On December 19, 2023, the bilateral income tax treaty between the United States and Chile (formally, the Convention between the Government of the United States of America and the Government of the Republic of Chile for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital, and hereafter referred to as, the "Treaty") entered into force more than a decade after it was signed.
The Treaty's entry into force is a significant milestone for the United States and Chile, as the Treaty is the first bilateral income tax treaty between the two countries and represents only the third income tax treaty with a country in Latin America.1 It also marks an opportunity for multinational businesses with operations in these countries to review the provisions of the Treaty with an eye toward how their particular businesses may benefit, including with respect to intragroup operations and financing activities. Of acute importance to multinational groups is satisfying one of the tests under the "limitation on benefits" provision to receive the benefits of the Treaty.
The Treaty is generally consistent with United States treaty policy and takes into account the United States Model Income Tax Convention of November 15, 2006 (the "U.S. Model Treaty") and recent United States income tax treaties. The Treaty, however, does deviate from these other treaties and the U.S. Model Treaty in several key respects. The following highlights certain major provisions of the Treaty.
Taxes Covered
The Treaty, in general, applies to taxes on income and capital imposed either by the United States or Chile, regardless of the manner in which such taxes are levied. The existing United States taxes to which the Treaty applies are: Federal income taxes imposed by the Internal Revenue Code (the "Code"), Federal excise taxes imposed on insurance premiums paid to foreign insurers, and Federal excise taxes imposed with respect to private foundations. With respect to Chile, the Treaty applies to all taxes imposed under the Chilean Income Tax Act. The Treaty will also cover certain taxes that are enacted after the Treaty was signed.
Permanent Establishment
The Treaty definition of "permanent establishment" generally follows the definition contained in the U.S. Model Treaty. A notable deviation from the U.S. Model Treaty, however, is that a permanent establishment will arise where an enterprise of either the United States or Chile performs services through one or more individuals who are present and performing such services in the other country for one or more periods exceeding a total of 183 days in any twelve-month period.
Reduced Withholding Rates
With respect to dividends, the Treaty generally limits the withholding rate to 15 percent. A reduced rate of 5 percent is available if the beneficial owner of the dividend is a company that owns directly at least 10 percent of the voting stock of the company paying the dividend. The Treaty also generally provides pension funds with an exemption from dividend withholding.
With respect to interest, the Treaty generally limits the withholding rate to 15 percent for the first five years the Treaty is effective and thereafter to 10 percent. Additionally, a 4-percent withholding rate may be available to beneficial owners that are banks, insurance companies and certain other enterprises.
With respect to royalties, the Treaty generally limits the withholding rate to (i) 2 percent for the use of, or the right to use, industrial, commercial, or scientific equipment and (ii) 10 percent for the use of, or the right to use, any copyright, patent, trademark, design or model, plan, secret formula or process, or other like intangible property, or for information concerning industrial, commercial, or scientific experience.
Notably, the Treaty does not provide an exemption from withholding for certain parent-subsidiary dividends that is found in other recent U.S. income tax treaties.2 Also, unlike the U.S. Model Treaty and other recent U.S. income tax treaties, the Treaty does not provide a withholding exemption for certain payments of interest and royalties.
Limitations on Benefits
The Treaty contains a detailed limitation on benefits provision, which is intended to prevent treaty shopping. The limitations are generally similar to those contained in the U.S. Model Treaty, and notably also include tests for "headquarters companies"3 and enterprises with a permanent establishment in a third country.4
Exchange of Information
The Treaty provides for the competent authorities of the United States and Chile to exchange information that is foreseeably relevant for carrying out the terms of the Treaty or the domestic tax laws of either country.
Reservations
The U.S. Senate approved the Treaty in June 2023, subject to two reservations that are incorporated into the Treaty through an exchange of diplomatic notes. The purpose of these reservations is to address certain changes to the Code enacted under the Tax Cuts and Jobs Act of 2017 (P.L. 115-97) after the Treaty was initially signed. The first reservation preserves the right of the United States to impose the base erosion and anti-abuse Tax (BEAT) enacted under Section 59A of the Code. The second reservation addresses the repeal of the indirect foreign tax credit under former Section 902 of the Code and the enactment of the dividends received deduction under Section 245A of the Code.
Effective Dates
In the case of withholding taxes, the Treaty is effective for amounts paid or credited on or after February 1, 2024. With respect to all other covered taxes, the Treaty is effective for taxable periods beginning on or after January 1, 2024. The exchange of information provisions are generally effective as of December 19, 2023, the date the Treaty entered into force.
Footnotes
1. The United States also has bilateral income tax treaties currently in force with Mexico and Venezuela.
2. For example, in the case of the United States' other income tax treaties with Latin American countries, the treaty between the United State and Mexico provides a withholding exemption for dividends paid by certain 80-percent or more owned subsidiaries. However, the income tax between the United States and Venezuela does not provide for such an exemption.
3. A company will generally be considered a "headquarters company" for a multinational group if: (i) the company provides in its country of residence a substantial portion of the overall supervision and administration of a group of companies (which may be part of a larger group of companies), except that group financing may not be the principal activity of the company; (ii) the group of companies consists of corporations resident in, and engaged in an active business in, at least five countries, and the business activities carried on in each of the five countries generate at least 10 percent of the gross income of the group; (iii) the business activities carried on in any one country other than the company's country of residence generate less than 50 percent of the gross income of the group; (iv) no more than 25 percent of the company's gross income is derived from the contracting country that is not the company's country of residence; (v) the company has, and exercises, independent discretionary authority to carry out its supervision and administration of the group; (vi) the company is subject to the generally applicable income taxation rules in its country of residence; and (vii) the company's income derived in the contracting state that is not the company's country of residence is derived in connection with, or is incidental to the income generated by, the active business referred to in clause (ii) above. Additionally, if any of the gross income requirements under clauses (ii), (iii) or (iv) above is not met for a taxable year, the company may satisfy the requirement by applying the applicable ratio to the average of the gross incomes for the four years preceding the taxable year.
4. An example of such a structure would be where a resident of Chile, which would otherwise qualify for benefits under the Treaty, earns United States income that is attributable to a permanent establishment in a third country.
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.
