Executive summary
On June 22, 2023, the Senate voted 95 to 2 in favor of consenting to ratify the tax treaty between the United States and Chile (the treaty). The Senate’s two-thirds majority vote officially sent the treaty to President Biden for ratification and back to Chile for approval from its Congress. Once the treaty enters into force, Chile will become the third Latin American, and second South American, country with a double tax treaty with the U.S.
The treaty, along with a Protocol, dates back to 2010 but has not received a Senate floor vote for over a decade due to concerns over language on the base erosion and anti-abuse tax (BEAT) and relief from double taxation (i.e., the foreign tax credit (FTC)). To resolve these concerns, the Senate Foreign Relations Committee approved the text of the treaty with certain reservations and declarations (i.e., a proposed resolution of ratification).
The treaty is broadly consistent with the 2016 U.S. Model Income Tax Treaty (the U.S. Model) but deviates from the U.S. Model by including more restrictive limitation of benefit (LOB) rules and would subject dividends, interest and royalties to higher tax rates. The treaty does not provide a tax exemption for some parent-subsidiary dividends.
The treaty will enter into force after ratification by both countries.
United States and Chile income tax treaty moves forward
Key highlights of the treaty
Foreign tax credits made more available
Given new limitations introduced in recent U.S. FTC regulations, the ratification of the treaty could not have come at a more crucial time for taxpayers. Under these regulations, historically creditable foreign income taxes can become non-creditable should a taxpayer fail to meet the criteria outlined under Notice 2023-55. In the most basic sense, the regulations allow taxpayers to credit only foreign taxes that qualify as income taxes using U.S. federal tax principles. Foreign taxes that fail to qualify as a ‘foreign income tax’ are generally not creditable but may be deductible instead.
However, some U.S. income tax treaties specifically provide that a foreign tax is an income tax for purposes of the U.S. FTC rules. To the extent the foreign tax is an income tax under a treaty and treaty benefits are elected, the foreign tax could qualify as a 'foreign income tax' potentially eligible for a credit. Absent such a treaty provision, U.S. taxpayers who fail to qualify for the temporary relief granted under Notice 2023-55 must undergo a rigorous analysis, including reviewing local tax law and source rules, to determine the creditability of a foreign tax.
Once the treaty enters into force, the U.S. will recognize certain Chilean income taxes (the taxes imposed under the Income Tax Act (Ley sobre Impuesto a la Renta)) as an income tax eligible as a credit against U.S. income tax liability. However, other U.S. income tax rules governing the limitation on the use and availability of the FTC still apply although taxpayers will not have to analyze whether these taxes are an income tax.
Taxpayers looking for additional information on the 2022 final FTC regulations and 2022 proposed FTC regulations can read RSM's previous tax alerts (Treasury releases technical corrections to final FTC regulations, Treasury releases much anticipated proposed FTC regulations and Ten quick reminders for FTC).
Withholding taxes reduced
Dividends: The treaty reduces the withholding rate on dividends to 15%. The treaty rate is 5% when certain ownership and holding periods are met. There is no withholding requirement on dividends paid to certain pension funds.
Interest: The treaty reduces the withholding rate on interest to 15% (lowered to 10% after a five-year period beginning once the treaty provisions take effect). The treaty rate is 4% if the interest is beneficially owned by certain financial entities.
Royalties: The treaty reduces the withholding rate on royalties to 10%. The treaty rate is 2% on royalties for the use of, or the right to use, industrial, commercial or scientific equipment, but not including ships, aircraft or containers.
Reservations
Reservations “change the United States’ legal obligations under a treaty without changing the treaty’s text.”1 A reservation allows for ratification without having to re-open the negotiation phase of the standard treaty-making process.
The treaty was approved subject to two reservations:
- Reservation on tax on base erosion payments of taxpayers with substantial gross receipts
- Reservation on relief from double taxation
Both reservations are intended to clarify and address certain changes made to the Internal Revenue Code as a result of the Tax Cuts and Jobs Act of 2017 (TCJA) subsequent to negotiation of the treaty. The BEAT reservation clarifies that the treaty does not prevent the imposition of BEAT under section 59A. The FTC reservation addresses the repeal of section 902 and adoption of section 245A.
While the Chilean Congress already ratified the treaty in 2015, they will have a chance to respond to such reservations (e.g., accept, object, take no action).
Declarations
Declarations “are statements that express the Senate’s views or opinion on matters a treaty raises.”2 A declaration often describes the Senate’s position on policy issues. Unlike reservations, declarations do not change a treaty’s legal effect.
The approved treaty included two declarations. The first declaration states that the proposed treaty is self-executing, as is the case generally with income tax treaties. The second declaration clarifies the position of the Senate that further work is required to fully evaluate the policy of "Relief from Double Taxation" articles in future tax conventions and their relationship to U.S. domestic tax laws in light of the substantial changes made to the Internal Revenue Code in 2017.
Final reminders
The treaty will enter into force after the U.S. and Chile have notified each other that they have completed their requisite domestic procedures required for entry into force. The withholding provisions will be effective for amounts paid or credited on or after the first day of the second month following the date the treaty enters into force. For all other taxes, the provisions will be effective for taxable periods beginning on or after Jan. 1 of the calendar year immediately following the date the treaty enters into force.
The full text of the treaty and Resolution of Ratification can be found on the congress.gov website.
