Tax treaty developments: Chile
11 April 2013
Posted by: Author: Johann Hattingh
Source: Johann Hattingh (PwC)
For a very long time, South American countries have resisted the conclusion of tax treaties patterned
on the OECD’s Model Tax Convention. Tides have been changing, and the text of the first ever tax
treaty concluded between South Africa and Chile has now been released by the Chilean authorities.
Chile has since 1998 signed approximately 27 tax treaties patterned on the OECD’s Model Tax Convention. Those concluded with the USA (2010), Australia (2010) and South Africa (2012) await formal ratification and are therefore not yet effective.
South African motivations
South Africa’s motivations for entering into treaty negotiations with Chile were revealed when the South African Revenue Service (SARS) briefed Parliament’s Standing Committee on Finance about the treaty in October 2009 South Africa had invested nearly ten times the amount in Chile than Chile had invested in South Africa.
Similarly, exports to Chile amounted to ZARR530 million in 2008, which mainly comprised fruit juices, lamps and chemical fertilizers. Imports from Chile were however of greater magnitude, amounting to R1 billion in 2008 and included chemical fertilizers, maize and insecticides.
It is clear that the negotiations have been difficult and protracted, as it taken more than three years for the parties to reach a consensus.
Chilean tax system
Chile has a schedular income tax system (as opposed to a globular system such as that of South Africa), which means that tax is levied on income or a gain only if there is a specific provision taxing that income or gain, as set out in separate Schedules.
First Category Tax (Legal Entities)
The basic tax on income of a Chilean legal entity domiciled or resident in Chile and engaged in commerce, mining, fishing or industry is the First Category Tax, which is assessed on a net basis at a rate of 20% (previously 18.5%) on the entity’s worldwide income.
Unusually, branches of foreign corporations that operate in Chile are subject to the First Category Tax on their worldwide income (also charged at the rate of 20%).
Additional Tax (‘Impuesto Adicional’)
Non-residents such as foreign shareholders or foreign partners are subject to an ‘additional tax’ charged at the rate of 35% on Chilean-source distributions or remittances, with a credit granted for the First Category Tax paid on underlying profits.
Branches are subject to the 35% Additional Tax on amounts remitted or withdrawn during a given calendar year, less a credit for any First Category Tax, which is payable in April of the year following a distribution.
Secondary tax is charged on payments to non-residents in terms of the schedules relating to interest
(35% other than bank interest), royalties (30% less an additional tax credit of 15%) and management fees (35%, except for technical services taxed at 15%) paid to non-residents.
The Additional Tax is gathered through a classic withholding mechanism at source, and is charged on the gross amount of a particular item that is subject to the charge.
Second Category Tax (Individuals)
Income arising from wages, salaries, overtime payments, bonuses, fees, gratuities, profit sharing and any other form of remuneration is subject to the Second Category Tax, which is charged at progressive rates of tax (the highest marginal rate being 40%).
Individuals who are resident or domiciled in Chile are liable for the Second Category Tax on worldwide income.
Domicile is defined as physical presence with the intent to remain in Chile.
Residence for tax purposes is acquired upon remaining six consecutive months in Chile in one calendar year, or more than six months, whether consecutive or not, in two consecutive calendar years.
Foreigners working in Chile are subject to taxation only on their Chilean-source income during the first three years in Chile, after which their worldwide income is taxed.
Tax Treaty Reductions Dividends
The rate of tax for dividends is 5% if a minimum shareholding of 25%of capital is met; otherwise the rate of tax is limited to 15%.
The treaty however determines that these limitations ‘shall not limit application of the Additional Tax’ if
the First Category Tax is fully creditable when computing the amount of Additional Tax.
In other words, when a full imputation credit for underlying income tax is claimed, the Additional Tax rate in respect of dividends (currently 35%) will be left undisturbed by the treaty. Imputation credits are automatically granted.
The treaty contains a special clause that preserves the unrestricted taxation of branches for as long as the First Category Tax is deducted in computing the Additional Tax on the income of a branch. In the ordinary course no reduction of Chilean tax on the remittance of branch profits would therefore be available under the treaty.
For interest, the treaty rate of tax is 5% of gross interest derived from loans granted by banks and insurers, from traded bonds and securities on a recognized market and from credit sales of machinery and equipment.
The tax rate is 15% for all other types of interest. In these instances, it appears that a significant reduction of Additional Tax may be achieved under the treaty, down from 35% to either 5% or 15%.
The rate of tax in respect of royalties is limited to 5% of the gross amount for the use of industrial, commercial or scientific equipment and 10% of the gross amount for all other types of royalties. Here too reduction of Additional Tax under the treaty may occur.
Other types of payments or remittances in respect of business activities should typically qualify as
business profits for purposes of the treaty taxable where the recipient is tax resident unless attributable to a permanent establishment.
South African resident companies that, for instance, derive fees from Chile for management, administration or technical services, may be exempt under the treaty from Chilean taxes on income if they do not have a permanent establishment in Chile in connection with such services.
The treaty however contains specific provisions that deem a permanent establishment to exist in respect of services.
Specifics to note
The treaty with Chile takes the OECD Model as a basis, but deviates in certain important aspects that are more fully discussed in what follows.
Extended Permanent Establishments
The concept of a permanent establishment under the treaty includes the provision of all types of services (consultancy and professional services are specifically mentioned) when such services are furnished within a treaty State for a period or periods exceeding 183 days in any twelve-month period.
For these purposes, if associated enterprises carry out identical or substantially the same services, the time periods of such enterprises’ activities are aggregated.
Furthermore, under the treaty insurers that collect premiums in a treaty State or insure risk in such a
country through a dependent representative are deemed to have a permanent establishment.
Dual Resident Corporate Entities
Another important deviation in the treaty concerns companies that are tax resident in both Chile and South Africa under the respective domestic provisions. Such dual residents are subject to double taxation and classically, OECD Model-based tax treaties resolves such double taxation by determining that the company shall be exclusively tax resident in the treaty State in which its place of effective management is situated.
Under the South Africa Chile tax treaty, the effective management criterion is substituted with an administrative discretion.
Accordingly, the responsible South African and Chilean authorities must ‘endeavourer’ to reach mutual agreement on whether a dual resident company should reside only in Chile or in South Africa. If no mutual agreement is reached, the dual resident company is not entitled to claim relief from double taxation under the treaty.
Such a dual resident will not have an effective legal remedy because there is no objective rule in respect of which a Court may determine the company’s status.
It is noted that under the treaty, the validity of so-called ‘residence certificates’ issued by the Chilean authorities is acknowledged as proof of compliance with residency requirements under the treaty.
International Sea and Air Transport
Income from international shipping and air transport will be taxable in South Africa or Chile if the enterprise that derives such income is a resident of either State. Residence for this purpose can refer to any of the following: domicile, residence, place of management, place of incorporation or any criterion of similar nature.
‘Long arm’ Taxation of the Sale of Shares
Under the OECD Model, a sale by a resident of a contracting state of shares in a company of the other contracting state are taxable in that other state only if the underlying assets comprise mainly of fixed property situated in that other state. The treaty gives Chile the right to impose tax on the alienation of any shares in a Chilean company without regard to the underlying assets.
Items of income that are not specifically dealt with may be taxed by the treaty State in which the income arises. Under the OECD Model such income is taxed exclusively by the treaty State where the recipient resides.
Pensions & Secondees
The treaty mostly follows the OECD Model as far as the taxation of individuals is concerned, except in respect of the taxation of pensions, which may be taxed in the treaty State where they arise (under the
OECD Model pensions are exclusively taxable in the residence State of the pensioner).
The treaty furthermore contains a provision that may allow seconded staff to enjoy equal tax treatment of their continued pension contributions in their host State.
There are other instances in which the treaty does not follow the OECD Model’s principles, or only partially does so. However these are specific, and are not dealt with in this article.
In the main, the tax treaty concluded with Chile will bring welcome double tax relief and certainty of tax treatment to South African investors, once it becomes effective.
It is also apparent that complexities will arise due to the Chilean schedular tax regime, the system of imputation credits and the interaction of these with the tax treaty. It is evident that Chile has fought hard to protect its tax base, particularly in relation to the remittance of dividends and branch profits.
South African investors will have to carefully navigate these matters but if successful, it may achieve significant reductions in the tax cost associated with cross-border investment between Chile and South Africa.
It is encouraging to see that the South African authorities have been taking cognizance of strategically important investment destinations and specifically consider the operations in such locations of major South African multinationals when deciding to enter into lengthy treaty negotiations that require the
commitment of significant resources.
A worrying aspect concerns the lack of certainty under the treaty for dual tax resident entities, which are subject to a crippling form of double taxation. It is arguable that disproportionate discretionary powers will be granted to administrative officials to determine the fate of such entities. The fact that these authorities are not obliged to reach a solution and that no objective criterion is available to the courts to determine an outcome raises constitutional questions about the extent of decision-making power granted to officials that are, in theory, supposed to only administer and not make rules. The problem is the total lack of a rule to administer, as well as a lack of consistent, clear and openly defined criteria according to which the discretionary power ought to be exercised