Important Considerations for the US Chile Tax Treaty

At a glance:

• The main takeaway: Taking full advantage of the US Chile tax treaty starts by understanding the treaty and what it permits, how you can benefit and how to avoid potential pitfalls.
• Implications for your business: Businesses that wish to invest or establish new operations in Chile need to understand the treaty’s stipulations if they want to receive the full benefits the treaty can provide.
• Next steps: Absorb the insights in this piece, then schedule a consultation with Aprio to identify the opportunities and explore the options available to you and your business.

Schedule a consultation with Aprio’s International Tax Services team today.

The full story:

Introduction

The new US – Chile tax treaty was first signed in 2010, then finally went into force in December 2023 after 13 years of deliberation by the governments of both countries. The treaty – only the second of its kind between the US and nations in South America – was built to remove roadblocks standing in the way of mobility, investment and interdependence between the two nations, and carries some significant implications for individuals and businesses in both Chile and the US (as discussed in my previous piece). 

The way has now been paved for bilateral investments in either country by their opposites, but the lack of roadblocks is not a guarantee of laissez faire. The treaty itself is built on the backbone of the United States Model Income Tax Convention of November 15, 2006 (i.e., the 2006 US Model Tax Treaty), and comes with some significant changes that should be taken into account by companies or individuals looking to operate or invest in either jurisdiction.

Timing Taxes and Withholding

The first consideration is timing. Provisions relating to withholding at the source took effect on February 1, 2024, while provisions relating to other taxes took effect on periods starting on or after January 1, 2024. Taxpayers must be aware of the timing to ensure the treaty’s benefits are applied correctly. If an individual or organization misinterpreted the treaty and assumed that all of its provisions went into effect on the same day it went into force, they may risk underpaying or over withholding and potentially incur related penalties from the related tax authorities.

Information Sharing

Article 27 of the treaty requires the two countries establish a robust information sharing system. Authorities in Chile and the US will be required to furnish almost any financial information relating to the assessment or collection of, the enforcement or prosecution in respect of or the determination of appeals in relation to tax laws in either country. This increased transparency should make it much easier for the two countries to prevent any kind of tax evasion among individuals or businesses operating in the other country.  

Domiciles and Permanent Establishments

If an individual or organization wants to take full advantage of the treaty’s tax provisions, they don’t just need to know which country will provide the most beneficial treatment – they need to understand how and when each country’s respective tax laws will apply.

According to the treaty, individuals are subject to the tax laws of the state by reason of their domicile, residence, citizenship or similar criteria. Most citizens of either country will thus be subject to their respective country’s tax laws.

Businesses will be taxed according to whether they have a permanent establishment in either or both countries. The definition of what constitutes a permanent establishment is drawn primarily from the 2006 US Model Tax Treaty, albeit with a few differences.

In addition to the standard definitions of a permanent establishment as a fixed place of business including factories, workshops, offices, mines and oil or gas wells, the treaty also defines a permanent establishment as:

• An installation for the on-land exploration of natural resources that lasts for more than three months;
• A building site or construction or installation project and its supervisory activities, a drilling rig or ship used for the exploration of natural resources that that exists or is in use for more than six months;
• An enterprise that performs services in the contracting state for more than 183 days (about 6 months) in a twelve-month period.

Any business that wants to do business or perform any of these activities for more than the allotted time should thus be prepared to foot the bill for any tax liabilities incurred in either country.

Limitation on Benefits

The treaty’s special provisions includes an article on the limitation on benefits, intended to prevent or greatly reduce the prevalence of treaty shopping among people and businesses seeking relief from tax laws in either and/or both jurisdictions. The article lays out the restrictions limiting eligibility to individuals, public companies and legal “persons,” all subject to numerous qualifying and disqualifying factors, with the end result being a very restrictive set of eligible recipients of the benefits afforded by the treaty.

Individuals and businesses should verify that their organizations qualify as eligible recipients before making investments or setting up foreign operations in either country. If they fail to do their due diligence they may end up with much higher tax liabilities than they expect, potentially harming the profitability and even viability of their operation.

Withholding Adjustments at Source

The treaty lays out a number of adjustments to withholding rates at the source, as well as nearly the same number of adjustments, exceptions and carveouts for various classes of businesses. These include:

• Dividends: the general rate is set at 15% under the treaty, with a reduced rate of 5% for companies that hold at least 10% of the voting power of the dividend-paying company.
  • Regulated investment companies (RIC) and real estate investment trusts (REITs) paying dividends to residents of Chile are not eligible for the 5% rate.
• Interest: 15% for first five years after treaty enters into force, except for certain cases eligible for a 4% rate.
• Royalties:
  • Taxed at 2% for payments on industrial, commercial or scientific equipment
  • 10% for payments made as consideration for most other processes or intellectual property
• Insurance: Taxed at 2% rate
• Reinsurance: Premiums taxed at 5% rate
• Capital gains on shares or other equity interests: Generally set at 16% rate, with several reservations and qualifications

Increased Interaction with Chilean VAT

In 2020 Chile made changes to their value added tax (VAT) laws and began assessing VAT on nonresident taxpaying providers of streaming entertainment, software, technology, data storage and other downloadable digital services. Withholding on these and other externally provided services are typically exempt from Chile’s 19% VAT.

Since the treaty eliminates the withholding, those foreign services will now often be subject to Chilean VAT. US service providers should now be able to treat service fees as business profits under the treaty, which are exempt from Chilean withholding tax. Unless some exemption applies, US service providers will now have to deal with the Chilean VAT tax regime more often.

Relief from Double Taxation

The treaty’s provisions for mitigating or eliminating double taxation may be the most important part of the agreement. The general concept is fairly simple: If a citizen or organization based in the US pays income taxes (as defined by the treaty) to Chile, they will receive an equal amount of tax credits from the US government, and vice-versa for citizens and organizations based in Chile.

Though the concept itself may be simple, the treaty lays out a number of exceptions, stipulations, special circumstances and other complications that make it much more difficult to tell whether any given tax liability will be eligible for the treaty’s benefits. Companies and individuals would be smart to carefully inspect the text to ensure that they will be able to mitigate their tax liabilities under the terms of the treaty.

Closer Relations

The new US Chile tax treaty contains a great number of beneficial provisions that will help encourage more investment and mobility between the two countries. Organizations and individuals have the opportunity to work and operate in either country without incurring exorbitant tax bills, but they need to be careful that they meet the treaty’s requirements first.

Schedule a consultation with Aprio’s International Tax Services team today and explore the opportunities opened up by the US Chile tax treaty.

Related Resources:

The Implications of the US – Chile Tax Treaty

Navigating the Tax Implications of Offshore Resources

Case Study: Customs Compliance and Broker Management Drives Big Savings and Resolves Issues