Recently, the Chilean Tax Office has sent several letters reminding taxpayers that starting in 2017, two general tax systems will come into force instead of one, as we know today.
The Old System
The Chilean tax system that is currently in force until the end of year 2016 is based on the integration of the corporate taxation with the final taxation on shareholders' of these companies.
The corporate tax is triggered on an accrual basis, and then, once profit is withdrawn or paid to partners or shareholders, either in Chile or abroad, income is taxed on a second level equivalent to personal taxation either with Withholding Tax (WHT) for non residents or Global Complementary Tax (supplementary tax or surtax) for Chilean residents. The corporate tax is used as credit against this final tax resulting in the final taxpayer only paying the difference.
Therefore, the income that has being accrued but has not actually been paid, either as dividends or withdrawals to the shareholders of companies, both in Chile or abroad, is taxable only for the corporate tax (First Category Tax) at a current rate of 24% for the tax year 2016.
The purpose of the current system is to incentives reinvesting profits or income back into the company so that the owners do not cash out profit. As long as they do not distribute dividends, they do not pay the final taxation or in the case of non-residents, which may be legal entities or persons a WHT (Withholding Tax) of 35%.
The New System
The tax reform has two new general tax systems that will come into force starting January 1st of 2017.
1) System A, also known as "Attributed Tax Regime": Companies will be taxed with a 25% corporate tax rate for all taxable income accrued, which will be immediately and automatically allocated or "attributed" to their owners/shareholders, with a final taxation of 35% on the top threshold bracket, Chilean residents or not. Non-residents will pay a total tax of 25% no matter if they have a Treaty to Avoid Double Taxation (DTA) or not.
The major difference is that unlike today, final taxpayers will pay final taxation whether they cash out dividends or not as they pay on accrued (attributed) or cash basis, what ever occurs first, so, if they are non-residents they will pay the 35% on withholding tax (WHT) every year even if no dividends were actually received in cash.
2) System B, also known as "Partially Integrated Regime": Companies will be taxed with a 27% corporate tax rate for all taxable income accrued with a final taxation of 44.45% on the top threshold bracket. Non-residents of countries that have a signed DTA with Chile will remain with a WHT of 35%.
Corporate tax is higher than system A (27% instead of 25%), however, under this regime, shareholders will still be allowed to defer personal and withholding taxes until such profits are effectively distributed as final taxation will be triggered on cash basis just as it is today. In simple words, taxpayer will only pay taxes when they receive dividends.
On the other hand, it only allows investors to use 65% of the credit for the taxes paid at the company level, which is why final taxation hikes up to 44.45%. This 44,45% will apply to Chilean residents and non-residents of countries that have no DTA in force.
We note that the 35% WHT will remain for foreign companies that originate from a country that do have DTA with Chile in force, such as Australian taxpayers/shareholders of Chilean companies.
Which System should I choose?
We strongly suggest having a tax lawyer look at each company's situation before making a final decision. Especially, if the company is expected to become profitable at some point in the near and funds will be repatriated back to the shareholder.
Without reviewing financial statements, tax returns and lacking background information of what will be the profit and distribution policy of the company in the near future, we can not say for sure which system is better, however, we may point out important tips that you should take into account.
- If your Chilean company is not making any taxable profit/income yet, you will not pay taxes until you start to actually have profit/income. This applies for either System. Neither the company, nor the shareholders will pay.
- If the Chilean company is making taxable profit/income and distributes 100% of theses amounts to their shareholders, system A is better because corporate tax is slightly lower (25% instead of 27%) and furthermore, local residents of the higher threshold (those that earn more than USD 10,000 per month) will pay only a 35% tax rate instead of the 44,45%, that they would have to pay in the semi-integrated system as they cannot use 100% of the corporate credit. In this system they can, so they remain with the 35%.
- If the Chilean company does not distribute or distributes only a small amount of taxable income/profit to their shareholders, most probably system B will work better. This system allows postponing taxation. Final taxation on shareholders/owners is only triggered on a cash basis. With this being said, the Chilean company will pay 27% as a corporate tax rate. However, shareholders will not have to pay immediately for that year the 44,45 or 35% as final taxation. Furthermore, we highlight that for foreign residents based in countries that have a DTA with Chile, this "penalty" for postponing taxation will have no effect as they remain with a WHT of 35%. This is one of the main reasons why system B is recommended for these kinds of shareholders.
- We suggest checking your tax situation if you are a shareholder of a "Ltda" (limited liability corporation), and the company is making significant taxable profit every year.
- We suggest checking your tax situation if you have Chilean shareholders.
- In all cases, and especially if your company has both Chilean and non-resident shareholders, they have to unanimously choose a system otherwise the company falls into the default regime.
- Companies may change from one system to the other but must remain at least 5 years in either one. This is why we suggest looking at your current business situation and how it may change in the future.
- There is a legal procedure to choose tax system, for example, in stock companies (SAs) they must make the decision in an Extraordinary Shareholders Meeting.
What if I do not choose any of them? Which is the default system for my company, starting 2017?
It depends on the legal structure of the company.
- S.A. (stock companies) cannot choose and will be taxed within system B as default. These are usually big companies that reinvest their profit so this system works best for them.
- Ltdas. (Limited liability companies) and EIRLs cannot choose and will be taxed within system B as default. These are usually small companies who`s owners cash out most of the profit during the year.
- SpA (Companies of shares) can choose between either System A or B. By default, they fall into system B if no election is made and duly notified to the Tax Office/ IRS.
Summarising: The most relevant issue is the profit distribution policy of each company for the next 5 years considering both the tax rates of the company and its owners, as indicated below.
Summary for Companies:
- System A: 25% year 2017. It will not increase.
- System B: 25,5% year 2017 and 27% as from 2018.
Summary for Owners/Shareholders of Companies:
- System A: 35%
- System B: 44,45% at the top threshold (for those who receive an income higher than 10,000USD per month). Only above this amount will the individual pay 44,45%. Below such amount per month, the tax rate is lower.
- System A: 35%.
- System B: for owners/shareholders based in a country with a DTA in force with Chile: 35% as WHT flat rate no matter how much tax profit is remitted abroad and without any deductions allowed (e.g. shareholder of a Chilean company but a resident of Australia).
- System B for owners based in a country that does not have a DTA in force with Chile: 44,45% (e.g. shareholder of a Chilean company but a resident of USA).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.