Sweeping Chile tax reform plan proposes tax on digital services, restores corporate tax integration

By Francisco Sepúlveda, RGS Abogados, Santiago de Chile

Chile’s government on 23 August delivered to Congress the main features of a proposed comprehensive tax reform.

The new Chile tax reform would reestablish full corporate integration, introduce significant benefits to reduce the corporate tax burden, introduce new resident and permanent establishment definitions, significantly weaken the GAAR, and provide corporations with greater opportunities to deduct business expenses, among other things.

Moreover, a new withholding tax on digital services provided by nonresidents would ask credit card companies to collect the tax.

The intention of the Chile tax reform package is to bring the tax system up to date and to simplify its structure and compliance mechanism.

It is expected that these modifications will occur in 2019, affecting tax returns lodged April 2020.

Chile’s earlier reforms

Chile’s prior tax reform, introduced by Law 20.780 in September 2014 and Law 20.899 in February 2016, generally restricted full integration between the corporate income tax and final taxes, under which taxes paid at the corporate level worked as a credit against resident and non-resident shareholders’ tax liability.

With the idea of boosting tax collection, the prior Chile tax reform reduced the imputation credit from 100% to 65% of corporate income tax resulting in a maximum aggregate tax burden of 44.45%.

At the same time, full integration was maintained for companies that elected the attributed-income system, under which the entire profit of the company was attributed to its shareholders whether these profits were remitted or withdrawn or not.

The changes were accompanied by the creation of several new profit and credit record requirements and a series of mandatory affidavit requirements designed to deliver as much information as possible to the tax authority.

The first period in which income tax returns were filed under the new system was 2017, with a deadline set in April 2018.

However, the complexity of the new system resulted in the newly elected government of President Sebastián Piñera announcing structural changes to the Internal Tax Law (ITL) to simplify the system and generate incentives for tax compliance.

Chile tax reform – integration

Under the proposed rules, most of the changes introduced in 2014 and 2016 Chile tax reform are reversed.

Accordingly, a full imputation credit will be recognized for corporate income tax paid in Chile against any tax liability corresponding to its shareholders.

These proposed changes, which are likely to be implemented, would result in a complete integration between the individual income tax (Impuesto Global Complementario) applicable to residents on the basis of progressive rates ranging from 0 to 35% and the withholding tax applicable to non-residents in the cases of profit distributions (Impuesto Adicional) with a flat 35% rate.

Corporate tax rates

 The new proposal would maintain the corporate income tax rate at 27% for large businesses and 25% for small and medium companies.

 Moreover, under the new tax reform package, in an attempt to eliminate distortions derived from a different tax treatment based on profit distribution policies, taxes are only triggered by profit distributions or withdrawals.

 Under the earlier 2014 and 2016 tax reform, corporate income tax rates had been set at 27% for the partially-integrated system and 25% for the attributed-income system, with the higher rates designed to penalize companies that chose not to distribute profits therefore delaying taxation at the shareholders’ level.

Transparency

The new reform measures are complemented by a proposal aimed at establishing a full transparency mechanism for small businesses, which would result in the elimination of administrative burdens.

Under these measures, no tax return is required at the company level and tax liability is fixed at the level of the partners or shareholders who are responsible for filing the relevant tax returns.

International tax reforms

The Chile tax reform package also adds new international tax law rules, including a new domestic definition of the terms “resident” and “permanent establishment.”

Under its current conception, the characterization of a person as a “resident” for Chilean tax purposes occurs once a person spends more than six months in a 12-month period (continuously) in Chile; or when the person spends more than 183 days in Chile in any two-year period.

The test is simplified under the reform by setting out a single 183-day test in any 12-month period, therefore reducing opportunities for tax avoidance through the manipulation of the tax residence test.

PEs

The inclusion of the term “permanent establishment” (PE), which was not previously defined therein in the tax code but only attributed meaning by referring to the definition in tax treaties, is another highlight of the Chile tax reform package.

Under the proposed definition, OECD standards are followed to the letter.

Thus, the typical “fixed place of business” PE and the legal definition of dependent agency PE could be expected to form part of Chile’s internal laws.

Indirect asset sales

Under the rule taxing the indirect sale of underlying assets located in Chile, introduced recently, the Chilean entity which shares were indirectly sold was jointly responsible for any tax due arising from the indirect sale in Chile.

The Chile tax reform package eliminates this joint responsibility rule, restricting the relevant tax liability to the non-resident company selling the respective underlying asset.

GAAR under Chile tax reform

Modifications are also made to Chile’s  GAAR, which are meant to provide certainty to taxpayers.

A crucial feature of the 2014 and 2016 tax reform was the introduction of a principal-purpose test, combined with express provisions sanctioning aggressive tax planning both at the level of the company and its advisors.

However, the broadness of the GAAR and the uncertainty regarding the capacity of the Chilean IRS to apply the rule created uncertainty.

Under the new version of the rule, not only are certain scenarios which may have triggered the GAAR’s application left outside its scope but, notably, the Chilean tax authority is forced to demonstrate that any transaction under GAAR scrutiny lacks any other purpose than the anticipated tax benefits derived from it.

This fundamental change and the many limitations set out in the draft bill for the application of the rule are expected to reduce dramatically the dissuasive effect behind the GAAR’s creation in 2014.

Taxation of nonresident digital services

Under the new proposal, taxes would be imposed on foreign digital platforms rendering services in Chile, regardless of the location of their servers.

In recent years, the tax consequences of digital presence has been a major issue worldwide. Although the Chilean tax code contains withholding tax rules under which digital services provided by non-resident companies trigger the application of taxes in Chile, the lack of any concrete mechanisms for the IRS to control these operation results in non-taxation.

Bearing that in mind, the draft bill establishes the new framework for the taxation of digital services provided by non-resident companies in Chile, which ultimately depends on the person using the relevant services.

If the services are used by individuals, a 10% indirect tax is applicable. This new tax is to be withheld by the entity issuing the credit card or equivalent which is used to pay for the service. If the relevant service is used by a company, withholding rules apply at the standard 15% rate.

The abovementioned distinction is relevant insofar as tax treaties are only available to restrict the application of direct taxes (income taxes).

Under this logic, while companies may benefit from lower tax treaty rates; the indirect character of the tax which affects services provided to individuals implies that no reduction of said tax should be availed.

Enhanced expense deduction

The Chile tax reform package also adds a new and broader conceptualization of “deductible expenses” for the purpose of the corporate income tax.

Under the current rules, the deduction of expenses is subject to a series of tests. From a general perspective, an expense would only be accepted as a deduction from a taxpayer’s taxable income if there is any income being generated.

Other than the correlation between income and expenses, several requirements need to be fulfilled. Amongst others, one needs to demonstrate that the relevant expense is necessary for the company’s activity; directly connected with the activities of the company; and mandatory or, under the interpretation of the IRS, inevitable.

These requirements have been the most common instrument used by the Chilean IRS to carry out its auditing processes and challenge taxpayers’ tax returns.

To promote investment, the new proposal softens these requirements. By way of illustration, expenses are to be accepted not only if they are directly connected with the activities of the taxpayer, but also if there is even an indirect connection, which would occur if the expense is to facilitate the activities of the company, or if it is incurred in the interest of the company.

Under this new logic, expenses will be accepted whether they are ordinary or extraordinary, habitual or exceptional, mandatory or voluntary. From a general perspective, the new regulation implies that expenses will be subject to a general test of reasonability in relation to their amount.

While all this sets out an already significant change, the proposed reform package goes even further and also includes the possibility of deducting expenses linked to entrepreneurial social responsibility and to obligations to indemnify or compensate damages of different nature.

IRS, taxpayer mediator

The tax reform package also provides for the creation of an entity in charge of protecting and securing taxpayers’ fundamental rights before the IRS.

Called the“Defensoría del Contribuyente,” this new institution will not have the ability to represent taxpayers at the jurisdictional level. However, it will operate as a mediator between the taxpayer and the tax administration to provide efficient solutions to the multiple conflicts before the authority.

The idea is to promote an alternative solution to controversies and to avoid the judicial review of such issues therefore lowering costs both for the taxpayer and the IRS.

Chile tax reform — tax amnesty

The reform also introduces a general amnesty process for undeclared assets held abroad (a 10% sole-tax) applicable to all kinds of movable, immovable, tangible, and intangible property.

This is an improved version of the tax amnesty introduced in 2014 through Law 20.780.

The amnesty rule would create a one-year transitional period for purposes of declaring movable, immovable, tangible, or intangible property held abroad which has not been subject to tax laws of Chile.

Potential applicants will be subject to two limitations.

One rule limits applicants to only those individuals who have been domiciled or resident in Chile before 1 January 2018 and to entities that have been established or incorporated in Chile as of that date.

The second limit restricts the assets that qualify for the process. The benefit will only be available for goods acquired before 1 January 2018 and for income derived from those assets until 31 December 2018.

While the assets declared under the amnesty rule will be subject to a 10% sole-tax special regime, any profits or income derived in 2019 from those assets will be subject to common income tax rules.