Fundamental and major tax reform proposed, including new rules for mining companies
Tax reform bills submitted to the Chilean congress on 7 July 2022 contain substantial and structural changes to the corporate income tax regime that would affect businesses operating in the country. The proposals include a reduction in the corporate rate, abolition of the partially integrated tax system and replacement with separate taxation of companies and shareholders, changes to the transfer pricing rules and the introduction of a royalty regime on the mining industry, with varying effective dates. This article looks at the main proposals affecting companies.
Corporate tax law proposals
- Tax rate: The rate of the “first category income tax” on general business income would be reduced from 27% to 25% and a “development rate” of 2% would be introduced that would increase the company's first category tax. A taxpayer would not have to pay the development levy if it expended a certain amount on specific "investments after productivity. These measures would apply as from 1 January 2025 to events that have occurred and/or to income received or accrued as of that date.
- Dividend distributions: Chile currently operates an integrated tax system (fully and partially integrated). The tax reform would abolish the integrated tax system and replace it with a “dual system” under which the taxation of companies would be separated from the taxation of shareholders. Under existing law, when a large company distributes dividends, shareholders under the partially integrated regime may credit 65% of the corporate income tax payable by the distributing company against the 35% withholding tax on the dividend/profit distribution; shareholders under the fully integrated regime may credit all of the corporate tax paid against the withholding tax. Notably, the integrated system would continue to apply to:
- Small and medium-sized companies (SMEs), which currently are entitled to a full credit; and
- Shareholders located in a country that has concluded a tax treaty with Chile and that receive dividends from that company, i.e., dividends paid to such nonresidents are subject to a 35% withholding tax and the recipient may credit the entire corporate income tax paid against the withholding tax.
The tax reform bill would introduce a new 22% tax that would apply to dividends or amounts withdrawn from a large company. The tax would have to be withheld by the Chilean company and corporate income tax would not be available as a credit for the shareholder. According to the bill, the highest tax rate on dividends would not be more than 43%.
The proposed rules generally would apply to amounts obtained as from 1 January 2025 (with some exceptions).
- Taxation of retained earnings: A tax on retained earnings would be introduced at a rate of 1.8% where at least 50% of the annual income of companies under the general regime derives from passive income (e.g., dividends, interest, income from the assignment of the use, enjoyment or exploitation of intangibles and income from the leasing or temporary assignment of immovable property). This measure would apply as from 1 January 2025, although a transitional 1% rate would apply for tax year 2024.
- Capital gains tax: Capitals gain derived from the transfer of shares traded on the stock exchange would be subject to a 22% tax, increased from 10%.
- Tax losses: Tax loss carryforwards would be limited to 50% of net taxable income determined in each year, but losses would still be able to be carried forward without any time limit. This measure would apply as from 1 January 2024.
- Foreign tax credits: Several changes are proposed to the foreign tax credit rules, which would apply as from 1 January 2024. Specifically, the maximum tax credit rate would be reduced from 35% to 27%. Additional Tax withheld in Chile on remittances from domestic entities to foreign entities would be eliminated, as would the indirect tax credit for taxes paid abroad in certain cases (in this case, a credit would be available only where there is a direct participation); only first category taxpaying entities (that have relevant investments abroad) would be able to credit taxes paid abroad against their final Chilean tax; and relief from foreign tax credits would not be available to partners or shareholders of such entities. These measures would apply as from 1 January 2024.
- Thin capitalisation: The thin capitalisation rules currently are triggered when a taxpayer is in an excess indebtedness position, which occurs when its total annual indebtedness exceeds three times the tax equity determined on 1 January of the year or at the time the business commences operations in Chile (i.e., a 3:1 debt-to-equity ratio). In such cases, a portion of the interest or other financing-related expenses paid by a Chilean company to a foreign related company is subject to an additional 35% tax at the level of the borrower and is a deductible expense in computing net taxable income. The tax reform would abolish the option to deduct the tax as from 1 January 2023 to events that have occurred and/or to income received or accrued as of that date.
- Investment funds: Changes would be made to the tax treatment of private investment funds, which currently are exempt from tax on Chilean-source income and are entitled to a preferential tax rate of 10% on foreign-source income:
- Private investment funds would become first category income taxpayers (corporate tax), except for funds that invest all of their assets in “venture capital” investments for at least 330 days within a calendar year, a fact that would have to be verified by the Chilean Production Development Corporation. Profit distributions by private funds would taxed at a rate of 22%.
- Public investment funds would continue not to be subject to corporate income tax, but dividend and profit distributions would be subject to a 35% tax where the beneficiaries (whether individuals or legal entities) are located in a country that has concluded a tax treaty with Chile, or corporate tax plus 22% in the case of legal entities located in other countries.
These measures would apply as from 1 January 2025.
- Research and development (R&D): Incentives for R&D would be enhanced: (i) the tax credit against corporate tax would be increased from 35% to 50%; (ii) the maximum credit would be increased from 15,000 to 45,000 Monthly Tax Units; and (iii) SMEs would be allowed to request a refund of excess credits, rather than be required to carry them forward to subsequent years. In addition, a new provision would be introduced to the effect that the credit against corporate tax would amount to 50% of current R&D expenses and the annual depreciation amount of fixed assets provided these expenses were incurred within the framework of an R&D project that would have a positive effect on the environment and certain other conditions are fulfilled.
These measures would apply as from 1 January 2023. However, taxpayers certified before the effective date or that have initiated the relevant procedure, also would be able to benefit from the new rules.
- Registry for ultimate beneficial owners (BOs): A registry would be set up and managed by the Chilean Internal Revenue Service (IRS). All companies would be required to provide information to the IRS on individuals (whether resident or nonresident) who (i) hold directly or indirectly a participation of 10% or more of a legal entity; (ii) can elect, either directly or indirectly, the majority of the directors of the Chilean entity, change or remove them; and (iii) exercise effective control over the Chilean entity (understood to mean the ability to make decisions or otherwise manage the entity). If the identity of the ultimate BO cannot be determined, it would be deemed to be the person who exercises management or administration functions of the Chilean entity. The new registry obligations would apply as from 1 January 2025, except for large companies and investment funds, for which the rules would apply as from 1 January 2024, with the submission due in March of the relevant year).
Several changes are proposed to the transfer pricing rules, including the following:
- Business restructuring: The tax authorities’ powers would be enhanced with respect to challenges to transfer prices and values or establishing prices/values if they were not on arm’s length terms with respect to intercompany transactions and business restructurings where transferred functions, assets, risks, goods or activities would be able to generate taxable income. The bill would extend the IRS powers in cases where agreements, contracts, etc. are terminated or substantially modified.
- Transfer pricing adjustments: Under existing rules, the point of the interquartile range used to calculate a transfer pricing adjustment is not specifically set, although, in practice, the tax authorities use the second quartile. Under the tax reform bill:
- If a taxpayer accepted the transfer pricing analysis conducted by the authorities and corrects its transfer pricing filing, the adjustment would be made using some point within the interquartile range; and
- If the taxpayer did not accept the adjustment or correct its transfer pricing filing, the tax authorities would calculate the adjustment using the second quartile.
- Self-initiated adjustments: Taxpayers would have the ability to initiate an adjustment of transfer prices that do not comply with the arm’s length principle, but only if the adjustment increases the tax base, i.e., a self-initiated adjustment would not be possible if the adjustment reduced taxable income or the tax base. The bill clarifies that the adjustment could be made in the income tax return and the taxpayer would be able to avoid the 40% penalty.
- Advance pricing agreements (APAs): Taxpayers would be allowed to submit a preliminary request to the IRS to ascertain the viability of concluding an APA. In addition, the term of an APA would be extended from three to four years and possibly to transactions during the three previous tax years. Taxpayers would be required to submit an annual report on compliance with the APA.
The specific mining tax is proposed to be abolished and replaced with a new tax, called a mining royalty, that would apply as from 1 January 2024. Considering that Chile is the world's largest copper producer, the new royalty could have a widespread impact.
The mining royalty would have two components:
- Ad valorem component, which would affect annual copper sales and would be imposed at a rate of 1% or 2% on mining companies with annual production volume of more than 50,000 metric tons but less than 200,000 metric tons of fine copper. The rate would range from 1% to 7% if the annual production volume exceeded 200,000 metric tons of fine copper; and
- Mining margin component, which would apply at rates ranging from 2% to 36% on the operating profitability of a mining company whose annual sales are comprised of more than 50% copper and exceed 50,000 metric tons of fine copper. (Different rules would apply where annual sales come from less than 50% copper.)
Special rules would determine operating profitability and annual total sales.