/ Tax Treaty between Chile and the United States of America: A Boost for the U.S. Investment Fund Industry

Felipe Cousiño P.
Franco Gorziglia
Alessandri Abogados

After more than 13 years from its signature by the governments of Chile and the United States of America, the first income and capital tax treaty between these two countries has been finally ratified and came into force on December 19, 2023. However, in respect of taxes withheld at source, the entry into force will be for amounts paid or credited on or after February 1, 2024; and in respect of other taxes, it will be for taxable periods beginning on or after January 1, 2024.

According to the U.S. Department of the Treasury, the treaty will provide certainty and stability of the tax treatment for U.S. and Chilean investors and will reduce in source-country withholding taxes on certain cross-border payments of dividends, interest and royalties. Also, the new treaty contemplates other important provisions, including a mutual agreement procedure to resolve tax disputes and relieve double taxation; provisions to ensure the full exchange of tax information between the U.S. and the Chilean tax authorities; protections against discriminatory tax treatment; and a comprehensive limitation on benefits provision (LOB) to ensure that only residents of the two countries will enjoy the benefits of the treaty.

In the case of dividends, the maximum rates of withholding tax in the source country will be 15% in general and 5% if the beneficial owner is a company which holds directly at least 10% of the voting stock of the company paying the dividends. Because of Chile’s integrated, two-level income tax on business profits (First Category Tax and Additional Tax), the protocol to the treaty establishes that Article 10 of the treaty will not limit the application of the Additional Tax at the ordinary rate of 35% on dividends, to the extent that the First Category Tax remains fully creditable against the Additional Tax.

An appealing feature of the treaty is that dividends will not be taxed in the source country if the beneficial owner of the dividends is an entity established to provide or administer pensions or similar benefits, or to earn income for the benefit of such arrangements, and that is generally exempt from tax in its country of residence, thus creating attractive opportunities for Chilean pension funds willing to invest in the U.S. capital markets.

Capital gains from the alienation of shares or other rights representing capital will be generally taxable in both states. However, the following capital gains will be taxable solely in the state where the beneficial owner of the gain is a resident, provided that certain conditions are met: (a) gains derived by a pension fund resident of a contracting state from the alienation of shares of a company resident in the other contracting state; (b) gains derived by a mutual fund or other institutional investor resident of a contracting state from the alienation of shares of a company resident of the other contracting state and whose shares are regularly traded on a recognized  stock exchange located in that other contracting state and alienated on such stock exchange of that other state; and (c) gains derived by a resident of a contracting state from the alienation of shares of a company resident of the other contracting state and whose shares are regularly traded on a stock exchange of that other state, provided that the acquisition and sale of the shares take place under certain conditions.

As a consequence of the tax treaty provisions highlighted above, Chilean pension funds investing in the United States will be exempt from U.S. income taxes on dividends and capital gains. It is expected that this will create a big incentive for U.S. fund promoters to use their U.S. platforms for their sales to Chilean pension funds rather than using their global platforms.

With regards to interest, the withholding tax in the source country will be limited to a maximum rate of 10% on interest in general (except for a 15% rate which applies for an initial 2-year period from the effective date) and 4% on interest derived by a bank, insurance company or finance company doing transactions with related parties, or an enterprise that sells on credit machinery or equipment, or any other enterprise provided that the enterprise derives more than 50% of its liabilities from the issuance of bonds in the financial markets or from taking deposits at interest and more than 50% of the assets of the enterprise consist of debt-claims against unrelated persons. Notwithstanding, under the treaty interest originating from back-to-back loans or equivalent arrangements may be taxed in the source country at a rate not exceeding 10%.

In the case of royalties, the withholding tax in the source country will be limited to 10% on royalties in general and 2% on royalties for the use of industrial, commercial or scientific equipment, excluding ships, aircraft or containers comprised in Article 8 on international transport.

Both states provide for the imputation or credit method to avoid international double taxation. If the income derived or capital owned by a resident of a contracting state is exempt from tax in that state, that state may nevertheless take into account the exempted income or capital in calculating the amount of tax on other income or capital.

The signature of this treaty is deemed to represent remarkable progress for the economic relations between Chile and the United States, as it will significantly reduce tax-related barriers. On the capital markets front, there is big expectation that the treaty will offer to Chilean institutional investors, especially Chilean pension funds, a tax-attractive, certain and stable tax regime for investing in the Unites States. Further, it is expected that the reduced withholding taxes on cross-border payments between Chile and the United States will encourage companies with activities in the region to use holding, finance and service companies established in Chile. Chilean investors will also find it easier to invest into the United States and repatriate capital and profits to Chile.