BNamericas explainer: How Chile's tax reform will impact miners

The Chilean government presented a tax reform at the beginning of July to reduce tax avoidance and evasion, achieve a better distribution of wealth and help fund the social rights that the country requires. 

The aim of the reform is to collect 4.1% of GDP in tax within four years, and although the finance ministry has claimed that 97% of people will not see their taxes rise – the changes target the 3% of the population with the highest income – the most significant impacts are likely to be felt in the business sector.

The proposals include restructuring income tax, a wealth tax, inheritance and equity tax, and copper and lithium mining royalties.

In terms of income tax, the government has outlined a system where there is a separation between the taxation of companies and of their owners. The change is intended to simplify the tax system and reduce the amount of red tape involved in submitted annual tax returns. However, it would mean capital income being subject to a new dividend tax.

On the one hand, the corporate tax rate would be cut to 25% from the current 27%, which is a positive change, since it would be calculated based on net taxable income, Ernst & Young (EY) tax expert Juan Antonio Rivera said in an online event to discuss on the impacts of the reform. 

However, doubts remain about how deferred taxes and profits related to companies' assets and liabilities will be calculated, such as the IAS 12 accounting standard for income taxes, Rivera added.

A development rate of 2% is added, which is applied to net taxable income and expenses that the companies invest in R&D, equipment acquisition, and/or technological services intended to boost productivity by hiring local suppliers.

“These expenses can be reduced as part of the 2% rate. In short, the government has included this incentive so that companies allocate more resources to improve their technological standards and productivity," said the EY lawyer.

For individuals, a 22% capital tax is created that is applied to the dividends of taxpayers (Chileans or foreign residents from countries without a double taxation agreement) who can pay their taxes by incorporating the dividend into the supplemental overall tax, according to a report from legal firm Carey.

This system would not affect SMEs or foreign investors residing in countries with agreements to avoid double taxation with Chile, according to Carey. An additional 35% tax will be applied to them if these agreements include a clause by which the corporate tax can be used as credit for payment of the final tax, Rivera said.

In a nutshell, apart from the corporate tax, companies will be required to pay this capital tax, which Rivera says could end up creating double taxation for companies.

There is also a levy on the deferral of final taxes that obliges companies to demonstrate their income through accounting, making them subject to a rate of 1.8% when 50% or more of their annual gross income comes from passive income, such as dividends and capital gains. This tax will impact investments by foreigners in Chile, as well as investments made by Chileans abroad, said María Javiera Contreras, lead partner of transaction advisory services at EY Chile.

The reform also includes a wealth tax that will apply to all high-net-worth individuals residing in Chile. This concept applies to assets such as vehicles, real estate, stakes in companies, investment portfolios, and financial instruments in Chile and abroad.

The bill proposes a 1% wealth tax on assets ranging from 6,000-18,000 UTA (annual tax units) (US$4.9mn-US$14.7mn) and a 1.8% duty on assets over 18,000 UTA.

If assets have a return of 5% per year, for example, the new wealth tax is added to the income tax, meaning the individual would have to pay 79% of profits on their assets to the State. This would be a motivation to move capital abroad, said Pablo Greiber, partner of family business at EY. 

If passed the new tax regulations would come into force in 2024.

MINING ROYALTY

For mining, a regime is established that applies mainly to large-scale copper mining. The sector currently has to pay a specific tax on mining activity (IEAM) that is based on taxable mining operating income (RIOM), the progressive rates for which vary between 5% and 14% when the taxpayer's annual sales exceed 50,000t of fine copper.

Considering the tax insufficient to collect what is necessary for the State, in 2018 the lower chamber of congress also proposed a mining royalty on copper and lithium mining. The original bill established ad valorem progressive rates between 3% and 34% on annual copper sales, which was widely criticized for increasing costs and discouraging investment in the industry.

At the time, mining associations rejected the proposal, arguing that the current IEAM is a safe and sufficient model for the sustainability of mining development, in addition to contributing to the State. 

"As revenues increase due to the price effect, margins, profits and also the tax rate also rises, so the tax increases," Diego Hernández, president of mining association Sonami, said last year about the current tax on mining.

The bill was later amended by the senate mining and energy committee, establishing an ad-valorem rate of 1% for companies with production lower than 200,000t/ of fine copper. 

For companies with higher output, the rate would be subject to variations in copper prices, ranging between 1% and 3% of annual sales. Meanwhile, the calculation of profitability would be adjusted according to the copper price, varying between 2% and 40%, coming from the difference in income tax and the result of the progressive rates of the so-called adjusted mining margin (Memaj).

This bill was dispatched by the senate mining committee to the finance committee in March 2022, but it has also been subject to criticism, particularly for not considering the payment capacity of companies or cost structures.

“We call on the senators on the finance committee to think in the long term, since this could become bread today but hunger tomorrow. If the companies go bankrupt or leave the country, people will be responsible for killing the goose that lays the golden eggs,” said Manuel Viera, the former president of Chile's mining chamber, in an opinion column published by news outlet Cooperativa.

Chile's President Gabriel Boric has maintained a large part of the proposal approved by the senate, raising some of the rates of tax on operating profitability, but maintaining rates for mining companies for whom less than 50% of their sales come from copper or which produce less than 50,000t/y of copper.

The proposed government thus establishes a regime for companies with production greater than 50,000t/y of copper based on two components: the ad valorem, that is, on annual copper sales (or gross income), and another on the mining operating margin.

The ad valorem component establishes tax rates ranging from 1-2% for those producing between 50,000t/y and 200,000t/y of copper, and 1-4% for those with an output higher than 200,000t/y.

The component of mining income would have levies of 2% to 32% on operating profit when copper prices are between US$2 and US$5 per pound, based on the adjusted taxable mining operating income (RIOMA).

"The taxes on the mining margin or depreciation of fixed assets or company expenses cannot be subtracted from RIOMA, hitting the mining business hard," said Alicia Domínguez, tax partner and mining expert at EY. Investments in assets and pre-operational expenses, such as exploration, are essential and costly elements of mining projects.

"The royalty affects Chile's competitiveness as a country that receives mining investment. The emphasis should be on a tax regime that is capable of capturing the largest amount of tax when there are cycles of high profitability, but which is also competitive enough with respect to other jurisdictions to continue attracting mining investment to Chile,” said Domínguez.

Another effect would be small companies having to pay the same rates as large companies in periods of high prices and in low price cycles, impacting their growth. If the aim is to capture the real profit and make it taxable in a significant way, the rates on mining should not depend on the price of copper, but on the mining operating margin of each operation in order to identify and tax profits at higher rates at the appropriate times, the expert added.

“As laudable as it is, we have to be careful not to financially suffocate foreign investors or create new uncertainties. A progressive and clear tax increase can be good for the country, but an unclear and unreliable tax reform would probably be very harmful,” Mirco Hilgers, Chilean mining law specialist for legal services firm Baker McKenzie, told BNamericas regarding the royalty. 

The mining royalty bill is currently being studied by lawmakers and the results of that analysis are expected in the fourth quarter of this year. If the legislation is passed, it would represent between 0.5% and 0.6% of GDP, according to information from the Chilean senate.

With respect to the tax revenues collected, 35% would go to the regions where mining takes place and 65% to the rest of the country. If the tax is passed and approved, that would generate around US$300mn in 2025. 

The money raised would also boost the fund for regional research and competitiveness by around US$100mn per year. That means the mining regions would receive four times more resources per capita than the rest of the nation.

CONCLUSION

An OECD report, entitled Tax Policy Reviews: Chile 2022, revealed that the tax burden as a percentage of the country's GDP is one of the lowest among its member countries at only 20.7% in 2019, far below the average of 34.7%.

According to the tax income report for 2021 published in July by the internal revenue service (SII), the country's taxation increased 72% compared with the previous year, reaching US$20.7bn, with the mining sector contributing more than a fifth of the total tax revenues, its largest contribution in a decade.

The increase in tax revenues was driven by a 65% hike in corporate tax collection, which generated an additional US$6.35bn. This was also helped by the economic growth in 2021 and the higher copper prices, which were up 46.3%. The 10 largest private mining companies in Chile together saw their tax payments grow 126% (US$1.85bn, accounting for 29% of the total increase in the tax revenues).

In the 2010-22 period, large private mining companies paid first-category taxes of US$18.7bn and US$5.95bn of specific tax. In 2010, the sum of both duties was US$1.3bn, while this year it was US$4.68bn. In the same period, revenues from the specific tax on mining activity grew 200% to US$1.36bn.

To some extent, these figures contradict the arguments of some politicians that the State does not collect enough taxes when copper prices are high. And the current tax regime is considered stable by the companies, which has contributed to the country being the world's top copper producer.

Protection has been provided to miners with high costs by not setting rates based on the price of copper, but on the operating margin, which is higher when copper prices rise. Therefore, the application of the government's proposed royalty when prices are low could be damaging to the sector, especially for copper deposits that involve high costs.

The Santiago chamber of commerce, meanwhile, has praised some aspects of the tax reform, especially regarding the continuation of a protective regime for SMEs and with respect to the new tax incentives to invest in productivity by including SMEs in the tax breaks for R&D.

Nevertheless, the trade association, which includes more than 2,400 companies operating in the country, has also raised concerns, such as the separation of income tax into different components, arguing it will increase the tax burden for a large number of firms.