Senate clears Chile tax treaty for ratification

Senate clears Chile tax treaty for ratification

The Senate voted 95- 2 on June 22 to approve a Chile tax treaty for ratification. Once ratified, the treaty will reduce tax and withholding rates, and will offer a rare treaty jurisdiction for multinationals with a Latin American presence.

The Senate vote itself does not ratify the treaty. The Senate instead provides advice and consent allowing for the president to ratify the treaty. The treaty will not take effect until the countries exchange instruments of ratification, and the Chilean Congress must first re-approve the treaty due to reservations added by the Senate.

The treaty was originally signed in 2010, but languished for years over objections from Sen. Rand Paul, R-Ky. Momentum for ratification began building last year due to Chile’s importance as major producer of lithium and copper, key ingredients in electric vehicle batteries, solar cells, and wind turbines. The Senate resolution providing advice and consent added two reservations to account for legislative changes under the Tax Cuts and Jobs Act (TCJA).

The reservations preserve the right of the U.S. to impose the base erosion and anti-abuse tax under Section 59A and update the article on relief for double taxation by amending the language to account for the dividends received deduction under the TCJA.

The treaty generally aligns with the U.S. Model Treaty, but there are key differences in select areas. Some of the most important provisions in the treaty include the following:

• Dividends: The treaty largely follows the 2006 U.S. Model Treaty with respect to dividends. The country in which the dividend arises retains the right to tax the other country’s resident at 15%, reduced to 5% if the beneficial owner of the dividend owns at least 10% of the voting stock of the dividend paying company. 
• Interest: Interest income is subject to tax at source at a rate of either 4%, 10% or 15%. The 4% rate applies to interest paid to banks, insurance companies, finance and lending businesses, and other similar entities. In all other cases, a rate of 15% applies for the first five years in which the treaty is in effect and at 10% thereafter.  
• Royalties: Royalties are subject to tax at the source where the property is used with a 2% rate for royalties paid for the right to use certain industrial, commercial or scientific equipment, and 10% for the use of other intellectual property. Royalties are treated as arising in the contracting state when the payor is a resident of that state. This provision does not align with U.S. law, which states that royalties are sourced to where the underlying intellectual property is exploited.  
• Capital gain on shares: The source country may tax gains from the disposition of shares at a rate of 16% in certain cases.

• Permanent establishment (PE): The PE clause deviates from other treaties in a few important respects. First, the definition of PE is expanded to include an installation used for on-land exploration of natural resource to the extent that activity continues for more than three months. Other treaties typically include longer periods like six months or 12 months. Second, a PE exists whenever a resident of one country performs services in the other country for a period exceeding 183 days within any 12-month period. Other treaties require that, for example, the services be performed for the same or connected projects, allowing residents to avoid a PE for separate projects. Finally, the treaty provides that any installation for on-land exploitation continuing for more than three months constitutes a PE in Chile. 

• Transfer pricing: Taxpayers may request a Mutual Agreement Procedure if subject to double taxation inconsistent with the tax treaty on adjustments derived from transfer pricing. Taxpayers can also agree to Advance Pricing Agreements between both jurisdictions.

The provisions would generally take effect for tax periods beginning on or after the first day of January following the date the treaty enters into force. The withholding provisions would become effective for amounts paid or credited on or after the first day of the second month following the date on which the treaty enters into force.

Next steps

The approval of the treaty by the Senate marks a significant milestone in strengthening the economic relationship between U.S. and Chile. Once ratified, the treaty is expected to be ratified and will provide significant relief for multinationals with operations or investments across the U.S. and Chile. It brings forth a range of benefits for businesses and individuals from both countries, offering increased certainty and clarity in cross-border taxation to ensure that taxpayers are not subjected to double taxation. By reducing barriers and creating a more favorable tax environment, the treaty promotes trade and investment, opening up new opportunities for economic growth. The addition of this new treaty jurisdiction in Latin America may also provide planning opportunities for businesses with operations in other Latin American countries. The only other countries in the Americas in a tax treaty with the U.S. are Canada, Mexico, Barbados, Jamaica, Trinidad and Venezuela, according to the latest IRS information. Overall, this treaty serves as a crucial framework to foster bilateral economic growth, encourage international business activities, and enhance the economic ties between the U.S. and Chile.

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