Expenses and the Chilean Taxation System
Tax Expenses: What types of expenses does Chile’s IRS allow a company to deduct from its financial profit (gross income)?
It is common knowledge that companies must only pay taxes from the profit forming part of its taxable base and that which they have made during a certain tax period. The taxable base corresponds to the financial profit of a tax period, inclusive of adjustments.
In Chile, the corporate tax rate applied to gross income currently stands at 20%. However, Chile’s recent tax reform is set to increase this rate to 27% as early as 2017, depending on the tax system chosen.
Companies always want to portray an image of stability and profitability in their financial statements, whilst other taxpayers will usually want to appear to have a lower taxable net income. Therefore, issues commonly arise where taxpayers try to incorrectly deduct expenses that they claim are “necessary to generate (gross) income”. Whilst debate surrounds this issue, only the tax authority and the Chilean IRS rulings can determine what expenses fall into this category.
The Chilean Income Tax Law does not adequately define what expenses are “necessary to obtain taxable income”. However, the rulings of the Chilean IRS have consistently shown that expense deductions will only be allowed where the following requirements are met:
- Expenses must be necessary to produce the income;
- They must be directly related to the business activity of the company;
- They cannot be already deduced as forming part of the costs of the goods or services required to produce the income;
- The taxpayer must have effectively incurred the expense during the relevant period (paid or due), and;
- The taxpayer must be able to prove the authenticity and provide evidence to backup the incurred expense.
Incorrectly deducted expenses were subject to a 35% penalty tax, regardless of the perpetrator’s legal structure. As of 27 September 2012, the tax reform increased penalties for certain disallowed expense deductions. Consequently, where it is possible to identify the beneficiary of an expense, the beneficiary would be subject to the regular 35% penalty tax to be paid by the company plus an additional 10% to be added on the final taxation base. The result was an overall tax burden of 45% for foreign residents. This tax rate has once again been increased by the tax reform, in force since October 1, 2014 to a 40% penalty tax. According to the new rate, the tax burden for non-residents is now an overall 50% considering the additional 10% previously mentioned that is added on to the final taxation base. The Chilean Income Tax Law imposes other regulations on how taxpayers can determine the types of expenses they are entitled to discount for their “Renta Líquida Imponible.” Recently, courts have suggested that there must be a close correlation between the expense incurred and the income/profit that it will produce, although this seems rather onerous considering the difficulty in predicting economic outcomes.
Chile’s tax reform, published at the end of September, has incorporated various obligations. For example, the IRS states that expenses occurred in a supermarket over 5 UTM (Approx. USD$ 82.00) must be reported to the IRS in order to be deductible from the gross income. The reform’s proposed changes have been the source of much debate and controversy over the years. While the controversy continues, the Supreme Court has remained firm on the idea that the necessity of a deducted expense is a fact that must be proved before the courts.
Illustrating this point, a few years ago there was confusion over whether expenses incurred in companies’ annual festivities and national holidays such as “18 de Septiembre” (National Day) were actually expenses necessarily incurred to generate taxable income. The Chilean IRS rejected all expenses that related to food, drink, and small souvenirs for employees, finding them unnecessary to generate taxable income. However, since then the Chilean Courts have overruled the IRS’s decisions and these expenses are now deductible. Despite the developments in jurisprudence, the tax reform has created uncertainty around the expenses incurred by a taxpayer at supermarkets or in similar commercial establishments. The tax reform has imposed new requirements for these types of expenses and by doing so has created ambiguity on an issue that was already settled by Chilean Courts.
If you have questions regarding your Chilean subsidiary and how changes to the Chilean taxation system will effect your future operations, please do not hesitate to contact our offices. With a team of both Common law and local lawyers, we are able to bridge the gaps that tend to arise when doing business in the region.
Miguel Guerrero Fuentealba is a Senior Associate with the Harris Gómez Group, an international and multidisciplinary firm, specializing in cross border transactions between Australia and Latin America.
Miguel advises clients on taxation, legal structures, labour law and other commercial matters. Miguel worked for Deloitte Chile within their international tax division. He has an extensive amount of experience advising multinational clients on tax related matters related to domestic legal compliance, tax planning, repatriation of capital and due diligence reports on tax and legal compliance.