Chile: Easing Of Restrictions And Elimination Of Capital Gains Tax On Portfolio Investments In Chile

As it has been announced in the past few months and with the main purpose of revitalizing the Santiago Stock Exchange, Chile is currently in the process of eliminating some of the major tax related hurdles to foreign portfolio investments in its securities market. Many of these changes are still in the process of being enacted, but some have already been put in place through administrative regulations. In addition to this, a bill of law, which is currently in its last phases of the debate in the Senate before being passed, will completely eliminate the capital gains tax for investments in certain securities, such as publicly traded shares, made by certain types of foreign investors, mainly, portfolio investors.

In the current Chilean tax regime, three main tax obstacles of a tax administrative nature have been identified as major limitations to a more permanent and larger flow of portfolio investment into Chile. These limitations are: (i) the requirement of a Taxpayer Identification Number (Rol Unico Tributario or "RUT", in its Spanish acronym) for any foreign investor, including non-resident individuals or entities investing in publicly traded shares in a stock exchange; (ii) the mandatory requirement for non-resident investors of appointing a legal representative and formal registration of the appointment before the local tax authorities; and (iii) the obligation for foreign investors of maintaining local accounting authorized by the Chilean tax authorities.

The first requirement of obtaining a RUT is contained in the Chilean Tax Code¹ and it is a general formality required for all taxpayers in Chile. The applicability of this requirement to non-resident investors is set forth in an administrative regulation² interpreting the referred statutory provision. The basis of this administrative interpretation is the general language used by the Tax Code, which refers to all individuals or entities that are "…susceptible to being subject to taxes, that by reason of their activity or condition, may cause taxes…"³ Obtaining a RUT involves a formal presentation to the Chilean tax authorities (Servicio de Impuestos Internos or "SII") through the use of special forms and the filing of certain documentation, all of which must be done directly by the non-resident or through an attorney especially empowered for this purpose.

The same aforementioned administrative regulation⁴ also requires that the non-resident appoint a legal representative who is a resident of Chile. This appointment must be done through the execution of a public deed containing a power of attorney, which must have special clauses.⁵ In the case of a non-resident, the only way to grant such a power of attorney outside of Chile is to have it authorized by a notary public or by the respective Chilean Consul. In the first case, the authenticity of the notary public has to be authorized by the Chilean Consul through a certificate issued by the Department of State of the respective State where the power was granted. Finally, the power of attorney must be authorized in Chile by the Ministry of Foreign Affairs and then filed with a Chilean notary public. This entire process naturally implies time and fees from lawyers, notary publics, consular services, etc.

The third administrative limitation for a non-resident to invest in Chilean publicly traded shares is the requirement of maintaining local accounting in Chile. This requirement stems from the general rule of "complete accounting",⁶ contained in the Tax Code, applicable to all taxpayers, unless a special exception applies. No special exception in the current Chilean tax legislation is available to non-resident portfolio investors.

The administrative hassles and bureaucracy involved in the compliance of the referred three tax administration requirements established for non-resident portfolio investors in Chile have constituted a major drawback to this type of investment and have seriously curtailed the volume of transactions made in the Santiago Stock Exchange. In 1998, an amendment⁷ to the capital gains regime was enacted on a transitory basis⁸ that changed the current capital gains tax regime applicable to shares that are publicly traded in a stock exchange to an alternative sole 15% tax on capital gains arising out of the sale of such shares, regardless of whether the sale is deemed to be habitual or not.⁹ However, this reduction in the capital gains tax rate did very little to activate the Santiago Stock Exchange, since according to the concerns of major non-resident portfolio investors, as well as investment bankers in Chile, the referred tax administration requirements continued to pose serious limitations to this type of investment. This situation has caused the new administration to initiate a process where the referred limitations will be virtually eliminated to encourage more portfolio investments into Chile. In addition to this, a major tax reform currently being debated in Congress will completely eliminate the capital gains tax on portfolio investments in Chile.

Regarding the first requirement for non-resident investors of obtaining a RUT, a new administrative regulation was issued on December, 2000,¹⁰ which, while not entirely eliminating the requirement of the RUT, it at least enables non-resident investors of shares that are publicly traded in a stock exchange to obtain the RUT through the respective stock brokers or "custodians" with which the investor operates in Chile. A custodian is the banking entity operating in Chile that the investor uses to make the respective investment in Chile, in case a banking entity is used instead of a stock broker (this is regardless of whether the banking entity eventually uses a stock broker for the particular investment). This special mechanism for obtaining a RUT, however, may not be used by investors whose operations in Chile are ultimately destined to take the control, administration or management of the companies in which it invests.¹¹

The new mechanism for obtaining a RUT also eliminates the requirement of having a legal representative in Chile, since the referred regulation now allows the respective custodian or banking entity to issue the RUT, as well as to withhold any withholding taxes applicable to their investments.

Finally, regarding the complete accounting requirement for non-resident portfolio investors, the referred tax reform being discussed in Congress includes an amendment to Article 68 of the Income Tax Law that will allow the SII to free non-resident taxpayers (such as a portfolio investor) from maintaining accounting in Chile, provided that they only invest in publicly traded shares or securities, even if they have appointed a representative in charge of their investments in Chile.

The second, and probably most important major aspect destined to encourage new and more portfolio investment in Chile is the elimination of the capital gains tax for this type of investment. As mentioned before, a major tax reform is currently in the final stages of discussion in the Chilean Senate, and will probably be passed in the first semester of 2001. Among the many different tax amendments involved in the proposed bill is a new capital gains tax regime, which exempts certain capital gains obtained by "foreign institutional investors", mainly portfolio investors, from all income taxes. If passed, this amendment to the capital gains tax regime should be a major catalyst for new portfolio investments in Chile.

According to the current tax regime in Chile, capital gains obtained from the sale of shares in a Chilean corporation or sociedad anónima ("SA") are subject to capital gains tax at two different rates. If the sale is made after one year from the date of acquisition of the shares, is a result of a transaction deemed to be non-habitual (made by a non-habitual seller), and is made between non-related parties, capital gains obtained in such sale are subject to a 15% sole tax. Otherwise, if any of the three mentioned elements occur in the sale, then the capital gain is subject to a 35% capital gains tax. Additionally, as we said before, there is also a transitory optional capital gains tax regime in force whereby a taxpayer may choose to pay a 15% sole tax on capital gains obtained in the sale of shares that are publicly traded in a stock exchange in Chile, regardless of whether the sale is deemed to be habitual or not.¹² This special regime only applies to capital gains obtained from tax years 1999 through tax year 2002 inclusive.

The new tax regime being currently discussed in Congress exempts all capital gains obtained by "foreign institutional investors", mainly portfolio investors, in the sale of shares that are publicly traded in a stock exchange, as well as bonds issued by the Central Bank of Chile or local companies, when the sale is made in a stock exchange or according to the provisions of the Securities Market Law,¹³ or in any other form authorized by the Superintendencia de Valores y Seguros ( "SVS", equivalent to the Securities and Exchange Commission in the U.S.). In order for a foreign investor to qualify as an institutional investor, it must be formed outside of Chile and not have a domicile in Chile, and it must be at least one of the following:

1. An investment fund that offers its shares or quotas publicly in a country with an investment grade for its public debt, according to a classification performed by an international risk classification entity registered with the SVS;
2. An investment fund registered with a regulatory agency or authority from a country with an investment grade for its public debt, according to a classification performed by an international risk classification entity registered with the SVS, provided that its investments in Chile constitute less than 30% of the share value of the fund, including deeds issued abroad representing Chilean securities, such as ADRs of Chilean companies;
3. An investment fund whose investments in Chile represent less than 30% of the share value of the fund, including deeds issued abroad representing Chilean securities, such as ADRs of Chilean companies, provided that not more than 10% of the share value of the fund is directly or indirectly owned by Chilean residents;
4. A pension fund, i.e., a fund formed exclusively by natural persons that receive pensions out of an accumulated capital in the fund;
5. A Foreign Capital Investment Fund, as defined in Law Nº 18.657; or
6. Any other foreign institutional investor that complies with the requirements set forth by the Ministry of Finance through general regulations for each category of investor, prior information from the SVS and the SII.

Other requirements for the foreign institutional investors are that it must execute a written contract with a bank or a stock broker, both incorporated in Chile, by which they undertake to perform the purchase and sale orders, as well as to verify the applicability of the tax exemption and inform the SII of the investors it operates with and the transactions it performs. Finally, the foreign institutional investor must register with the SII by means of a sworn statement issued by the entities referred above (Bank or stock broker).¹⁴

The actual elimination of the tax administration requirement of obtaining a RUT and appointing a legal representative, as well as the current process of eliminating the local accounting requirement, together with the elimination of the capital gains tax for non-resident portfolio investors in Chile, should provide a major incentive to a more fluid and increased flow of portfolio investments into Chile, enabling the Santiago Stock Exchange, among others, to resurface from its almost decade long depression.