Chilean President Michelle Bachelet, elected for the period 2014-2018 and who became President on March 11, has announced a significant reform to the Chilean tax system. The goal is to increase the tax burden to finance a very ambitious educational reform.
The future government has not yet provided technical details about the reform, although the bill is expected to be sent to the Congress during the first 100 days of the government. Based on the broad description provided as of today, the proposal could imply a significant change in the taxation of final taxpayers -individuals residing in Chile and non-resident individuals or entities- from a cash basis to an accrual basis.
Currently, the Chilean tax system is an integrated system where the corporate tax paid at source, on an accrual basis, is a credit against final taxes, which are triggered on a cash basis. This system implies that companies keep a record of the taxable profits generated in a special register called “Taxable Profit Ledger” (FUT) to register the qualification of a future distribution to final taxpayers and the credit available, if any. The purpose of the integrated system is to encourage keeping profits invested in local companies instead of distributing them to local individuals or foreign investors. Such incentive is the deferral of final taxes which rates are higher than corporate rates, until profits are actually distributed to final taxpayers.
The announcement says that the FUT would be eliminated and that “owners” would start paying taxes on an accrual basis for all the profits generated by their companies rather than only based on actual withdraws. The main question here is whether the above will imply that: (i) final taxpayers would pay taxes on an accrual basis regarding any income triggered by companies where they have an equity interest, including even interests in open stock corporations or, (ii) the system will be changed only regarding passive income of investment companies. In our opinion, the second scenario is the most likely considering the relevant downsides and administrative difficulties that the first scenario would imply.
The reform would imply a grandfather clause for profits already registered in the FUT, and the new rules would be applicable starting the fourth year of the reform.
The reform proposal also contemplates a gradual increase during a 4-year period of the corporate tax rate, from 20% to 25%, and a reduction in the maximum rate for local final taxpayers from 40% to 35%.
Stamp tax maximum rate would be increased from 0.4% to 0.8%.
The proposal would also include anti-avoidance rules and substance over form provisions. Currently, Chile has a formal system that makes it difficult for the IRS to scrutinize structures.
The proposal contemplates the introduction of an instant depreciation mechanism, which would allow companies to discount from earnings the overall investment of the current year. This rule would compensate the benefit derived from the deferral of final taxes.
In addition, some personal tax exemptions for profits made with certain financial instruments should be available for individuals.
Lastly, the reform contemplates measures oriented to Small and Medium Enterprises (“SMEs”), new taxes to protect the environment and an increase in taxes for alcoholic beverages and cigarettes, in order to discourage their consumption.
The proposal also broadens the VAT applicable to the sale of real estate and introduces new rules for taxation of Private Investment Funds.
Finally, the reform project considers eliminating the foreign investment statute known as Decree Law 600, with the intention of reaffirming the country’s institutional stability.
Source- Carey – Jessica Power- Partner
