Businesses Must Carefully Review US-Chile Tax Treaty Provisions

The US-Chile Tax Treaty’s approval in December 2023 gives businesses opportunity to increase their profitability through three areas: elimination of double taxation, foreign tax credits, and lithium-ion imports.

The new treaty contains a variety of monetary benefits that should incentivize new investment and growth between the two countries—a positive step. But individuals and businesses must thoroughly analyze all treaty requirements, such as value-added tax and limitations on benefits, before expanding operations to ensure success.

Timing and Withholding

Treaty provisions on taxes initially went into effect Jan. 1, while provisions on withholding went into effect Feb. 1. These two effective dates require taxpayers adhere to specific timing to ensure treaty benefits are applied correctly.

If these provisions are misinterpreted, businesses may risk underpayment or over-withholding, which could lead to penalization. For example, if a US entity providing services to Chilean customers assumes the treaty provision applies before the effective date, it may incorrectly apply reduced withholding rates and face underpayment penalties from Chile.

Additionally, if a Chilean taxpayer paid royalties to a US licensor after January but applied pre-treaty withholding rates, the result would be over-withholding, and the taxpayer could face penalties from the IRS. The IRS can assess interest on underpayments plus a 20% accuracy-related penalty if the underpayment exceeds certain thresholds. Chile has similar penalties for non-compliance.

Domiciles

If an individual or organization wants to take full advantage of the treaty’s tax provisions, they don’t just need to know which country will provide the most beneficial treatment—they should understand how and when each country’s respective tax laws will apply.

According to the treaty, individuals are subject to the tax laws of the state by reason of their domicile, residence, citizenship, etc. Most citizens of either country will thus be subject to their respective country’s tax laws.

Businesses will be taxed according to whether they have a permanent establishment in either or both countries. Any business that wants to perform activities included in the permanent establishment rules, such as exploration of natural resources or building construction, for more than the allotted time should be prepared to foot the bill for any tax liabilities incurred in either country.

Limitation on Benefits

Special treaty provisions outline limitations on benefits, meant to prevent or greatly decrease the likelihood of tax avoidance among those operating in either or both countries. These provisions say you must actually be a real resident of Chile or the US to get lower tax rates and other benefits.

Individuals must prove they live in or are residents of that country. For public companies traded on stock exchanges, the government will review where a company is based and who the owners are to make sure it’s not owned by a shell company in a third country.

For other businesses such as corporations or partnerships, there is testing to ensure who the actual owners are and whether income is just passing through to residents of other countries.

Before investing or starting a business in either country, entities must confirm whether they qualify for the treaty’s benefits. If they fail to do so, they might end up paying more taxes than planned, which could hurt business operations.

Withholding

The treaty also includes many adjustments to withholding rates, which are important because they determine how taxes are deducted from payments made to or from foreign businesses.

These withholding rates also influence the attractiveness of investments and cross-border transactions, impacting economic activity and international trade flows, so entities should be aware of each tax rate and exceptions. These rates include dividends, interest, royalties, insurance, reinsurance, and capital gains on shares or other equity interests.

For example, the tax treaty provides reduced withholding rates or exemptions for dividends paid between related companies meeting certain ownership thresholds. Certain types of interest payments, such as portfolio interest, may be exempt from withholding tax under domestic law or treaty provisions.

Chilean VAT

Chile updated its VAT laws in 2020 and began taxing nonresident providers of various digital products and services. Withholding of these taxes has typically been exempt from the 19% VAT rate—but the new treaty eliminates the withholding. Foreign services will now be subject to Chilean VAT laws.

US-based services will now be able to treat these service fees as profit, as they are exempt from Chilean withholding tax, and therefore, will have to deal with Chilean VAT regularly.

US companies providing digital products and services to Chilean customers should review their contracts and sales processes to ensure accurate VAT collection and remittance in Chile. They should also determine if a Chilean permanent establishment exists, as this could void the withholding tax exemption under the treaty.

Double Taxation Relief

Provisions for mitigating or eliminating double taxation may be the most important part of the treaty. If a citizen or business based in the US pays income taxes to Chile, they’ll receive a tax credit equivalent from the US government and vice versa.

While this provision seems simple, multiple exceptions and other special circumstances make it difficult to determine whether an entity will qualify for tax benefits. Companies should review the treaty and its stipulations closely to make sure they can reduce their tax bills according to its rules.

For example, the treaty has two main mechanisms to eliminate the possibility of double taxation. With the exemption method, certain types of income that were earned by a resident of one country will be exempt from tax in the other country.

With the credit method, which applies to income not exempted under the exemption method, credits are allowed against taxes paid to the other country on the same income. This essentially prevents the same income from being taxed twice.

The core purpose of the treaty is to prevent double taxation. However, proper analysis and compliance are crucial, as the treaty contains complex rules and limitations on benefits to prevent abuse or over-application of the double tax relief.

The treaty marks a positive step toward strengthening the bond between the two nations in the years ahead.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Vanessa Piedrahita is tax partner and Latin America practice leader at Aprio.

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