In force from January, 1, 2017.
35% rate increase of penalty tax: a few practical applications
(Aplicaciones prácticas al Art. 21 de la Ley de Impuesto Sobre la Renta)
Chilean tax reform 2014 (Law 20.780, the “Tax reform”) changed dramatically the Chilean taxation system. Among the latest amendments – which came into force in January, 1, 2017-, it is possible to highlight the increase of the penalty tax of article 21 of the Chilean Income Tax Law (hereinafter the “CITL”). In general, this penalty tax is applied to “non-allowable expenses”, as defined in article 31 CITL and repeatedly stated by the Chilean tax administration’s opinions (hereinafter the “SII” due to its Spanish acronym).
Among the different cases in which article 21 CITL might be applied, a few specific cases tend to be critical for foreign investors:
a) Debt write off between a local subsidiary and its head office domiciled abroad
In this case, the SII has distinguished between the situation of the debtor and the creditor. For purposes of the application of article 21 CITL, we will focus our analysis in the creditor position. In this respect, the SII has repeatedly stated that the voluntary waive to their rights in a debt write-off situation will be deemed as non-allowable expenses, subject to the application of 40% penalty tax from 2017 onwards. The foregoing case constitutes a very common situation in the subsidiary – head office relationship.
b) Start-up expenses related to energy projects subject to the approval of the local Environmental authority
Article 31, N°9 CITL provides that star-up expenses can be amortized in up to a period of 6 consecutive commercial years, from the date that such expenses were generated, or the year on which the company starts generating incomes from its main activity, when this fact is later than the date on which the expenses were generated.
Nonetheless, former article 21 CITL – amended by the Tax reform - expressly excluded the application of the 40% penalty tax on start-up expenses related to energy projects subject to the approval of the local Environmental authority. This exclusion was eliminated from the CITL from 2017 onwards, therefore our understanding is that general rules on non-allowable expenses should apply (i.e. 40% penalty tax, provided these kind of start-up expenses do not meet the general requirements contemplated in article 31 CITL.).
c) Intragroup services
In the context of intragroup services, the SII may challenge expenses incurred by local companies in case some of the following issues could not be proved:
- Whether intra-group services have in fact been provided;
- Such services shall be needed to generate income for the service recipient;
- That there is no duplicity of functions, that is to say, that the service is not simultaneously lent by a third party to the company or that it is not internally developed by the company;
- That a third party is willing to pay for the services;
- The intra-group charge for such services is in accordance with the arm’s length principle.
In case of deficient documentation or impossibility of proving the substance of services received, the local company faces the risk of being subject to Transfer Pricing adjustment by the SII and, consequently, the application of the penalty tax of article 21 CITL (35% on adjustments to operations conducted during 2016, 40% from 2017 onwards). Moreover, in this case the SII is also entitled to apply an additional fine of 5% calculated over the same determined differences.