TAXATION OF THE MINING INDUSTRY IN CHILE: AN UPDATE

• Jurisdiction: United States

MINING LAW & INVESTMENT IN LATIN AMERICA
(April 2003)
CHAPTER 7A
TAXATION OF THE MINING INDUSTRY IN CHILE: AN UPDATE
Rodrigo Valenzuela
Ernst & Young
Santiago, Chile

March 2003

Mining taxation is not the set of special tax rules applicable only to the mining industry, but rather it is the set of general tax rules that have an especially significant impact on the industry. Accordingly, the important changes in Chilean mining taxation I will consider in this update are changes in certain general tax laws which happen to have an important effect on mining.

Curiously enough, however, these particular changes in general taxation were enacted having the mining industry in mind as their target.

In fact, for several years there has been a totally unwarranted but nonetheless real concern among certain congressmen and politicians that large foreign mining companies are not paying their dues in taxes because of loopholes in the law. The view is that the loopholes have been related basically to excess interest payments and to abuse of transfer pricing. The debate was academic for some years, until the country's growth rate declined, tax collections diminished accordingly and, then, the two areas mentioned above became the subject of the new legislation I will discuss. Before doing so, however, I will refer to still another recent change in legislation, which gives a good idea of the general mood of authorities. This change refers to the offshore sale of the parent of a Chilean company.

Accordingly, this paper will dwell on the following three issues which have been subject to changes in Chilean tax during the last two years:

1) Offshore sale of the parent company of a Chilean subsidiary

2) Taxation on interest payments

3) Transfer pricing rules

This update does not include all changes occurred lately in Chilean tax legislation or in criteria of the Internal Revenue Service, all of which, of course, do affect mining companies as they affect any other business. I have preferred to highlight the three abovementioned areas of change which have as a common thread their link to foreign investment and the fact that they all are a consequence of official concern regarding appropriate taxation of the industry.

1. Offshore sale of parent company with Chilean subsidiary in Chile

This change in law was passed under extremely unusual and unfortunate circumstances from the standpoint of the clarity and stability of rules applicable to foreign investors. In fact, the new law was introduced as a last minute effort by authorities to change the effects of a sale already being negotiated between two companies which, pursuant to law in force, would have ended up being tax free.

At the time, one foreign entity was selling its mining operations in Chile to a Chilean buyer by way of selling the foreign parent of the Chilean mining company. Under regulations in force, the gain derived from the sale or any other kind of disposal of share or interest held by a foreign company in another foreign company that in turn held share or interest in a Chilean entity, was not regarded as Chilean source income.

Consequently, if the sale was made -as was precisely the case- by a non Chilean resident which is subject to taxes in Chile only on its local source income, the operation would be regarded as a non-taxable event in Chile since the gain, if any, would have been considered as foreign source income obtained by a non-resident entity.

The law was changed ¹ on November 23, 2002, effective for returns filed for calendar year 2002, in a way that now Chilean source income includes the sale or any other kind of disposal of share or interest in a legal entity incorporated abroad, whose acquisition enables the purchaser to directly or indirectly participate in more than 10% of the property or profits of a Chilean company, provided the purchaser is a person or entity resident, domiciled or incorporated in Chile. There is no limit to the number of tiers that may exist between the foreign seller and the local company being sold.

The gain, which is subject to a 35% rate tax to be withheld by the local purchaser, is defined as the excess of the part of the purchase price attributable to Chilean content, over what is a reasonable approximation of the normal cost base of the participation in the Chilean company had it been sold by its direct owner. The part of the purchase price attributable to Chilean content is defined as the proportion of the book value of the Chilean company with respect to the equity of the foreign company being sold. The purchaser has to file with the Internal Revenue Service a sworn...