Volume 6, Number 4, Page 3

Chilean Tax Reform: An Overview

By Barbara Viduarre Miller

The Executive Message delivered by the President of the Republic to Congress last April initiated a tax reform process significantly more ambitious and radical than the text approved by Congress (published in the Official Gazette on July 29, 1998). The main purpose of the reform is to increase revenue in order to finance an increase in Social Security spending. The Following article includes the main arguments in the Executive Message, a brief description of actual amendments to the Income Tax Law and an overview of "transitory articles, " which contain provisions to be in force from fiscal year 1999 (calendar year 1998) to fiscal year 2002 (calendar Year 2001).

The Executive Message delivered by the President of the Republic to Congress proposed to increase revenue for Social Security benefits through the reduction of tax evasion, elimination of tax loopholes and certain tax benefits.

The message described the measures to be adopted, as follows:

The main income tax changes were the amendment of Article 57 bis of the Income Tax Law (containing mechanisms to reduce taxes through investment in certain vehicles); the reduction of legal loopholes; abrogation of the tax credit granted against First Category Tax (corporate tax) for real estate tax on non-agricultural land and ;some complementary measure.

a) Article 57 bis of the Income Tax Law was to be reformed with the elimination of letter A of said Article, which contains tax benefits for investment in shares of publicly owned companies, as this mechanism is considered discriminatory and unjust. Additionally, letter B of said article, which deals with personal savings in nominative documents, was considered excessively complex. Therefore the bill proposed to eliminate letter A and simplify letter B.

b) A principle of the Chilean tax system applies beneficial tax treatment to the withdrawal of profits when they are reinvested; and a more severe tax regime to the withdrawal of profits not destined for reinvestment. The Bill proposed to correct certain cases of taxpayers taking advantage of loopholes to elude the final payment of taxes on profit withdrawals, in clear contradiction of the spirit of the reinvestment principle.

c) The Bill proposed the elimination of tax credits granted against First Category Tax for real estate tax applied to non-agricultural land, in order to correct the erroneous "integration" of real estate tax with First Category Tax. Such integration, according to the Bill, distorts the efficient allocation of resources in the economy.

Complementary measures included an increase in the credit granted against First Category Tax for the purchase of fixed assets, which was meant to stimulate growth in small and medium enterprises.

The new plan for fiscal scrutiny is based on the need to apply additional measures against tax evasion, as breaches of tax obligations not only restrict public income but also generate unfair advantages in the private sector.

The plan proposed that the amendments would permit the financing of pensions, and more than one half of such financing would come from increased fiscal scrutiny. The closing of legal loopholes and the perfection of Article 57 bis is to finance approximately 20 percent of the increased pensions, whereas the remaining measures will finance approximately another 20 percent.

The final text, approved by Congress, and enacted as Law 19,578, contained significantly fewer amendments than originally provided for in the ambitious plan, though the main areas covered were included in the final tax reform.

The main amendments to the Income Tax Law are the following:

1) Article 14 of the Income Tax Law was amended so that profits resulting from the acquisition of shares of publicly traded companies, and subsequently transferred, will be considered a withdrawal of the original amount invested in such shares and will be taxed accordingly. This closes a popular loophole, whereby profits were reinvested in shares, and subsequently sold at little or no profit without triggering personal tax on the original withdrawal.

2) Before amendment, Article 21 of the Income Tax Law treated loans granted to individual shareholders or partners (those subject to "surtax") as ''profit withdrawals" for tax purposes. The new text also includes shareholders or partners subject to "additional tax," thus granting equal treatment to resident and non-resident shareholders or partners.

Amended Article 21 also increased "presumed income," in the case of motor vehicles owned by companies for use by partners or shareholders, from 10 percent of the tax book value of such goods (a general rule applicable to all movable assets) to 20 percent of such value.

Amended Article 21 also adds a new instance of "presumed income." If any asset of a company is delivered in guarantee of a direct or indirect obligation of its shareholders or partners, and the guarantee is enforced, a profit withdrawal equal to payment made by the guarantor will be presumed for the respective partner or shareholder.

Excess payments made to the head office by a Chilean branch, or to a controller by subsidiary, are also considered to be presumed income, under the new text of Article 21.

3) Article 31 of the Income Tax Law, which sets requirements for expense deductibility, was also amended. It now includes as admissible expenses payments made towards real estate tax, if such tax cannot be used as a credit against First Category Tax.

4) Article 57 bis was amended to eliminate a provision containing personal benefits for investments in certain securities, and to clarify the mechanisms whereby taxpayers subject to surtax may offset certain investments against the same.

5) Transitory Articles. Special attention must be given to the transitory articles. In most cases, transitory tax provisions become "permanent." The most relevant transitory articles regarding income tax are described below:

a) The crediting of real estate tax against corporate tax is limited, for some taxpayers for fiscal years l999 to 2002 (commercial years 1998 to 2001).

b) All taxpayers (habitual or non-habitual) who obtain capital gains from the transfer of publicly traded shares for fiscal years 1999 to 2002 may opt to pay 15 percent of the difference between the sales price and the acquisition price adjusted by inflation, or surtax. This election must be made every year to apply to all such transactions during the year, and may only be changed on an annual basis. This benefit is granted with certain restrictions. It is not applicable if a transfer is made to a related party or in the case of a transfer of shares sheltered under 57 bis of the Income Tax Law.

c) During fiscal years l 999 to 2002, payers of surtax (individuals domiciled or resident in Chile) may deduct 50 percent of dividends and interest payments received if they meet certain requirements. Dividends must be received from open stock corporations listed on the stock exchange and interest payments must originate from deposits in national or foreign currency made in any national bank or financial institution. This benefit is subject to certain restrictions, including the amount to be deducted, and may not be used jointly with the benefits set forth in Article 57 bis of the Income Tax Law.

Barbara Viduarre Miller is an attorney with Baker and McKenzie in Santiago, Chile.