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US-Chile treaty enters into force
December 2023
In brief
What happened?
The US-Chile income tax treaty (the Treaty) and accompanying protocol (the Protocol) entered into force on December 19, 2023.
Why is it relevant?
The Treaty is effective for taxes withheld at source beginning February 1, 2024, and for other taxes, for taxable periods beginning on or after January 1, 2024.
What to consider?
Taxpayers that have operations and payments involving Chile should examine how the Treaty provisions apply to their activities and may begin to apply the Treaty in early 2024.
In detail
Background
The Treaty, which represents the second US income tax treaty with a South American country (after the treaty with Venezuela), was signed in February 2010, ratified by the Chilean Congress in September 2015, and ratified by the US Senate in June 2023 with two reservations (Reservations) and two declarations (Declarations). Although the Treaty was ratified by Chile in 2015, it was necessary for the Reservations that were approved by the US Senate to be accepted by the Chilean Congress. The Reservations were approved by the Chilean Congress on November 15, 2023, and are reflected in an exchange of notes signed by Chile on October 6, 2023. Subsequently, the United States and Chile notified each other through diplomatic channels that their respective applicable procedures were satisfied, and the Treaty entered into force on December 19, 2023.
The Treaty is broadly based on the 2006 US Model Treaty, with certain modifications, including a more restrictive limitation on benefits (LOB) article and higher rates of taxation on dividends, interest, and royalties. The Treaty also includes both a Protocol accompanying the Treaty, which contains extensive additional rules including fiscal transparency principles in line with current US standards, and an exchange of notes between the United States and Chile providing additional interpretive guidance.
Observation: The interpretation and application of US tax treaties require looking not only at the treaty text itself, but also at accompanying documents that may modify, explain, or otherwise provide interpretative guidance. In the case of the Treaty, detailed interpretive documents—in the form of a protocol and exchange of notes—were released simultaneously with the Treaty text, and amendments were made by an exchange of notes in 2023.
Effective dates
With respect to taxes withheld at source, the Treaty is effective for amounts paid or credited on or after the first day of the second month following the date of entry into force, thus effective on February 1, 2024. With respect to other taxes, the Treaty is effective for taxable periods beginning on or after January 1 of the calendar year immediately following the date of entry into force–i.e., January 1, 2024. Information exchange provisions are effective from the date of entry into force.
Treaty provision highlights
Residence
In addition to residence rules for individuals and entities, the Treaty treats US and Chilean charitable organizations and pension funds as residents, including when such entities are not subject to tax in their country of residence.
Permanent establishment (PE)
In addition to the 2006 US Model Treaty definitions of a PE, the Treaty provides special definitions for certain natural resource-related activities and certain enterprise services in the other country based on the aggregate period or periods in any 12 months.
Rates for withholding of tax at source
Tax rates for dividends
The general tax rate for dividends under the Treaty is 15%, with a reduced rate of 5% where the beneficial owner of the dividend is a company that holds directly at least 10% of the voting power of the company paying the dividend. Under the Treaty, dividends paid by a regulated investment company (RIC) or a real estate investment trust (REIT) to a resident of Chile are not eligible for the 5% rate, and are eligible only for the 15% rate (in the case of payments made by a REIT, the 15% rate applies only in certain circumstances).
Notably, the Protocol makes the provisions of Article 10 essentially inapplicable to dividends paid by companies resident in Chile. As a result, to the extent the Chilean First Category Tax (corporate-level tax at the current rate of 27%) is fully creditable against the withholding tax, the reduced rate contained in Article 10 would not be applicable to dividends paid by Chilean companies to US shareholders. They would therefore remain subject to an ‘Additional Tax Withholding’ in Chile at an effective rate of 8%. Thus, the income is taxed at the shareholder level at a rate of 35%—that is, for the purpose of calculating the amount of the Additional Tax, US shareholders of Chilean companies can credit the full amount of the First Category Tax. However, the Protocol also provides that if, in accordance with Chilean domestic legislation, the First Category Tax ceases to be fully creditable in the calculation of the Additional Tax to be paid, the amount of the Additional Tax will be limited by the provisions of Article 10.
Tax rates for interest
The Treaty generally permits taxation of interest at a 10% rate (15% for the first five years after the interest provisions enter into force), except that a 4% rate will apply in certain cases. The 4% rate does not apply to ‘back-to-back’ loans.
Tax rates for royalties
Royalties may be taxed at a 2% rate for payments made as consideration for the use of, or the right to use, industrial, commercial, or scientific equipment. The rate is 10% for payments made as consideration for the use of, or the right to use, any copyright of literary, artistic, scientific, or other work (including computer software, cinematographic films, audio or video tapes or disks, and other means of image or sound reproduction), any patent, trademark, design or model, plan, secret formula or process, or other like intangible property, or for information concerning industrial, commercial, or scientific experience. In addition, the Treaty contains a special sourcing rule that generally provides that royalties are deemed to arise in the country of the payor unless the royalties are borne by a PE, in which case they are sourced to the location of the PE.
The Treaty also includes a provision that, if Chile enters into a treaty with another country providing for lower withholding taxes on interest (discussed above) or royalties, or more limitations on the taxation of capital gains (discussed below), the United States may request a consultation with a view to entering into a protocol to incorporate such greater benefits.
Taxation of insurance and reinsurance premiums
The Treaty permits the taxation of insurance premiums paid to an insurer of the other country at the rates of 2% for reinsurance premiums and 5% for insurance premiums.
Taxation of capital gains on shares or other equity interests
The Treaty generally permits taxation of capital gains on the disposition of shares or other equity interests in a company of the other country at the rate of 16%, except that certain substantial holdings (50% for shares and 20% for other equity interests) are not subject to the 16% limit on taxation. Exemptions from taxation are provided for dispositions by pension funds and certain shares and equity interests that are publicly traded on a stock exchange in the seller’s country of residence. These capital gains rules generally do not apply to the sale of shares or equity interests that principally hold real estate, where each country may fully tax gains in accordance with its domestic laws.
Relief from double taxation
An exchange of notes reflecting the Reservations amends the Relief from Double Taxation article to replace the indirect foreign tax credit language in the Treaty text (which equates to the pre-2017 tax reform legislation indirect foreign tax credit under Section 902) with a provision that permits a US corporate shareholder owning at least 10% of the vote or value of a Chilean tax-resident company to deduct the amount of dividends received from the Chilean subsidiary in computing its taxable income (which equates to the current-law dividends-received-deduction under Section 245A).
Observation: The removal of the indirect credit commitment (which is commonly found in US income tax treaties) from the Treaty also may have implications with respect to not only the now-repealed Section 902 credit, but also to the Section 960 indirect credit for underlying taxes relating to income inclusions under Sections 951 and 951A.
Observation: In the Declarations, the Senate clarified that for future treaties, further work is required to fully evaluate the policy reflected in the Relief from Double Taxation article in view of the changes resulting from the 2017 tax reform legislation.
Under the Treaty, in accordance with and subject to the provisions of Chilean law, Chile has agreed to allow a credit against Chilean tax for US tax paid in accordance with the Treaty on income from sources outside Chile.
Observation: This provision may permit, for example, a Chilean corporation to fully credit US withholding taxes on interest payments, which are reduced but not eliminated under the Treaty.
Limits on treaty benefits for income attributable to a third-country PE
The Treaty contains a triangular branch rule that affects the rate of tax applicable to income attributable to branches of companies. This applies where the branch is located in a third country and the combined taxation of the income by the treaty country and the country in which the branch is located is less than 60% of what the applicable home office country tax rate would have been had the income been fully taxable by the home office country.
LOB article
The treaty with Chile contains a modern and restrictive LOB article that is consistent with other treaties that are based on the 2006 US Model Treaty, which was the US Model followed at the time of the Treaty negotiation. Among the categories of qualified persons are publicly traded companies and their subsidiaries, headquarters companies, and companies meeting an ownership and base erosion test, among others. If a resident of a Contracting State is not a qualified person, it may be eligible for benefits under an active trade or business test with respect to an item of income. Because it follows the 2006 US Model Treaty, the Treaty does not provide for a derivative benefits test, which is available under many US tax treaties.
For additional detail on the LOB article and other provisions, see our PwC Tax Insight from earlier this year.
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