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United States - Analysis of U.S.-Chile Tax Treaty Summary

Core Content

The U.S.-Chile Income Tax Treaty was approved by the U.S. Senate on June 21, 2023, and is expected to enter into force once Chile ratifies the treaty. This treaty is significant as it is one of only two U.S. treaties in force with South American countries (the other being with Venezuela) and the first new treaty approved by the U.S. Senate in over a decade. The treaty aims to reduce or eliminate double taxation on income and facilitate cross-border commerce and investments.

Main Provisions and Key Information

Entry into Force

• The treaty will enter into force after Chile ratifies the two reservations made necessary by changes in U.S. tax law post-2010.
• Chile must complete its ratification process, including approval by the National Congress and publication in the Official Gazette.
• If the exchange of ratification instruments is completed before the end of 2023, most provisions will take effect on January 1, 2024.
• Withholding tax provisions will apply from the first day of the second month after entry into force.
• Article 27 (Exchange of Information) will be effective from the date of entry into force.

Taxes Covered (Article 2)

• The treaty applies to income and capital taxes, including capital gains, imposed by the U.S. and Chile.
• State and local taxes, property taxes, and social security/unemployment taxes are not covered.
• Social security taxes are governed by the U.S.-Chile Social Security Totalization Agreement (effective December 1, 2001).

Residency (Article 4)

• A U.S. citizen or green card holder is considered a resident of the U.S. unless they have a substantial presence, permanent home, or habitual abode in the U.S. and are not a resident of a third country.

Permanent Establishment (Article 5)

• An enterprise is deemed to have a permanent establishment in the other country if it performs services for 183 days or more in any 12-month period through individuals present in the other country.
• Collective presence of employees is counted as one day per day, not per employee.
• Telephone or computer-based services are not included in the PE definition.
• If a PE exists, the source country may tax the net profits attributable to the PE.

Withholding at Source (Articles 10, 11, 12)

• The treaty provides reduced withholding rates on dividends, interest, and royalties.
• Dividends: 15% tax rate, reduced to 5% if the beneficial owner owns at least 10% of the voting stock.
• Interest: 10% tax rate (with a 5-year phase-in period from 15% to 10%).
• Royalties: 2% for industrial, commercial, or scientific equipment; 10% for all other royalties.
• Banks, insurance companies, and similar entities are subject to 4% source-country taxation on interest income without phase-in.

Capital Gains (Article 13)

• Real property gains may be taxed in the country where the property is situated.
• Personal property gains attributable to a permanent establishment or fixed base in the other country may be taxed in that country.
• U.S. residents selling shares in a Chilean company may receive a foreign tax credit for Chilean taxes paid.
• Special rule for U.S. expatriation tax: individuals may elect to treat the sale of property in Chile as if they sold and repurchased it at fair market value, allowing Chilean tax to apply only to post-emigration gains.

Independent Personal Services (Article 14)

• Income from independent personal services is taxable only in the home country unless the services are performed in the host country and the individual has a fixed base there.
• Applies to independent contractors and professionals, but not to directors, artists, or athletes.

Dependent Personal Services (Article 15)

• Compensation for dependent personal services (e.g., employees) is exempt from host-country tax if:
  • The individual is present in the host country for no more than 183 days in a 12-month period.
  • The compensation is paid by a non-resident employer.
  • The employer does not have a permanent establishment in the host country.

Directors' Fees (Article 16)

• Directors' fees are taxable in the country where the company is resident, unless the fees are for attendance at meetings held in the other country.

Pensions (Article 18)

• Pension income is not taxed until distributed.
• Both countries may tax the distribution, but no more than 15% is allowed in the source country.
• Exemption applies if the amount would be exempt in the source country if the recipient were a resident there.
• U.S. citizens and green card holders are not eligible for the pension deduction benefit.
• Eligible U.S. pension plans include:
  • 401(a), 401(k), 403(a), 403(b), 457(g), and 7701(j) plans.
• Eligible Chilean pension funds include those administered by the Instituto de Previsión Social and the social security system under Decree Law 3500.
• The benefit is limited to 60 months.

Students and Trainees (Article 20)

• Payments to students, apprentices, or trainees are exempt from host-country tax if:
  • They are received from outside the host country.
  • The individual was a resident of the other country at the time of arrival or immediately before.
  • The purpose is full-time education or training.
• Business trainees may be exempt without the 2-year limitation if they meet U.S. visa and residency requirements.

Relief from Double Taxation (Article 23)

• The U.S. will use the foreign tax credit method to relieve double taxation.
• Chilean taxes on income from U.S.-source are eligible for credit, subject to special rules for U.S. citizens in Chile.
• The saving clause allows the U.S. to tax its citizens regardless of residence, and the treaty includes special credit rules to prevent double taxation.

Summary of Treaty Departures from the 2006 U.S. Model

• Introduction of a new Independent Personal Services Article.
• PE rules for services exceeding 183 days.
• Withholding rules for interest and royalties.
• Special rules for capital gains, pensions, and expatriation.

Conclusion

The U.S.-Chile Tax Treaty is a significant step in enhancing tax cooperation and economic ties between the two countries. It introduces new rules and exemptions for individuals and businesses, particularly regarding permanent establishment, withholding taxes, and double taxation relief. The treaty is expected to become effective in 2024, pending Chilean ratification, and will provide clarity and benefits for cross-border taxpayers.