An overhaul of the Chilean tax system and its potential impact
In Chile, 2022 must be the year of breathtaking numbers. The chilean currency has devalued by more than 36% since October 2019, inflation reached 12.5% in 12 months, and Real wages decreased by 1.8% over the same period. Still, foreign investment fortunately remained strong, at a record level of 60% above the historical average between January and May for 2003-2022.
It is perhaps because of the inherent good news represented by this latest development – and a momentary disregard for the former – that the administration of President Gabriel Boric, with a approval rating by only 33% in the third month of his mandate, on July 7 sent a 241-page tax bill to Congress, which, if approved, should radically change the Chilean tax environment.
While the content of the tax bill is endorsed by highly respected Finance Minister Mario Marcel, former head of the highly independent Chilean Central Bank, its content is undoubtedly consistent with Boric’s campaign platform, characterized at times by his opponents as endangering the continuity of Chile’s economic progress over more than 30 years.
Apart from that, this bill can be summed up in three points:
- Its impact on businesses and investors.
- Its effect on people residing in Chile.
- Its influence in the fight against tax evasion.
Taxation of companies and investors
The first thing to note is that this reform would reduce the corporate tax rate from 27% to 25% with a caveat: an additional 2% will be taxed unless a comparable amount has been spent to boost productivity, such as the acquisition of advanced technologies. equipment, a measure that has already received justified praise in the context of a small country that should do more in terms of research and development.
Amending a key aspect of the Chilean income tax system, the tax bill proposes to cap the existing unlimited use of tax loss carryforwards by providing that they can be used to reduce taxable income by up to 50 %, with the remaining excess to be used in the future.
The accumulation of wealth being poorly perceived by the Boric administration, which prides itself on having created a tax reform that would only affect the richest 3%. taxpayers— the bill proposes a new annual tax of 1.8% on holding companies and passive investment companies on their undistributed profits.
However, the significant change concerns investors, who until recently benefited from a fully or semi-integrated tax system, in which the corporation tax paid by the companies they own is credited against the taxes they should pay when they receive dividends.
Under the bill, dividends paid to investors will be subject to a one-time tax of 22% against which corporate tax paid by the entities distributing them will not be charged. Concretely, this means that an investor in Chile or in a non-conventioned country, whatever his income, will be subject to a consolidated tax charge on dividend income of 43.06%.
There would be a few exceptions to this rule:
- Foreign investors from treaty countries with which Chile is committed to maintaining an integrated tax system will still benefit from an effective consolidated tax burden of 35% on dividend income, being allowed to credit the tax on corporations paid by the entity paying the dividend against a tax charge of 35%. % withholding tax on the dividend. In the specific case of American investors, for whom the convention has been pending approval by the US Senate since 2010, they will still benefit from being considered as investors of a country that has signed a convention until 31 December 2024, unless the US Senate approves the tax treaty before that date. .
- Chilean individual investors with an effective tax burden of less than 22% could instead pay personal tax on the dividend at their marginal rates.
- Investors in small and medium-sized Chilean companies would be entitled to deduct 100% of the corporate tax paid by their companies from their personal income tax or applicable withholding tax on dividends received.
A point to note for multinational enterprises is that under tax law, and for the first time, self-assessed transfer pricing adjustments would be permitted if they result in additional taxable income, but not subject to a penalty. tax of 40% as is the case today. It’s a win, no doubt.
Expense deductions are reasonably maintained, but a new requirement to use them in proportion to the revenue they help generate is mandatory.
Meanwhile, related party debt financing is further limited by the establishment of a 35% non-deductible tax on interest and other financial charges associated with excess indebtedness.
Finally, the tax on capital gains associated with freely traded shares and quotas would increase from 10% to 22%.
Impact on people residing in Chile
One of the most controversial aspects of the tax bill is the proposed taxation for individuals, with workers facing higher rates for the top four taxable income brackets, capped at 43%.
As one can imagine, high net worth individuals were not left out of the equation and could face a 1% wealth tax on their net assets above approximately $4.5 million (as of July 10, 2022 ) and 1.8% on net assets to $13.4 million.
Additionally, where high net worth individuals are tempted to leave the country and give up their tax residency, the bill proposes a 5% exit tax on their wealth over $4.5 million, in addition to the wealth tax that may apply for the year. before their departure.
Impact in the fight against tax evasion
As my Uruguayan friends know, small markets in Latin America, such as Chile and Uruguay, have always relied on a single asset to attract foreign investment: legal certainty.
For tax practitioners, this principle is often tied to tight 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 example :
- The general local anti-avoidance rule – GAAR – would allow the Chilean tax authority to reclassify 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. In addition, the liability of those who assist in aggressive tax planning, such as tax advisers and business advisers, is enhanced. Notice to Advisors.
- Banking secrecy would be further eroded because when the IRS requests information about a taxpayer from a bank, any challenge would require the taxpayer to explain to a court why access should be denied, instead of asking the Chilean IRS to explain why access should be granted in the first place. With such a proposal, where the right to privacy should be justified, one wonders why Chile would maintain bank secrecy.
- Finally, and as a quick and easy alternative to GAAR, the IRS will gain the power to reclassify a stock sale as an asset sale if it believes the structure was pursued to avoid indirect taxation associated with a stock transaction. ‘assets. , or if the value of the shares derives 50% or more from real assets.
A few takeaways
There isn’t much about Chile’s tax reform that should come as a surprise. It aims to make high earners pay more by increasing the rates of the top four tax brackets out of eight, while leaving the bottom four tax brackets intact and thus affirming that around 75% of Chilean individuals will not be subject to income tax at all. It is probably intended to collect, without constraint, from some 6,300 wealthy individuals who will be subject either to wealth tax or to the exit tax.
And while pursuing a long-held goal, since the second administration of former President Michelle Bachelet, of completely separating the taxation of labor income from capital income, there is no denying that the leftist government that Chile has had since Allende chose to protect the interest of foreign investors from countries with which Chile has a tax treaty, while maintaining the special status of the United States.
With no majority in Congress, low approval for the president in opinion polls even below the low bar set by the wildly unpopular Sebastian Piñera in the first three months of his last term, and extreme polarization due to the vote on the new Constitution expected on September 4, 2022, negotiations have just begun – with consensus likely regarding anti-tax avoidance measures, and even more likely disagreement regarding wealth taxes and the lack of investment-friendly initiatives.
This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.
Ignacio Gepp is a partner at Puente Sur in Chile.
The author can be contacted at: [email protected]