Authors: Jorge Espinosa, Valdés, Granese y Espinosa Abogados, Santiago, Chile 1
Publication Date: March 13, 2003

Although the economic situation in Chile has not been promising, several very important tax developments occurred during 2002. All of these developments are important for stimulating a healthy economic environment for businesses operating in Chile. 

From a commercial point of view, 2002 has been the year for Free Trade Agreements in Chile. In fact, a very important Free Trade Agreement was signed last year by Chile with the United States. In addition, important agreements were signed with the European Community (EC) and with Korea, indicating a trend towards a more open and integrated market for Chile’s future economic growth.

After a review of the more important tax highlights affecting U.S. companies doing business in Chile, this article will examine the new investment, or holding company legislation in Chile. This new vehicle, plus Chile’s steady economic growth, will provide a sturdy platform for investing and financing operations in Latin America.

Tax Highlights in Chile

Corporate Tax Rate Increase
Starting on January 1, 2003, the First Category Tax in Chile, which includes taxable profits from any kind of business activity, regardless of the type of legal entity, is increased from 16% up to 16.5% rate for fiscal year 2003. Beginning in 20034, the permanent rate will be 17%.

Thin Capitalization Rules
New thin capitalization guidelines were implemented in Chile in 2001 for related party loans. Under these guidelines, a maximum 3:1 debt-equity ratio will be allowed for loans between related parties. These new thin capitalization rules apply to any direct or indirect borrowings made between related parties, including back-to-back loans guaranteed by a foreign bank or financial institutions. Excess interest paid to a related party will be taxed as a related foreign loan, subject to a 35% withholding tax rate.

New Chilean Source Rules for Sales of Shares or Partnership Interests 

Selling shares of stock or partnership interests in a foreign legal entity, which owns directly or indirectly interests or shares in a Chilean legal entity, will be considered as Chilean source income. Thus, any gains will be taxable in Chile. This new source rule applies where the foreign entity is allowed to participate directly or indirectly in the profits of another company legally incorporated in Chile.

New Useful Lives for Depreciable Property 

A new regulation was enacted by the Chilean IRS, reducing the useful life for various fixed tangible assets for depreciation purposes. For U.S. companies with operations in Chile, rapid, or accelerated depreciation will decrease earnings and profits for U.S. tax planning purposes.

In a General Ruling issued December 26, 2002, the IRS provided a list of assets subject to either normal or accelerated depreciation and reduced the useful life for most fixed assets, as follows:

• for machinery and equipment the useful life decreased from 20 to 15 years and from 6 to 5 years in the case of accelerated depreciation

• for computers and peripheral equipment the useful life decreased from 10 to 6 years and, in the case of accelerated depreciation, from 3 to 2 years

• for new construction the useful life was reduced from 100 to 80 years and, in case of accelerated depreciation, from 33 to 26 years. 

On the other hand, the newly enacted Law N` 19.840, reduced from five to three the minimum useful life required for applying the accelerated depreciation system for tax purposes. This change means that goods with a useful life less than five years can be written-off in one year.

Reducing the Marginal Tax Rates on Personal Income

Starting in January 1, 2003, personal taxes, like payroll tax and Global Personal Tax, with a marginal rate of 43% will be reduced to 40%. Additionally, tax rate brackets will be reassigned in order to provide lower tax rates for middle income families. In the future, personal taxes will be reduced significantly, which in turn will create new saving and investment opportunities for individuals.

Tax Treaty Developments

Chile has been actively negotiating a number of its double-taxation agreements (Tax Treaties). As of November, 2002, Chile had signed agreements with Argentina, Canada, Mexico, Ecuador, Peru, Brazil, Poland, Norway, South Korea, and Denmark, of which the first three were already in force. In addition, tax treaty negotiations were underway with the United States, Malaysia, Germany, Spain, Finland, France, the United Kingdom, Sweden, Venezuela and New Zealand. 

The recent tax treaties with Canada and Mexico decrease the withholding tax rate on interest payments from Chile from the normal 35% rate down to 15%. Withholding taxes on royalties paid for the use of intangible property will be reduced from 30% to 15%. In the near future, tax treaties with other countries will contain similar withholding tax reductions

Tax Litigation Reform

For some time, the Chilean IRS has been judge and advocate for the government in tax litigation procedures. In fact, the Regional Directors of the IRS are appointed as Tax Judges, so the same officials and employees that depend directly on his/her instructions during the audit, are actively involved in a subsequent dispute.

As a result of this conflict, the IRS enacted an internal instruction where Regional Directors appoint a Deputy Director as a Tax Judge, acting under delegated authority. A recent Supreme Court resolution, however, put aside all the tax court judges appointed by the IRS. In fact, the Court ruled that the constitutional power to judge and resolve tax issues only vests in the Regional Directors, and they do not have the power to delegate his/her authority to other IRS officials. As a result, the Court's holding means that all the tax cases which were resolved by deputies are null and void, and all their cases have to be returned back to an earlier stage in the proceedings where the IRS has to be answered by the taxpayer again.

This situation, plus the strong lobbying effort made by the important Entrepreneurial Association, was remedied by a recent bill presented by the Government to the Congress. The new legislation creates a very independent Tax Court system, which will receive its authority under the supervision of the Supreme Court.

Filing Tax Documents with a Digital Signature

A recent ruling allows taxpayers to file tax documents and declarations with the IRS using a digital signature. This new procedure requires taxpayers to obtain the proper inscription and validation of an electronic signature in advance with an independent, authorized company. Taxpayers will be permitted to conduct several IRS procedures in a safe but quick manner, and treat such procedures as official filings.

Electronic Invoices

The Chilean IRS, together with the private sector, are ready to approve and present to the Congress a bill for streamlining the processing of major transactions subject to VAT. The value-added tax is the most important tax from a revenue collection perspective, so it is important to save time and money by simplifying tax procedures and eliminating paper work. A majority of the big Chilean companies are expected to use these new procedures, which signifies a very important use of new technology available in the world.

New Holding/Investment Company Regime for Foreign Investors

On November 23, Chile implemented a new law, which establishes a holding or investment company to use Chile as a platform for investment in other countries. Income derived by a qualified holding company from investments in other countries is exempt and not subject to tax in Chile. In accordance with the first transitory provision of the legislation, the holding company regime has been effective from the first day of the month following its publication, or December 1, 2002.

The law permits foreign individuals, who are neither domiciled nor resident in Chile, to create legal entities as holding company or investment vehicles in Chile. Qualified entities must be organized under specific requirements and conditions to be explained later. In addition, these entities must invest only in Chile or abroad. These new entities can provide remunerated services to other companies engaged in investment activities, as well as investing in corporations organized in Chile.

The primary advantage associated with this type of entity is that no income tax will be paid in Chile, except for withholding taxes on payments to third parties. No income tax will be imposed with respect to a capital contribution or a capital withdrawal (distribution/redemption) made from the entity. Obviously, no income tax will be levied on profits or gains derived from the activities conducted by these entities abroad. As a result, this law will allow foreign investors - who are neither domiciled nor resident in Chile - to use a Chilean holding or investment company as a platform to channel their investments into other countries without paying income tax in Chile on profits or gains generated from their investments. This is possible because of the current stable geopolitical and economic climate in Chile.

Legal Characteristics of Holding Company Vehicle 

Companies organized in Chile for purposes of channeling investments abroad must be open corporations or closed corporations . Closed companies, however, must agree to be treated as an open corporation. 

The corporate by-laws of the company also must indicate they are covered by this special investment/holding company regime. These new entities are governed by the laws in Chile and contributed capital must, at all times, remain the property of and in possession by the partners or shareholders under this regime.

Main Tax Advantages of the Investment/Holding Company Regime

Companies qualifying under this new regime will be exempt from income taxes in Chile with respect to profits and gains derived from investments made outside Chile. The same exemption will benefit foreign shareholders, or individuals domiciled or resident abroad, with respect to remittances or distributions of dividends earned by companies under this regime. Also, the exemption applies to partial or total returns from abroad, as well as the gain derived from the transfer of shares in such companies.

There is an exception, however, regarding the amount of investments in Chile relative to the total equity of the company. For legal purposes, the new investment/holding companies are treated as domiciled in Chile, so they will be taxed in Chile only on their Chilean source income.

Qualification Requirements for Investment/Holding Companies and their Partners or Shareholders

To qualify for exemption under this new regime, the following conditions and requirements must be satisfied by the company, as well as their partners or shareholders:

1) Corporate Purpose Clause Requirements - The only purpose of these companies must be to make investments in Chile and abroad in the manner and conditions prescribed in the law.

2) Who can Qualify under this Regime? Restrictions and Limitations - The shareholders of the company and the partners or shareholders of qualified intermediaty entities holding 10% or more of the capital or profits of the new investment/holding company can claim the tax benefits under the new tax regime. Legal entities are qualified if they are not domiciled or resident in Chile, nor incorporated in a country or jurisdiction listed by the OECD as a tax haven or having a harmful or preferential tax regime. This restriction will not apply if, at the time the investment/holding company is formed in Chile and capital is contributed, the shareholders or partners and shareholders of an intermediary legal entity are domiciled or resident in a country or jurisdiction which is not listed by the OECD as a tax haven or harmful tax regime.

3) Restrictions to Investments made from Chile Abroad - Investments by the new holding company cannot be made in companies that are organized in countries or jurisdictions considered by the OECD as a tax haven or having a harmful tax regime. An exception applies, like shareholders above, for investments made abroad in entities that were not organized in a country black-listed by the OECD at the time the investment was made.

4) Exceptions for Individuals who are Resident or Domiciled in Chile - Notwithstanding the restrictions listed above, individuals domiciled or resident in Chile may acquire shares in holding/investment companies under this new regime. In this event, individuals cannot hold, directly or indirectly, 75% or more of the capital or profits in the company.

5) Nature and Source of Capital Invested in Qualified Holding/Investment Companies - The source of the capital for the new investment/holding company must be located abroad. The currency used must be freely convertible using any of the mechanisms set forth in Chilean law for importing foreign capital from other countries. The same treatment applies to profits derived from the contributed capital. Likewise, repatriation of such capital must be made in freely convertible foreign currency in accordance with the foreign exchange rules in force at such date.

6) An Alternative regarding Contribution in Shares or Rights -Notwithstanding the above, capital may be contributed in shares, as well as in stock rights in companies domiciled abroad owned by individuals neither domiciled nor resident in Chile. The amount of the contribution will be equal to the fair market or book value of the stock or stock rights, as appropriate, or acquisition value in the event no stock exchange value exists.

7) Limitations on Acquiring Loans Abroad - The new investment/holding company may borrow funds from outside Chile. Loans granted from overseas, however, can never exceed the amount of contributed capital attributable to foreign investors, or three times the amount contributed by an investor domiciled or resident in Chile. In the event the foreign investor's interest in the capital is increased or decreased, the company must apply the new debt/equity ratio, referred to above, within sixty-days (60) after the occurrence of one of the events described above.

8) Taxes levied on Loans and Interest paid Abroad - Loans referred to in 7), above, are subject to the general provisions regarding the Stamp Tax. Interest paid abroad is subject to withholding tax.

9) Requirements to Keep Accounting Records and Registration Information - In order for a company to qualify under the new holding/investment company regime, it must: · maintain complete accounting records in foreign or local currency, as elected, · 

• register with the Internal Revenue Service in Chile 
• provide in their corporate By-laws that they will follow the open corporation rules, 
• inscribe in the public register at the Chilean S.E.C., 
• periodically inform the S.E.C. by means of an affidavit that it is in compliance with the conditions and requirements mentioned above.

Finally, registered companies must inform the Internal Revenue Service of any capital brought into Chile, investments or any remittance or distribution made abroad by such entity.

10) Investment Opportunities in Chile: Requirements and Tax Consequences - Companies qualified under this new regime also may invest in corporations organized in Chile. Chilean companies must withhold a tax equal to 35%, as set forth in number 2) article 58 of the Income Tax Law on distributions to the investment/holding company. These companies will be entitled to a credit, established under article 63, with respect to profits distributed to an investment/holding company operating under this new regime. 

Shareholders who are domiciled or resident in Chile and earning income or dividends from a qualified investment/holding company will be subject to tax in Chile like shareholders in corporations organized outside Chile. In addition, these shareholders are entitled to a 35% tax credit as provided under letters B and C article 41 of the Income Tax Law. In this situation, profits are distributed on a FIFO (first-in-first-out) basis. These profits must be registered separately, that is to say, profits earned from companies organized in Chile and those earned abroad. Companies operating under this system must inform both the taxpayer and the Internal Revenue Service of the amount of credit that can be deducted.

11) Structuring Investments from Chile Abroad - In accordance with the provisions of article 87 of Law No. 18.046, an investment/holding company operating under this new regime must acquire its investment assets by means of a contribution of capital, stock or other convertible instrument. In addition, investments must be made in companies organized and formally established abroad or in a country or jurisdiction not blacklisted by the OECD, as mentioned above, for purposes of developing business activities. Business activities may be performed either directly or indirectly by subsidiaries, or through a chain of subsidiaries.

12) Treatment of Gains Derived from the Transfer of Shares by an Investment/Holding Company and Exceptions - The gain derived from the transfer or sale of appreciated shares held by a qualified investment/holding company will not be subject to income tax in Chile. Exceptions apply: · where the gain is attributable to shares in a company located in a country listed by the OECD or · when the transfer of shares is made by individuals who are domiciled or resident in Chile and who do not own or have a direct interest of 75% or more of the capital or profits in the company. In addition, when shares are totally or partially transferred to individuals or legal entities domiciled in any of the countries listed by the OECD or to subsidiaries, both the company and the shareholders are subject to the general tax regime set forth in the Income Tax Law. This issue also applies to dividends, profit distributions, remittances or capital repatriations occurring after the date of the transfer.

13) Exemption from Bank Secrecy.- The companies under this new investment/holding company regime are not subject to the provisions relating to bank secrecy and reserves established in article 154 of the General Bank Law. Any information relating to this matter must be provided to the Internal Revenue Service as established by the rules set forth in a Supreme Decree issued by the Ministry of Finance.

14) Non-compliance with the Law - Non-compliance with any of the requirements established in the new law will trigger income taxes under the general income tax rules. In this event, income taxes will be imposed on amounts earned during the calendar year in which non-compliance occurs.

Conclusion

The new tax law changes and investment company legislation in Chile, examined in this article, provide a good opportunity for multinational companies or individuals to use Chile as a base for investing in Latin America. Investors can take advantage of a broad and flexible tax and holding company system, similar to those existing in countries such as Spain and the Netherlands, which have a clear and easy-to-use system as well as adequate controls and registries. In addition, tax exemptions and mechanisms are available for facilitating the movement of funds into Chile, as well as moving capital and profits outside Chile. 

This new system in Chile allows foreign investors using the investment/holding company vehicle to choose the best country to conduct new business and develop business activities both in Chile and abroad. Moreover, the trade agreement network developed by Chile with Europe and, soon, with the United States and other countries within the region creates a stable and serious market environment. Chile has efficient communication networks, a sophisticated banking and financial system, adequate legal safeguards to protect foreign investments and a stable geopolitical environment, which according to international analysts, is the most solid and consistent in the Latin America region.