The protests that have taken place in Chile seem to have caused an indefinite pause in the discussion of the tax reforms. The newly appointed Minister of Finance already announced that he is open to explore alternatives to unlock the discussions, and the forum is expecting changes to the bill proposed by the government.
However, even in the absence of tax reform, the favorable tax treatment that the Chilean Income Tax Law currently grants to capital gains arising from the sale of shares of highly traded listed companies would be affected by changes in non-tax regulations that deal with the Chilean securities market.
Current Scenario and Objections to the Special Regime
As a general rule, the Chilean Income Tax Law provides that capital gains arising from the disposal of shares of companies incorporated in Chile will be subject to the general taxation regime, i.e. 35% withholding tax in the case of foreign investors.
In order to incentivize trading of shares and boost the Chilean securities market, the law sets forth a special exemption applicable to capital gains obtained in the sale of shares that are highly traded in a Chilean stock exchange (Article 107 of the Income Tax Law).
For the exemption to apply, the law requires, on the one hand, that the shares were acquired in:
- a stock exchange;
- a public offer for the acquisition of shares regulated by law (OPA);
- a public placement of newly issued shares;
- in an exchange of bonds convertible into shares; or
- in a redemption of securities process subject to Article 109 of the Income Tax Law; and,
on the other hand, that the shares are sold in:
- in a recognized stock exchange;
- in a public offer for the acquisition of shares regulated by law (OPA); or
- in a contribution of securities subject to Article 109 of the Income Tax Law.
The concept of “highly traded” shares existed before the creation of this special tax regime, and thus it is not defined in Chilean Income Tax Law, but rather in the regulations issued by the Chilean Financial Market Commission (local SEC).
According to those regulations, and specifically General Ruling No. 327 issued by the Financial Market Commission in 2012, a highly traded share is any share registered with the Commission and traded in a Chilean stock exchange that (a) has an “adjusted presence” equal or higher than 25%, meaning that at least in 25% of the 180 days prior to the sale the share reached a minimum transaction volume of $38,650 (approximately); or (b) the company whose shares are being sold has entered into a “market maker agreement” with a local broker.
The objections to this special regime arose with the notorious and relevant sale of a 24% stake of the Chilean lithium producer and distributor company SQM in 2018. Although the transaction generated income tax revenues of more than $1 billion, the fact that SQM entered into a market maker agreement prior to the sale caused objections to the regime, specially focused on the possibility of having market maker agreements driven exclusively by tax planning purposes, signed with the sole purpose of assuring the application of the exemption.
Government Response to the Tax Reform Bill
The objections were specially considered in the Tax Reform Bill already approved by the Chamber of Representatives and currently under discussion in the Chilean Senate. The Bill proposes to add a new requirement for the exemption to apply: the market maker agreement must have been in force for at least one year prior to the relevant transaction.
The proposal aims to prevent companies that do not have sufficient transaction volume from entering into tax driven market maker agreements, in preparation for a sale and with the sole purpose of activating the exemption for the benefit of the seller.
Despite the fact that this particular proposal seems to be transversally supported, its destiny is linked with the future of the whole Tax Reform Bill, which includes structural modifications that have not only been strongly resisted by certain politicians, but also recently questioned by members of the ruling political coalition.
Financial Market Commission Role: Proposed New Definition of “Highly Traded” Shares
The Financial Market Commission has recently closed the public consultation period of a new instruction related to the qualification of shares as highly traded. According to the preamble of the proposed new regulation, the modifications respond to the need of adjusting the rules to the Chilean stock market’s reality assessed by the Commission.
In summary, these new rules will raise the thresholds for the shares to be considered as highly traded, thus hardening the requirements for the tax exemption to apply.
As per the 25% “adjusted presence” requirement, the draft of the new regulation increases the threshold in two ways:
- first, raising to 75% the required adjusted presence, meaning that under the new rules the shares must have reached the minimum daily transaction volume in at least 75% of the last 180 days; and
- second, by increasing the required daily transaction volume from approximately $38,650 to approximately $115,950 (i.e. three times the current minimum amount).
The proposed new rules also harden the requirements for market maker agreements, by:
- raising from 180 days to 24 months the minimum term of such agreements;
- raising three times the minimum daily offerings requirement from approximately $19,350 to approximately $58,050; and
- raising three times the minimum aggregate of sale and buy offerings from approximately $38,650 to approximately $115,950; among other modifications.
According to the information available in the draft prepared by the Financial Market Commission, these modifications would not have a major impact in the stock market, the reason being that according to the Commission forecasts, under the new regulation a total of 78 companies and mutual funds would lose the highly traded qualification as a consequence of the raising of the adjusted presence requirement, 68 of which would have a market maker agreement that would allow them to maintain their qualification anyway.
The consequences of the modifications introduced in the Financial Market Commission’s new instructions will have broader effects, impacting also other regulatory matters, such as technical reserves of insurance companies, limits on the acquisition of treasury shares, and the determination of the liquidity requirements of mutual funds, among others.
As mentioned, the process of receiving commentaries and suggestions to the draft of new regulations was already closed by the Commission, and the authority is currently in the process of gathering the input received from the public and, eventually, issuing the new regulations.
A notorious transaction caused discussion about the design of the Chilean capital gains exemption applicable in case of sale of companies listed in Chilean stock exchanges. The government, in reaction to the debate, proposed amendments to the exemption, targeting the market maker agreements that were considered as a shortcut to entitle the sellers to use the exemption.
Although there seems to be consensus on the pertinence of proposed amendments, the recent social protests in Chile have paused the discussion of the Tax Reform Bill that aims to convert these amendments into law.
In parallel, the Chilean Financial Market Commission is working on new regulations that will harden the requirements for the shares to be considered as “highly traded.” Despite the fact that those eventual new regulations are not tax driven, they will have a material impact on the ability of the companies to be eligible for the preferential tax regime. Thus, even in absence of the tax reform, investors must keep an eye on these new regulations, which are within the boundaries of the competence of the Commission, and therefore can be approved by that authority without the intervention of the Congress. It is expected that the new rules will be issued soon by the Commission.
- Although the incorporation of the comments made by the general public to the draft regulation is yet to be seen, the final rules will most likely establish thresholds similar to those set forth in the draft already disclosed by the Financial Market Commission, during the public consultation process.
- Foreign investors can start evaluating the status of their investments in Chilean listed companies vis-à-vis the probable new thresholds and requirements, which were established in the draft disclosed by the Commission, and assess the convenience of entering into a new market maker agreement if they are planning a sale in the near future.
- Further, the imminence of the application of new thresholds may advance the decision of sale, or trigger the need of seeking tax advice if the investors foresee that the new rules would prevent them from the benefits of the exemption.
- The Tax Reform Bill must still be monitored, because the proposed changes related to sale of listed companies will probably be approved, and further, due to the recent social developments which occurred in Chile, we are expecting the introduction of additional changes to the project initially submitted to the Congress by the government.
Javier Cerón is a Tax Partner at Cariola Díez Pérez-Cotapos, Santiago, Chile
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.