US-Chile Bilateral Income Tax Treaty Enters Into Force

On Dec. 19, 2023, Treasury announced the entry into force of the U.S.-Chile bilateral income tax treaty (the Tax Treaty). The Tax Treaty is the first new comprehensive bilateral tax treaty signed by the United States to enter into force in over 10 years and is only the second U.S. comprehensive bilateral tax treaty in force with a South American country. The Tax Treaty is generally intended to reduce tax-related barriers to cross-border investments between the United States and Chile, including by providing for reduced withholding tax rates on income such as dividends, interest and royalties.

Historical Perspective

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 U.S. Senate. Chile’s Congress, on the other hand, approved the Tax Treaty already, back in 2015.

As discussed in our prior client alert, on June 21, 2023, the U.S. Senate approved the Tax Treaty subject to two reservations relating to changes introduced by the 2017 Tax Cuts and Jobs Act (TCJA), addressing base erosion and anti-abuse tax (BEAT) and Article 23 (Relief from Double Taxation). The reservation relating to BEAT clarifies that the Tax Treaty does not prevent the United States from imposing such tax (very generally, a minimum tax on domestic corporations intended to protect the U.S. tax base from erosion due to payments of deductible expenses to foreign related parties). The reservation relating to Article 23 addressed modifications to reflect the changes under TCJA, specifically the repeal of Section 902^[1]and adoption of Section 245A, pertaining to the deduction of dividends received by domestic corporations from foreign corporations provided certain requirements are met. 

The Chilean and U.S. governments exchanged diplomatic notes and agreed to include the U.S. Senate reservations in the Tax Treaty. The agreement was approved by the Chilean Senate on Nov. 15, 2023. On the U.S. end, the Tax Treaty cleared the last procedural step following its ratification by President Biden on Dec. 19, 2023.

Key Provisions

In General. The Tax Treaty is generally intended to reduce tax-related barriers to cross-border investments between the United States and Chile.

• Withholding tax on dividends will generally be capped at a maximum rate of 15%, with a reduced rate of 5% available for taxpayers that directly hold at least 10% of the voting stock of the dividend-paying company. Additionally, as confirmed by the U.S. Internal Revenue Service in Notice 2024-11, 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 abovementioned cap on 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.
  
  
• Withholding on payments of interest made to a beneficial owner that is a bank, insurance company or 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%.
  
  
• 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%. 
  
  
• 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. 
  
  
• 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. 

The Tax Treaty will also provide helpful guidance in respect of U.S. and Chilean foreign tax credit (FTC) rules. The FTC analysis on the U.S. tax front will be simplified by treating Chilean income taxes as creditable for U.S. tax purposes. Likewise, in Chile, the Tax Treaty is expected to reduce FTC leakage as the scope of FTC available for Chilean taxpayers under the Tax Treaty is broader than under Chile’s domestic FTC regime. 

Stock Market and Institutional Investor Benefits:

The Tax Treaty features exemptions for gains from the sale of shares by pension funds, mutual funds and other institutional investors in certain cases. Importantly, it also exempts gains from the trade of certain qualifying shares on the stock market that mirrors the Chilean capital markets benefits existing at the time the treaty was signed in February 2010. At that time, the Chilean capital markets benefits exempted most gains from the trade of shares in the Chilean stock market. The exemption continued to exist without major modifications until 2022, when Law 21.420 replaced the exemption with a 10% tax, only allowing institutional investors to keep the exemption.

Limitation on Benefits:

The Tax Treaty includes a Limitation on Benefits 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 at the applicable jurisdiction). When initially introduced, the Tax Treaty was the first Chilean treaty to include a Limitation on Benefits clause of any type. In recent years, especially after the OECD added a similar clause to its Model Convention in 2017, Chile has increasingly added a Limitation on Benefits clause to its treaties.

Effective Dates:

With respect to taxes withheld at the source, the Tax Treaty will have effect for amounts paid or credited on or after Feb. 1. For all other taxes, the Chile tax treaty is in effect for taxable periods beginning on or after Jan. 1.

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U.S. and Chilean taxpayers could significantly benefit from the provisions of the Tax Treaty as they enjoy further clarity and preferential tax treatment with respect to dividends, capital gains, interest and royalties from their cross-border investments and operations.

^[1] _{All section references herein are to the Internal Revenue Code of 1986, as amended.}

This alert was co-authored with Chilean tax partner Ricardo Escobar and associate Cristóbal Cibie of Bofill Escobar Silva Abogados.