August 10, 2022
Chile's Congress to discuss tax reform proposal
On July 8, 2022, Chile's Executive Power submitted the text of a tax reform bill to Congress.
This Alert provides a high-level overview of the bill's provisions.
Replacing the "integrated" system with four parallel taxation systems
The bill would eliminate tax integration, so domestic shareholders could not claim tax credits for corporate taxes paid by companies. As a result, a 22% flat tax rate would apply to distributed dividends.
The integrated system would continue applying to foreign shareholders who are resident in countries that have an income tax treaty with Chile, but would allow them to claim the 25% corporate income tax as a credit.
Chilean-resident individual shareholders who have an effective tax rate below 22% could treat the dividends as income subject to the individual income tax rate. This provision would cap the top effective tax rate (considering both corporate and final taxes) at 43% (which also is the top marginal rate of the individual income tax).
Additionally, the bill would establish new "Tax Entrepreneurial Registries" as part of a transition regime until calendar year 2027. Accordingly, the new registries would coexist with the current registries during that time. The new registries would consist of the "Accumulated Profits Registry" (RUA), the "Temporal Differences Registry" (RDT) and the "Exempted Income Registry" (REX).
As a result, the bill would establish fourparallel taxation systems for corporate taxes:
The bill would subject foreign shareholders to one of two corporate income tax regimes:
New "development surtax" and investment incentives
The bill would impose an additional 2% tax on the corporate income of taxpayers that fail to invest in "productivity" during the year. The development surtax would apply to the difference between 2% of the taxpayer's corporate income tax basis and the sum of the taxpayer's disbursements that qualify as an "investment in productivity." If such difference is negative or the taxpayer registers a loss during the year, the development surtax would not apply.
"Investments in productivity" would mean:
Limitations on foreign tax credits
The bill would eliminate indirect foreign tax credits (i.e., foreign taxes paid by foreign subsidiaries indirectly owned by Chilean entities would no longer be able to be claimed as foreign tax credits in Chile, regardless of whether the subsidiaries are located in the same or in different countries). Therefore, Chilean entities would only be able to claim the foreign taxes paid by its directly owned subsidiaries as a tax credit.
The ability to claim a tax credit for the Chilean withholding tax paid by Chilean subsidiaries indirectly owned by Chilean entities would also be eliminated.
The credit cap would be decreased from 35% of the taxes paid abroad to 27% of that amount.
The foreign tax credits would only offset the Chilean corporate income tax, but not the applicable withholding tax when the taxpayer distributes the underlying profits to individuals or abroad.
New tax on retained earnings
The bill would impose a 1.8% tax on the retained earnings of taxpayers under the general regime if 50% or more of their annual gross income is derived from passive income. The bill would treat the following income as passive:
The bill would not consider income from the transfer of fixed assets as passive, as long as the main business activity of the taxpayer is not linked to generating passive income, and the taxpayer has not been subject to the new 1.8% tax rate for the last three years.
The taxable basis for this tax is the sum of the taxpayer's retained profits plus the positive difference between accelerated and normal depreciation (if any). This tax would need to be paid annually.
Substitute tax applicable to retained earnings
A transitory regime available from January 1, 2023, to December 31, 2027, would allow taxpayers to pay a substitute tax in lieu of the dividend withholding tax that would apply once the new tax system is in force. This regime would only be available for pre-2017 tax profits. From January 1, 2023, to December 31, 2025, the substitute tax would be 10%. During the last two years (2026 and 2027) of the regime, the rate would increase from 10% to 12%.
The bill would not allow taxpayers to offset the substitute tax with a corporate income tax credit. The taxable profits on which the substitute tax is paid would become non-taxable and consequently, no additional taxation would be triggered on remittances to the shareholders. The taxpayer, however, would still be subject to the regular attribution order for distributed profits (i.e., taxable profits and depreciation differences would need to be exhausted before distributing non-taxable income).
Increase the tax rate on certain capital gains
In February 2022, Law No. 21.419 eliminated the tax exemption for capital gains from the transfer of stock and other financial instruments of public companies in the stock exchange and imposed a new 10% flat tax on those capital gains beginning in September 2022. The bill would increase the capital gains tax rate from 10% to 22%, starting in 2024.
Limitations on certain tax benefits
Tax losses use limitations
While the bill would allow losses to be carried forward indefinitely, it would only allow taxpayers to deduct losses up to 50% of the net taxable income determined in the year in which the deduction is applied. A transitory 75% limitation would apply for calendar year 2024.
Private and public investment funds
Currently, private and public investment funds are not subject to corporate income tax. The bill would subject private investment funds to the 25% corporate income tax, unless they invest in venture capital (as certified by CORFO). Public investment funds would maintain their corporate tax exemption, but profit distributions to shareholder companies would be taxed according to the general rules. The bill also would eliminate the preferential 10% withholding tax on profit distributions and, instead, would impose the 22% dividend tax on profit distributions made abroad.
The bill would limit the presumptive income regime to micro-entrepreneurs (i.e., those with an annual income below USD 80,000). This limitation would be gradually implemented over a four-year period, with the incentives under this regime shifting to the transparency system.
Deferred expenses doctrine
The Chilean tax authority has traditionally required expenses to have a correlation with the gross income generated in each period, so that the taxable basis reflects the actual income obtained by the taxpayer during that period. On that basis, the bill would establish a new principle under which payments related to the generation of income over more than one period would be considered a deferred expense that would be amortized during the period the revenue is obtained.
Modifications to the anti-avoidance rules
The bill would strengthen anti-avoidance measures by making the following changes:
The bill would modify the R&D tax incentives by increasing the percentage of R&D expenses that can be used as a tax credit against corporate income taxes from 35% to 50% for projects with a "positive direct environmental impact" (a new concept defined in the bill). The bill would increase the yearly tax credit cap from USD 880,000 to USD 2.65M.
The bill would extend the R&D incentives indefinitely (currently they end by December 31, 2025).
Additionally, the bill would eliminate application fees and would allow taxpayers who already claim the R&D credit to automatically qualify for the new R&D incentives.
The bill would modify the value-added tax (VAT) rules as follows:
For PYMEs, the current integrated taxation system is maintained, with PYMEs being subject to a 25% corporate income tax rate. Also, PYME owners would not be subject to the newly created 22% dividend tax.
New PYMEs that start activities up to six months before publication of the bill could claim a special tax credit against VAT for their first year of operations. The credit would equal 100% of the VAT for the first three months the company has sales or provides services; 50% for the following three months; and 25% for the following six months.
The bill would also allow PYMEs to claim 50% of their R&D expenses as a credit against their corporate income tax. The credit would be refundable for PYMEs that did not use the full R&D credit each year.
The bill would reduce the 1.5% interest for the late payment of taxes to 1% for PYMEs only.
Increase in the marginal mid-to-top tier rates for personal income taxes applicable to individuals domiciled or resident in Chile
The bill would modify the marginal rates (both employment/payroll and personal income tax rates) applicable to individuals domiciled or resident in Chile as follows:
Expense deduction limits
For individuals, the bill would impose a cap on expense deductions, exemptions and tax credits. The bill would cap the expense deduction at USD 16,000 annually. Exemptions and tax credits would be capped at USD 1,600, or 50% of the determined personal income tax before deductions. Tax credits arising from the integrated system (i.e., corporate tax credits associated with dividend distributions) would not be affected by this limitation. The personal tax exemption for dividends already levied with the new dividend tax also would not be affected by this limitation.
Mortgage interest deduction
The bill would limit the possibility of deducting interest from mortgage loans from the personal income tax taxable base to a single loan.
The bill would establish a new wealth tax that would apply from January 1, 2024, to individuals with domicile or residence in Chile and a personal estate worth more than 6,000 Annual Tax Units, equivalent to approximately USD 5M (based on its value in Chilean pesos by December 31 of each year).
The tax base would equal the assets minus the liabilities for which a deduction is allowed under the bill. To determine the tax base, the following rules would apply:
The assets would be valued at fair market value (defined as the value that would have been agreed between unrelated parties). Specific valuation criteria would apply for different types of assets (e.g., shares of companies according to the value of tax equity or financial equity or the average stock market price; real estate according to its tax appraisal, among others).
The following wealth tax rates would apply:
The bill would allow taxpayers to claim a tax credit for certain taxes levied directly on the taxpayer or taxes levied as a result of the taxpayer's direct or indirect ownership of legal entities. Taxpayers could claim a tax credit for the following taxes:
The wealth tax would accrue by December 31 of each year, and taxpayers would have to declare and pay the tax in June of the following year. The taxpayer could request to defer the payment for up to three months without accruing interest or fines.
Individuals whose net worth exceeds USD 4M but is below USD 5M would also have to declare their assets annually, but no tax would be levied on them, provided they remain under the USD 5M threshold.
The bill would impose an exit tax if the taxpayer loses its tax residence or domicile in Chile. Under this provision, taxpayers, who would file an application to obtain a "loss of domicile" certificate from the Chilean tax authority, would need to appraise their wealth in accordance with the wealth tax valuation rules and pay an exit tax equal to 5% of the declared wealth that exceeds approximately USD 5M. Once paid, the taxpayer would be released from paying wealth tax going forward.
Entrance into force
There are different applicability dates for these measures (if ultimately passed). As a general rule, the tax reform bill would enter into force in the month following its publication in the Official Gazette, but certain specific provisions would apply in January 2024, January 2025 and January 2026. Some features of the current corporate tax regime (which is extensively modified, as explained above) would remain in force until 2028.