Chileans Rush to Pay Tax on $242 Billion of Historic Profits

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By Tom Azzopardi

Thousands of Chile-based companies and individuals are rushing to take advantage of a one-off opportunity to pay less tax on 30 years’ worth of untaxed corporate profits equivalent to the country’s gross domestic product.

Companies in particular have up to Apr. 30 to declare tax liabilities, for profits earned up to the end of 2016.

So far the mechanism has raised more than Chilean Peso 552.7 billion ($835 million), the equivalent to 1.5 percent of projected government spending last year, more than four-fifths of which was paid in the last 12 months, tax authority Servicio de Impuestos Internos (SII) said Dec. 11.

The situation is a legacy of Chile’s previous tax system under which companies only paid tax on profits distributed to shareholders who could then use 100 percent of this tax as a credit against their taxes. The undistributed profits was recorded in the Untaxed Profits Ledger, known as FUT from its initials in Spanish.

Set up in the aftermath of Chile’s 1982 banking crisis to encourage companies to reinvest profits, the current government promised to do away the system which they said had become a vehicle for tax avoidance on a massive scale. According to SII, companies have accumulated $242 billion in untaxed profits, a sum equivalent to Chile’s GDP.

The administration’s solution, included in 2014’s wide-ranging overhaul of the tax code (Law 20,780), was a Substitutive Tax, allowing shareholders to declare up to 100 percent of their historic untaxed profits in exchange for payment at a lower tax rate, in place of the global complementary tax—paid by taxpayers domiciled in Chile—or the additional tax, paid by foreign investors.

Corporate tax paid by the company may count as credit against the Substitute Tax payment, allowing the owners to then withdraw the corresponding profits as and when the owners decide without paying any additional taxes.

The mechanism taxes the declared untaxed profits at 32 percent or, in some cases, at an often much lower variable rate.

According to SII, 1,418 entities and 304 individuals paid the Substitutive Tax at 32 percent, raising Chilean Peso 360.8 billion, while 1,884 entities and 172 individuals paid the tax at a variable rate, raising another Chilean Peso 92.8 billion.

The amount of un-withdrawn profits on which tax has been paid will be now recorded on company books as FUNT, from its initials in Spanish.

Avoiding Higher Tax Rates

“This is an interesting and convenient alternative for taxpayers allowing them to close the tax situation of accumulated profits ahead of the tax regime,” SII said.

By paying the Substitutive Tax, taxpayers can avoid paying tax on profits under the higher effective tax rates applicable to distributions made as of Jan 1. 2017 under the Semi-Integrated system.

Under the Semi-Integrated system, companies only pay tax on distributed profits, but shareholders are only allowed to credit 65% of the 27% corporate tax against their own tax liabilities. This implies a final tax rate of 44.45% for taxpayers domiciled in Chile or in countries with whom Chile has not signed a double taxation treaty.

Alternatively, companies may choose to pay under the Attributed System, which imposes a 25% tax on all profits whether distributed or not, although shareholders many use this as a credit against their personal income tax. However, this alternative is only open to companies with shareholders either resident individuals or not based in Chile.

According to SII, 83 percent of the country’s 1.12 million corporate taxpayers will pay tax under the attributed system while 195,505 companies will do so under the semi-integrated system, paying tax at 25.5 percent this year and 27 percent from 2018.

The number of taxpayers using the Substitutive Tax shot up last year after the government passed legislation (Law 20,890) which made it easier and more attractive to make use of the benefit, dropping the requirement that companies could only withdraw the historic profits once tax had been paid on all new profit.

This change means that companies that make payments under the Substitutive Tax can distribute the corresponding amount of profits to owners with paying any further taxation when and how they like, significantly reducing their tax bill over the long term.

The law also extended the deadline to use Substitutive Tax up to Apr. 30. This means tax declarations can be made up to this date, and may include profits earned up to the end of 2016.

As a result, use of the mechanism has soared. Payments made in 2016 represent a fourfold increase from the Chilean Peso 99 billion raised in 2015, SII figures showed.

The other advantage is security against future attempts by politicians to extract more government revenues from this paper money pot. In 2013, presidential candidate and former Finance Minister Andres Velasco proposed charging interest on the untaxed profits, an instrument which he said at the time could raise $5.7 billion annually.

“We don’t know what’s going to happen in the future with FUT,” Javier Jaque, a tax partner at EY Chile, told Bloomberg BNA on Jan. 11.

He added that with this mechanism, “we can close this situation.”

Popular Mechanism

Given the advantages, thousands more companies and individuals are expected to make payments under the mechanism before the window closes Apr. 30th.

“It could raise the same amount again,” said Rodrigo Hernandez, a tax partner at PwC Chile told Bloomberg BNA Dec. 11, noting that latecomers will be able to include another year of profits. But it may not suit all.

“Companies need to do the math whether paying tax now will generate a significant amount of money in the next three or five years,” explained tax lawyer Arturo Garnham of Garnham Abogados.

Shareholders also need to check they have sufficient corporate tax credit to benefit from the mechanism, noted Hernandez,

The extra funds will come just as the government is striving to close a burgeoning fiscal deficit, squeezed by the halving of the price of copper—Chile’s principal export, since 2011—and the slowest-growing economy in seven years.

“It’s worked fantastically well,” said Jorge Echevarria of Alessandri Asesoría Personal y Negocios, adding that the profits would otherwise “have remained on company books forever and ever.”

The current government steps down in March 2018. What it gains in the short term may cost future administrations dearly as shareholders are able to extract millions of dollars of profits tax-free from their companies for years to come.

“If it’s a huge success, in the long run, the treasury is losing a ton of money,” said Garnham. “We have a saying in Spanish: bread today, hunger tomorrow.”

To contact the reporter on this story: Tom Azzopardi in Santiago at correspondents@bna.com

To contact the editor responsible for this story: Penny Sukhraj at psukhraj@bna.com

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