Most favored nation and back-to-back clause

Circular Letter 27 of 06.28.2019

Many Chilean treaties to avoid double taxation contain most-favored-nation clauses, which basically establish that if Chile subsequently agrees a lower rate with another country, this rate becomes applicable to the treaty entered into in the first place.

On the occasion of the entry into force of the treaties with China and Japan, the IRS has issued Circular Letters (22 and 50 of 2018) explaining the application of this most-favoured-nation clause to several agreements. Through Circular Letter 27 of 2019, on the occasion of the entry into force of the treaties with Japan, China and Italy, the IRS gives instructions on the application of the most-favored nation clause with respect to interests and royalties to the treaties with France, Sweden and Argentina.

Likewise, Circular Letter 27 refers to Chilean agreements that contain clauses for back-to-back or similar financing structures, which are basically those in which a bank or financial institution is used as an intermediary to access treaty reduced rates. Circular Letter 27 establishes that despite the fact that a treaty contains specific clauses that establish a different treatment for back-to-back or similar financial structures, this does not prevent other specific anti-avoidance rules from being applied.

Use of foreign tax credits by professional companies

Ruling 1522 of 06.03.2019

Professional companies have the option of being levied with First Category Tax (similar to Corporate Tax) like any other company or treating the company as a tax transparent entity paying income taxes at the partners level.

Ruling 1522 refers to the case of a professional company that only pays taxes at the partners level, asking how it can make use of the tax credits for taxes paid in Brazil for services rendered in that country, since the professional company, as it is not a taxpayer, does not comply with the definition of resident of the double taxation treaty in force with Brazil, and therefore it would not be applicable.

In this context, the IRS, citing the comments to the OECD model, establishes that both the treaty and the credits can be applied by the partners of the professional company, who are the ones who finally pay the tax.

Capital gains on the sale of real estate – Concept of effective income

Rulings 1590 of 06.07.2019 and 1688 of 06.21.2019

Since the 2014 Tax Reform limited the tax benefits in real estate sales to individuals who are not First Category Tax payers on effective income, the IRS has had to issue several rulings to define the meaning that should be given to this requirement. In this context, during June 2019, the IRS issued two new rulings.

Ruling 1590 refers to the situation of a person who has assigned non-agricultural real estate to his individual company. The IRS establishes that although being a natural person, he is exempt from First Category Tax for the income generated by this asset, having the asset assigned to his individual company is always considered to determine First Category Tax over effective income, so he would not be entitled to any benefit. In our opinion, this criterion could be considered contradictory to Ruling 2541 of 2017 .

On the other hand, Ruling 1688 reiterates a criterion already contained in previous rulings, which is the case of an individual who sells real estate that is not included in the accounting records of his individual company, establishing that he would be entitled to the benefits for the sale of real estate not included in his individual company (exemption for UF 8,000 and tax of 10% rate for what exceeds).

Deduction of contributions made by members of a foundation

Ruling 1645 of 06.14.2019

Ruling 1645, in our opinion, contains a very good criterion, since the IRS accepts that the members of a foundation, whose object is the promotion of the institutions that sustain and allow the existence of a constitutional and democratic order in Chilean society, deduct as an expense the contributions made to the foundation.

The IRS’s conclusion is based on the fact that this foundation seeks to generate a benefit for the entire Chilean society, which would have a positive impact on the members, translating into a direct and indirect benefit for the contributors. This would allow the payment of contributions to meet two of the most commonly questioned requirements for an expense to be deductible, which are to be related to the business and necessary to produce income.

Alternative to goodwill?

Ruling 1681 of 06.20.2019

It is known that, after the 2014 Tax Reform, the goodwill generated in a merger due to the difference between the tax cost of the investment in the absorbed company and its tax assets was no longer treated as an expense.

In Ruling 1681, a taxpayer who wants to become the owner of a company’s aquaculture concessions, arguing the difficulty of transferring these concessions to unrelated third parties, states that he will buy 100% of a company created for these purposes to which the concessions were assigned, which will later be dissolved. In this context, it asks to be confirmed that the difference between the tax cost of the investment and the tax cost of the assets it receives from the dissolved company can be deducted as an expense.

The IRS confirms that the difference can indeed be deducted as an expense but makes a prevention that it has been doing lately, apparently in reference to the application of the general anti-avoidance rule, indicating that it will be verified in the auditing process that the reasons motivating this sale structure correspond to the commercial reasons stated by the taxpayer.

Merger of a Chilean company with a foreign company that has an agency in Chile.

Ruling 1690 of 06.21.2019

The IRS has already issued several rulings, accepting the application to cross-border mergers of the rule that allows mergers at tax value without generating income taxes (article 64 of the Tax Code). The particularity of Ruling 1690, is that the foreign company to be absorbed by the Chilean company, has an agency in Chile which would extinguish upon dissolution of the foreign company.

In this context, the IRS accepts that the agency’s simplified end of activities process is made, and that the income accumulated in this agency is not taxed with the End of Activities Tax of article 38 bis of the Income Tax Law, incorporating the agency’s taxable income to the absorbing company’s registries.