in article 41 A) provides foreign tax credit unilateral measures (this is, measures applicable for residents in non-treaty partner jurisdictions) in relation to specific types of income (in general, taxes paid on dividends distributions, royalties, and technical assistance).
Moreover, the law supports double taxation relief under the tax credit method agreed in tax treaties signed by Chile, which benefit a resident from a tax treaty partner jurisdiction with broader rules to offset taxes paid with respect to any income covered by a treaty.
Taxes that may be offset under foreign tax credit rules
The regulation describes the characteristics of taxes paid abroad that can be credited in Chile. For example, taxes paid abroad must qualify as income taxes imposed by foreign legislation. Accordingly, any payment to a foreign government in exchange for a concession will not be creditable in Chile.
In a ruling issued June 29 (ruling 1640/2021), the Chilean tax agency responded to a question regarding the qualification of US federal and state taxes as creditable income taxes. The tax agency instructed that federal or state taxes paid abroad may be offset in Chile if such taxes are levied on income, as determined according to Chilean law.
The regulation also instructs that a tax paid abroad may be offset in Chile whether determined on a real basis or on a presumptive basis – but only if such presumptive basis is considered under foreign legislation as an estimate that can substitute for a real basis result.
Finally, the regulation provides that a tax paid abroad may only be credited in Chile if it is mandatory, enforceable by the foreign authority, and not reimbursable. For example, a credit will not be allowed if a taxpayer does not request a reimbursement applicable abroad or if a taxpayer does not claim treaty benefits in the other country for taxes paid in excess of any reduced rate agreed under an applicable tax treaty.
Tax reform developments
A feature from the tax reform that aims to enhance outbound investment from Chile (by reducing double taxation), is that foreign tax credit rules do not require a determination of source of income. Therefore, if a Chilean resident has operations in a foreign country that applies a tax to income qualified as Chilean source income, a credit for such taxes will be allowed in Chile.
In addition, the law describes circumstances when a credit will be granted with respect to outbound investments with several layers of entities.
In a first layer foreign entity investment, a credit will be granted for both the corporate tax paid by the foreign entity and the withholding tax paid upon a profit distribution from such entity to Chile. For instance, in ruling 977/2021 issued April 19, the Chilean tax administration, under a broad interpretation of the word “distribution,” instructs that a Chilean resident that invests in a US corporation (first layer investment) will be allowed to offset the 21% corporate tax paid on earnings obtained by such corporation when the corporation is liquidated (as upon such liquidation profits will be remitted to Chile).
In a second layer foreign entity, both the corporate tax paid by such entity and the withholding tax paid on distributions from such entity to the first layer entity may be offset in Chile if the first layer foreign entity holds a 10% or more participation in the second layer entity. Additionally, the second layer entity must be resident in the same country as the first layer entity or be resident in a third country that has a tax treaty in force with Chile (either a treaty for avoidance of double taxation or for the exchange of information).
The application of the “third country rule” is validated in ruling 1640/2021, in which the tax agency confirms that a taxpayer will be allowed to offset taxes paid to a third country for an investment through a Chilean investment fund in a Cayman Islands entity (first foreign layer), which subsequently invests in an entity resident in a treaty partner jurisdiction (second foreign layer in third country), even if no taxes are payable in the jurisdiction where the first layer entity is located.
Finally, as an innovation, the tax reform provides for a tax credit for the withholding tax paid in Chile to be offset in Chile in a “round trip” scenario in which a Chilean resident ends up receiving a dividend from a foreign resident (usually a collective vehicle) that in turn invested (and received a dividend subject to withholding tax) in Chile.
New calculation method
The credit to be offset in Chile is limited to 35% of a gross up amount consisting of the sum of the (foreign) net income to be recognized in Chile and the total tax allowed as a credit. In turn, the foreign tax allowed as a credit is the lower of the taxes paid abroad for each type of income and 35% of the gross up amount.
Promotion of outbound investments from Chile
The effectiveness of the new foreign tax credit rules for promoting international trade will be tested over time. In any case, the possibility to offset taxes paid abroad against local income tax should be evaluated as part of any investment project, particularly in a period in which outbound investments from Chilean residents are going up.
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