An Overhaul of the Chilean Tax System and Its Potential Impact

In Chile, 2022 must be the year of jaw-dropping numbers. The Chilean currency has devalued by over 36% since October 2019, inflation has reached 12.5% in 12 months, and real wages decreased by 1.8% in the same period. Still, foreign investment has fortunately remained strong, at a record high of 60% over the historic average between January and May for 2003-2022.

Maybe it is due to the inherent good news represented by the latter development—and a momentary disregard for the former—that the administration of President Gabriel Boric, with an approval rating of just 33% by his third month in office, sent on July 7 a 241-page long tax bill to Congress, which, if approved, is expected to change the Chilean tax environment dramatically.

While the content of the tax bill is endorsed by the well-respected Finance Minister Mario Marcel, a former head of the highly independent Chilean Central Bank, its content undoubtedly coheres with Boric’s campaign program, characterized at times by his opponents as endangering the continuity of Chile’s over 30-year economic progress.

If picked apart, this bill can be summarized in three points:

• Its impact on corporations and investors.
• Its effect on individuals residing in Chile.
• Its influence in terms of fighting tax avoidance.

Corporate Taxation and Investors

The first thing to note is that this reform would reduce the corporate income tax rate from 27% to 25% with a caveat: an additional 2% will be imposed unless a comparable amount has been spent on boosting productivity, such as acquiring high-tech equipment, a measure which has already received well-justified praised in the context of a small country that ought to do more in terms of research and development.

Changing a core aspect of the Chilean income tax system, the tax bill proposes to cap the existing unlimited use of carryforward tax losses by providing that they can be used to reduce taxable income by a maximum of 50%, with the remaining excess to be used in the future.

Since wealth accumulation is viewed unfavorably by the Boric administration—one that takes pride in creating a tax reform that would only affect the wealthiest 3% of taxpayers—the bill proposes a new 1.8% interest-like yearly tax on holdings vehicles and passive investment companies on their undistributed profits.

However, the significant change relates to investors, who until recently have benefited from either a fully or semi-integrated tax system, wherein the corporate tax paid by the companies they own is credited to the taxes they ought to pay when receiving dividends.

As part of the tax bill, dividends paid to investors will be subject to a 22% tax as a sole lien, against which the corporate tax paid by the entities distributing them will not be counted. Effectively, this means that an investor in Chile or a non-treaty country, regardless of their income, will be subject to a consolidated tax burden on dividend income of 43.06%.

There would be a few exceptions to this rule:

• Foreign investors from treaty countries with which Chile has committed to maintaining an integrated tax system will still benefit from a 35% effective consolidated tax burden on dividend income, by being allowed to credit the corporate income tax paid by the entity paying the dividend against a 35% withholding tax on the dividend. In the specific case of US investors, for which the treaty has been pending US Senate approval since 2010, they will still benefit by being considered investors from a treaty country until Dec. 31, 2024, unless the US Senate approves the tax treaty before then.
• Chilean individual investors with an effective tax burden under 22% would be able to pay a personal tax on the dividend at their marginal rates instead.
• Investors in Chilean small and medium-sized enterprises would be entitled to credit 100% of the corporate income tax paid by their businesses against their personal income tax or withholding tax applicable on dividends received.

A point to highlight for multinational companies is that under the tax bill, and for the first time, self-assessed transfer pricing adjustments would be allowed if resulting in additional taxable income, but not subject to a 40% penalty tax as they are today. This is a win, without a doubt.

Expense deductions are reasonably maintained, but a new requirement to use them in proportion to the revenue they help generate is mandated.

Meanwhile, related-party-debt funding is further limited by establishing a 35% non-deductible tax on interest and other financial charges associated with an excess of indebtedness.

Finally, tax on capital gains associated with openly traded stock and quotas would increase from 10% to 22%.

Impact on Individuals Residing in Chile

One of the most controversial aspects of the tax bill lies with the taxation proposed for individuals, with workers facing higher rates for the top four brackets of taxable income, capped at 43%.

As may be imagined, high-net-worth individuals were not left out of the equation and might face a 1% wealth tax on their net assets over roughly $4.5 million (as of July 10, 2022), and 1.8% on net assets over $13.4 million.

Furthermore, upon high-net-worth individuals being tempted to leave the country and give up their tax residence, the tax bill proposes a 5% exit tax on their wealth above $4.5 million, in addition to the wealth tax that may apply for the year prior to their departure.

Impact in Terms of Fighting Tax Avoidance

As my friends from Uruguay will know, smaller market countries in Latin America, such as Chile and Uruguay, have consistently depended on a single asset to attract foreign investment: legal certainty.

For tax practitioners, this principle is frequently tied to strict controls on what the government can and cannot do, and the tax bill is certain in terms of expanding what the Chilean tax administration can do, for instance:

• The local General Anti-Avoidance Rule—GAAR—would allow the Chilean tax authority to recharacterize business operations at its discretion, but with the possibility of being challenged later in court and with the burden of proof on the Internal Revenue Service. Further, the liability of those aiding aggressive tax planning, such as tax and corporate advisers, is enhanced. Advisers beware.
• Bank secrecy would be further eroded, as upon the IRS requesting a taxpayer’s information from a bank, any challenge would require the taxpayer to explain to a court why access should be denied, as opposed to having the Chilean IRS explain why access should be granted in the first place. With such a proposal, where the right to privacy would have to be justified, one wonders why Chile would maintain bank secrecy.
• Finally, and as a quick-and-easy alternative to the GAAR, the IRS will acquire the power to recharacterize a sale of shares into a sale of assets if they believe the structure has been pursued to avoid the indirect taxation associated with an asset deal, or if the value of the shares derives in 50% or more from real assets.

A Few Takeaways

There is not much about the Chilean tax reform that should come as a surprise.It is intended to make high-income earners pay more by increasing the rates on the top four income tax brackets out of eight, while leaving the lower four untouched and thus maintaining that roughly 75% of Chilean individuals will not be subject to income taxation at all. It is without doubt intended to collect, with no restraint, from the roughly 6,300 high-net-worth individuals who will be subject to either the wealth tax or exit tax.

And while it continues a long-pursued goal, since the second administration of former President Michelle Bachelet, of thoroughly separating the taxation of labor income from capital income, it cannot be denied that the leftist government Chile has had since Allende has chosen to protect the interest of foreign investors from countries with which Chile has entered into a tax treaty, while maintaining the special status of the US.

With no majority in Congress, a meager approval of the President in opinion polls even below the low mark set by the widely unpopular Sebastian Piñera when in office for the first three months of his last term, and extreme polarization due to the vote on the new constitution expected on Sept. 4, 2022, negotiations have just begun—with consensus being likely concerning anti-avoidance measures, and disagreement even more likely with regard to wealth taxes and a lack of pro-investment initiatives.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Ignacio Gepp is a Partner with Puente Sur in Chile.

The author may be contacted at: igepp@puentesur.cl