Volume 5, Number 24, Page 3

Chilean Joint Ventures with Foreign Partners

by Antonio Ortúzar Solar, Bárbara Viduarre Miller and Jaime Munro Cabezas

Editor's Note:

Several new developments in tax law have changed the way in which Chilean joint ventures with foreign partners are taxed. The October 30, 1998 edition of the Inter-American Trade Report includes part one of the following review. Continued below are summaries of new developments including income tax, value added tax, the registration of foreign investments and transfer pricing.

In Chile, there is no specific legal, tax or accounting provisions by means of which joint venture agreements are regulated. Therefore, joint ventures are governed by the stipulations of the applicable join venture agreement, which is subject to general legislation.

Formal branches of foreign companies, "permanent establishments," and local entities owned by foreign non-domiciled members or shareholders are taxed in the same manner, as follows:

1) Corporate Tax, called First Category Tax, is assessed at a rate of 15 percent on net taxable earnings (as determined by complete accounting records). This tax is filed and paid in April of each year, with regard to the preceding fiscal year. Taxpayers must make provisional monthly payments which are set off against the annual tax.

The fiscal year begins on January 1 and ends on December 31. The law empowers the tax authorities to authorize a different fiscal year, but currently the authorities have a policy of not granting permission to establish other dates for the fiscal year.

2) Additional Tax is assessed at a rate of 35 percent on profits remitted abroad to non-domiciled and non-resident headquarters, members or shareholders. A credit equal to the First Category Tax effectively paid is granted against the Additional Tax, consistent with Chile's Comprehensive Integrated Income Tax system. Thus, the total tax burden is 35 percent, and the net Additional Tax paid is 20 percent of net taxable income.

Value Added Tax

Habitual vendors and service providers domiciled in the country are VAT taxpayers. Only VAT taxpayers can benefit from the tax credit system outlined in the Value Added Tax Law. Pursuant to the credit system, the VAT assesed on acquisitions of goods or services within the scope of business is set off against the VAT charged for sales and services. The rate of VAT is 18 percent. It is assessed on sales, imports and services, including local transportation of goods.

Choice of Structure

Forming either a branch or a local company (organized as an LLC or stock corporation) in Chile requires basically the same procedure. The company or branch must be formed by public deed, signed before a notary public. This deed must contain the bylaws of the company, and in the case of a branch, the declaration of the scope of business of the Chilean branch. An abstract of the deed must be published in the Official Gazette and registered at the Commerce Registry within sixty days of the signing of the public deed.

The choice of these alternatives will depend, from a tax standpoint, on factors including the following:

A branch used to participate in an "unincorporated" joint venture, as it is not a juridical entity separate from its headquarters, may be used to allow the losses of the branch to be set off against the profits of the headquarters, and thus lower the tax burden in the country of origin. Equivalent treatment is possible in the U.S. for SRLs (Socied de Responsibilidad Limitada, equivelant to LLCs) but not for SAs (Sociedad Anonima, or Corporations).

At the end of the joint venture, it is not possible for the investor participating through a branch to sell "shares" or "participations" of the branch (which in certain cases would be taxed as capital gain at a 15 percent rate). Branches upon liquidation must sell their assets, and the tax treatment is the same as for normal income (15 percent Corporate Tax and 35 percent Additional Tax, with the tax credit mentioned above). The sale of assets of a branch may also trigger taxes in the country of origin.

If an SA or SRL is used, the investor may sell ownership interests, rather than underlying assets. If the investor does not regularly in the purchase and sell such interests, the taxable gain may be subject to a sole tax of 15 percent. Again, country of origin taxes may apply.

Considering the above from a tax standpoint, this choice will depend on factors including the following:

1) Reinvestment

The members of an SRL are allowed to "reinvest" profits in certain entities (other SRLs, stock of first issuance, individual enterprises) and defer the application of Additional Tax until the investment is withdrawn from the recipient or distributed by the latter, provided the investment is made within 20 days after distribution and certain formalities are observed.

Shareholders of stock corporations cannot similarly benefit. They are taxed on dividends when they are remitted or placed at the disposal of the shareholder, with no exception.

It is important to point out that a bill to reform the Income Tax Law has been proposed to the Chilean Congress. The bill proposes that SRLs and SAs be subject to the same taxation and the application of this reinvestment mechanism be limited.

2) Temporal Differences

Taxable profits may not always coincide with financial profits, due to accelerated depreciation and other matters. Usually, these temporal differences mean that at the business' inception, a large financial profit is generated, but only a small tax profit is recognized or tax loss registered. In time, this effect is reversed, and tax profits may increase, while financial profits decrease.

In the case of SRLs, members are only taxed upon distribution of profits up to the amount registered in a special account named the "Taxable Profit Fund" (called "FUT"). If distributions exceed this amount, taxation is deferred until tax profits are realized.

In the case of stock corporations, dividends are taxed upon distribution even if the company has no accrued taxable profits. Thus, if use of accelerated depreciation results in no taxable profit, the shareholders are subject to 35 percent additional tax, with no credit, as no corporate tax is accrued. In later years, the tax profits may increase, with 15 percent paid at the corporate level, but cannot be credited against additional tax on dividends already distributed. Thus, double taxation is possible (this does not happen in SRLs). The above "temporal difference" would be eliminated by the proposed tax reform.

3) Capital Gains

At the end of the joint venture, the taxable gain in the case of the sale of shares is the difference between the acquisition price adjusted for inflation and sales price. If the shareholder is not habitually engaged in the purchase and sale of shares, the taxable gain is subject to a sole 15 percent tax, provided that the shares have been held for at least one year.

In the case of sale of an interest in an SRL, the taxable gain is the difference between the sale price and the book value of the interest, provided that the seller is not obligated to keep complete accounting records for tax purposes in Chile. If the seller is obligated to keep complete records, the taxable gain is the difference between the acquisition value of the rights (adjusted for inflation) and the sales price. This taxable gain is subject to normal taxation.

Foreign Investment

Foreign investment must be registered in the country, and may be done either through the provisions of Decree Law 600 or per Chapter XIV of the Summary of Foreign Exchange Regulations of the Central Bank of Chile.

Both mechanisms are fast and efficient. However, for major investments, Decree Law 600 is more appropriate, because it has certain advantages over the mere registration of the investment contemplated in Chapter XIV. The minimum investment in the case of Chapter XIV is US$ 10,000; whereas the minimum for Decree Law 600 is US$ 1,000,000.00.

Pursuant to Chapter XIV, the investor registers the investment with the Central Bank, through a commercial bank. The funds may be liquidated on the same day the Central Bank grants approval, which is usually on the same day the request is filed or within 48 hours. The capital must remain in the country for at least one year. Expatriation of capital is not subject to any tax. Access to the formal exchange market is granted both for profit remittance and for capital repatriation.

Decree Law 600 provides a mechanism whereby the investor signs a contract with the State of Chile. This contract grants certain permanent rights to the investor. These rights include access to the formal market, both for profit remittance and for capital repatriation. Furthermore, the investor may opt for tax invariability for ten years, with a fixed overall rate of 42 percent; if the investment exceeds a certain amount, the invariability may be granted for 20 years. The investor may waive tax invariability at any time. Note that the tax invariability rate is higher than the overall tax burden imposed as per the normal tax treatment, which is 35 percent. The difference is considered the "price" that foreign investors must pay for the guarantee of such invariability. The request for investment under Decree Law 600 must be filed with the Foreign Investment Committee, and the funds may be liquidated on the same day the request is filed. The actual execution of the contract with the State of Chile usually takes about one month.

Tax Treatment of Payments Made Abroad to Nondomiciled and Nonresident Entities

Amendments to the income tax law by virtue of Law 19,506, enacted in 1997, altered the tax treatment of payments made abroad to non-domiciled and non-resident individuals and entities. The current tax treatment of such payments is described below.

Royalty or license payments made to non-domiciled and nonresident individuals or entities are subject to a 30 percent withholding tax, assessed on gross amounts, with no deductions. (Note: no more than 4 percent of the income of the local entity may be deducted for income tax purposes by reason of a royalty or license payment, unless the payment is made to a totally unrelated entity or the tax assessed on the payment in the recipient country is 30 percent or more.)

If a service corresponds to engineering work or technical assistance rendered either in Chile or abroad, the rate is reduced to 20 percent. This sole withholding tax is also assessed on total amounts, with no deductions. There is no limitation on tax deduction by the paying local entity in this case.

Some procurement, supervision and management services may be considered technical assistance for this purpose and, if so, are subject to the tax treatment described above. The law does not specifically define the term "technical assistance," but it is deemed to be service, which requires the renderer to have knowledge of a specific science or art, the service being rendered in the form of a report or advice.

If a service cannot be classified as technical assistance or engineering work, the applicable tax rate is 35 percent. Furthermore, if in a single contract the amounts paid pertain to technical assistance or engineering services in addition to other services, or in the case of lump sum contracts which include all kinds of services, the tax authorities have ruled that all the payments under the contract are to be taxed at the 35 percent rate.

Payments made abroad for import of equipment and materials are not subject to any income tax. Imports are subject to 11 percent customs duties and to 18 percent value added tax.

The VAT law provides that when amounts remitted abroad are subject to the withholding income tax described above, VAT does not apply. For this reason VAT incurred on the local acquisition of goods and services cannot be recovered by the foreign entity, as only VAT taxpayers, who charge VAT, can benefit from the tax credit system provided in the Value Added Tax Law.

On the other hand, commercial vendors and service providers domiciled in the country are VAT taxpayers. VAT incurred by them on acquisitions of goods or services within the scope of their business is offset against the VAT charged on their sales and services

Transfer Pricing

Law 19,905 contains a new transfer pricing provision. The tax authorities may challenge the prices that an agency or branch charges its related company when they are not in line with the prices charged for similar transactions among independent entities, provide for reasonable profitability of the transaction, or cost plus a reasonable margin. The provision is also applicable to payments made by a branch or agency to its headquarters for goods or services provided, when such price are not in line with market value among unrelated parties. The tax authorities may also consider, in this latter case, the prices at which the same goods are sold to third parties by an associated company.

If the agency or branch does not enter into such transactions with independent parties, the tax authorities may challenge such price taking into consideration the international market value of the goods or services.

Likewise, the tax authorities may reject deduction as an expense of any excess in the amounts owed or paid as interest, commissions, or any other payment arising from credit transactions with the headquarters or related party or with a related financial institution.

The above provisions also apply when a company incorporated abroad has direct or indirect control over a company incorporated in Chile, and vice versa, and also when the same persons participate directly or indirectly in the direction, control or capital of a company incorporated in Chile and a company incorporated abroad.

by Antonio Ortúzar Solar, Barbara Vidaurre Miller and Jaime Munro Cabezas of Baker & McKenzie in Santiago, Chile. They may be reached at (56-2) 367-7000