On Oct. 25, the Chilean government submitted the reservations made by the U.S. Senate regarding the U.S.-Chile bilateral income tax treaty (the Tax Treaty) to the Chilean Congress for approval. Chilean tax practitioners expect the Chilean process for approval of the Tax Treaty to be completed this year or in early 2024.

On June 21, the U.S. Senate approved a resolution recommending that the U.S. president ratify the Tax Treaty, subject to certain reservations relating to the base erosion and anti-abuse tax (BEAT) and Article 23 (relief from double taxation) discussed below. The Tax Treaty and its accompanying protocol were originally introduced in 2010, and following certain refinements, were submitted to the U.S. Senate for consideration in 2012 but were not previously approved by the Senate. The Chilean Congress, on the other hand, approved the Tax Treaty in 2015.

The Tax Treaty will only enter into force after ratification and the exchange of diplomatic notes by both countries. In the meantime, however, under Chilean tax laws, U.S. residents may rely on a benefit available under Chilean tax rules to residents in treaty countries to claim a reduced Chilean dividend withholding rate, as further discussed below.

The Tax Treaty is intended to provide relief from double taxation to residents meeting the following requirements:

  • The withholding tax on dividends will generally be capped at a maximum rate of 15%, with a reduced rate of 5% available for taxpayers who directly hold at least 10% of the voting stock of the dividend-paying company. Additionally, dividends received by U.S. taxpayers from Chile may be treated as "qualified dividend income" and hence subject to preferential U.S. tax rates if applicable requirements are met.

  • The aforementioned cap on the withholding of tax with respect to dividend income will not practically apply to payments of dividends from Chilean corporations unless Chile makes certain modifications to its integrated corporate tax system in the future. The Chilean integrated corporate tax system reduces the Chilean dividend withholding tax from 35% to an effective 10.96% for treaty country residents. While the Tax Treaty is pending, such reduction is available to U.S. residents on a temporary basis until Dec. 31, 2025.

  • The withholding on payments of interest made to a beneficial owner that is a bank, an insurance company or a lending business, among others, will be limited to 4%. In all other cases, the maximum withholding rate on interest will be capped at 15% for the first five years after the treaty enters into force, after which time the withholding rate will decrease to 10%.

  • The withholding on payments of royalties will be generally capped at 10%, but withholding on consideration for the use of (or the right to use) industrial, commercial or scientific equipment will be capped at 2%.

  • The withholding on capital gains derived by a resident of a contracting state from the sale of shares of (or other rights to or interest in) a company that is a resident of the other contracting state will generally be capped at a maximum rate of 16%, provided certain ownership percentage thresholds are met. The Tax Treaty will also provide certain exemptions for sales of shares by pension funds, mutual funds and other institutional investors in certain cases.

  • In addition, the Tax Treaty will generally exempt most U.S.-source service fees (normally taxed by Chile at 35% if paid from Chile) as business profits of U.S. residents. However, that exemption would generally trigger a 19% value-added tax if the services are used in Chile.

As mentioned, the U.S. Senate approved the Tax Treaty subject to certain reservations with respect to the BEAT and the current draft of Article 23. The first U.S. Senate reservation clarifies that the Tax Treaty does not prevent the United States from imposing the BEAT (very generally, a minimum tax on domestic corporations intended to protect the United States tax base from erosion due to payments of deductible expenses to foreign-related parties). Under the second U.S. Senate reservation, Article 23 of the Tax Treaty would be revised to reflect changes to the Internal Revenue Code in 2017, specifically with respect to the repeal of Section 902 and the adoption of Section 245A, relating to the deduction of dividends received by domestic corporations from foreign corporations provided certain requirements are met.

The Tax Treaty will also provide helpful guidance with respect to U.S. and Chilean foreign tax credit (FTC) rules:

  • The Tax Treaty will simplify the FTC analysis on the U.S. tax front by treating Chilean income taxes as creditable for U.S. tax purposes.

  • In addition, the Tax Treaty is expected to reduce FTC leakage on the Chilean side, as the scope of FTC available for Chilean taxpayers under the Tax Treaty is broader than Chile's domestic FTC regime.

The Tax Treaty will also include a limitation of benefit clause based on the U.S. Model Tax Convention. That clause is generally intended to prevent abuse of treaty benefits and treaty shopping by imposing additional qualification requirements on the purported beneficiary (often focusing on the level of activity, taxation or presence of such beneficiary in the applicable jurisdiction). When initially introduced, the Tax Treaty was the first Chilean treaty to include a limitation of benefit clause of any type. In recent years, especially after the Organisation for Economic Co-operation and Development added a similar clause to its model convention in 2017, Chile has increasingly added a limitation of benefit clause to its treaties.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.