Chile looks to overhaul tax credit system

Chile introduced a new tax reform bill on 7th July 2022. The “tax reform towards a fiscal pact for social development and justice” was presented by the Chilean President and is currently progressing through the National Congress. In line with Chile’s ongoing plans to restructure the current system, the bill is aiming for a 4.1% net fiscal collection of gross domestic product. This will be principally achieved through a series of amendments, including eliminating or reducing existing exemptions and strengthening wealth taxes.

Chile currently has a tax system where any person, resident or domiciled in Chile, will pay taxes on their income whether the source is in Chile or abroad. In addition, income derived from activities or property within Chile are subject to taxation, whether the beneficiary of this income is resident, domiciled in Chile or not. Where there is cross-border activity, there is always a risk of double taxation.

In line with OECD principles, Chile seeks to reduce or eliminate double taxation through international coordination and Double Taxation Treaties. Domestically, another factor reducing the risk of double taxation has been the use of local taxes as credits against withholding tax due on distributions paid to non-residents. The extent to which the local corporate income tax can be credited against withholding tax depends on the recipient’s jurisdiction of residence and whether that jurisdiction has a treaty with Chile. Credits against withholding tax range from 100% for jurisdictions with a treaty to 65% for those without. This integrated credit system was implemented as part of a simplification of tax law, but actually widened the circumstances by which credits could be applied.

Possible restriction of tax credits

To evidence and support the fact that taxes were paid abroad, the Foreign Investment Register was created in 2020 so that the Chilean tax authorities could have a specific register of all direct and indirect investments. Taxpayers would only be entitled to a tax credit for entries included on this register, thus incentivising them to use it.

However, two years later, this matter is being reconsidered and subject to a possible amendment in the tax reform bill. The bill, as originally proposed, aims to restrict the ability to use tax credits against withholding taxes. The record of direct credits for withholding taxes and income taxes paid abroad is to be maintained, but the amount that can be credited against a withholding tax liability is to be reduced.

In addition, previously available indirect tax credits will no longer be available. These changes prevent holding companies from taking credit for taxes paid by subsidiaries. In addition, they also remove the ability of non-resident, non-domiciled individuals to use withholding tax credits against tax on Chilean-sourced income.

Modifications potentially more appealing to foreign investment

Looking at the bill’s purpose, these measures would significantly improve fiscal collection. In practice, however, the measures may disincentivise foreign investment and potentially increase the incidence of double taxation.  Due to the latter, it is doubtful whether the proposed measures are in line with the Model Double Tax Convention. The bill is still subject to change before it is finalised, so some of these difficulties may yet be resolved.

Following the electorate’s strong rejection of the draft new constitution, the government became receptive to modifying the original tax reform bill.  They recently announced the introduction of some changes including reversing the elimination of indirect foreign tax credits against the local corporate income tax. This is provided that the taxpayer can either demonstrate the traceability of the tax paid in a third country, or demonstrate that the dividends received from abroad come from revenue that has already borne all its income taxes in Chile.

The final legislative text of these changes is not yet known, so it is too early to comment on their scope. In principle, however, the proposed changes seem to be more accommodating to foreign investment.

For further insight into foreign tax credit developments in Chile, please get in touch.