Chilean projects are expected to face higher taxes.

A tax reform bill that Chilean President Michelle Bachelet submitted to the National Congress in April would increase the corporate income tax rate from 20% to 25% over four years. The new rates will be 21% in 2014, 22.5% in 2015, 24% in 2016 and 25% in 2017.

The bill is expected to be approved in September.

It would also impose thin capitalization rules that will limit the extent to which developers can “strip” earnings from Chilean projects by pulling them out as interest on shareholder debt. In the future, interest paid by a Chilean company on loans from related parties would be re-characterized as dividends to the extent the company has a debt-equity ratio of more than three to one. Debt from third parties would be counted in determining whether the company is too highly leveraged, but the only interest that would be treated as dividends is interest on loans from related parties.

Jessica Power, co-head of the tax group at Carey, a premier law firm in Santiago, said the company would also be treated as having too much debt to the extent interest and other financing costs in a year exceed 50% of the company’s taxable income before deducting such costs. The thin capitalization rules would apply starting on January 1, 2015. They will apply to existing shareholder loans, said Power.

Many developers capitalize Chilean project companies with debt in an effort to reduce the Chilean taxes on their projects. By distributing earnings as interest on such loans, the project company can deduct the distributed earnings, and interest paid cross border attracts a lower withholding tax — 4% or 15% depending on the facts — compared to 35% on dividends. These are the statutory withholding rates. Actual withholding may be lower where the developer is a tax resident of a country with a favorable tax treaty.

The tax reform bill would also move to taxing shareholders in Chilean companies on their shares of company earnings in the year the earnings accrue even if the earnings are not distributed until later. Earnings would be considered to accrue even before a dividend is declared, according to Jessica Power. Thus, this would have the effect of taxing shareholders on earnings that a company retains for reinvestment.

Expenses on transactions with related parties — for example, interest on shareholder loans — would be deductible only in the year actually paid.

Interest on loans to acquire equity interests or bonds could not be deducted. Rather, it would have to be capitalized into the basis in the equity or debt instruments acquired. This would not apply to borrowing to acquire assets.

A carbon tax would be imposed on emissions from any boiler or turbine with a capacity of at least 50 megawatts. The tax would be a minimum of the Chilean peso equivalent of US$0.10 per ton of particulate matter, nitrogen oxide or sulfur dioxide emitted, according to Manuel José Garcia with Carey. The tax rate could be higher under a formula tied to the concentration of pollutants in the local area. The tax on carbon dioxide emissions would be US$5 a ton. The tax would be an annual levy payable for the first time in April 2018 on 2017 emissions.

A stamp tax collected on loans would increase from the current range of 0.033% to 0.4% to flat tax of 0.8% for any loan with a term of more than two months.

by Keith Martin