It is widely known that digital services have steadily been expanding, providing a new range of goods and services and important revenues for the digital industry. This is the so-called ‘digitalisation of the economy’.
However, the legal tax frameworks of different countries were not necessarily prepared to face the new challenges arising from such digitalisation. Such complexities refer to, among other things, the offering of goods and services without having a physical presence in the customer’s jurisdiction, the categorisation of digital services within the common type of services characterised in domestic laws, the creation of new digital products, and the issue of multiple customers interacting with multiple foreign providers operating in different jurisdictions.
How and when to tax digital purchases (e.g. video games) and the use of apps and web platforms is currently representing a serious dilemma for tax administrations around the world.
In this sense the traditional permanent establishment concept, based on a relevant physical presence or existence of agents in a jurisdiction, has been demonstrated to be useless in capturing the digital offering of goods and services. The permanent establishment understanding, created in a non-digital word, requires an update.
Chilean tax Law is not an exception to the above scenario. With just a basic and incipient regulation of standard software and e-books, the Chilean IRS has provided a case-by-case analysis as to how to tax some digital products and services. But it has failed to establish clear guidelines or some uniform criterion for taxpayers – local or foreign – to determine when digital services are taxable and when not.
Chile is mainly an importer of digital goods and services, more than a producer of such, and therefore the establishment of a clear and consistent regulation, either legal or administrative, on digital activities represents an urgent matter. However, Chilean IRS pronouncements, more than contributing to such objectives, have established a kind of artificial categorisation of digital products, which appears mostly outdated, not in accordance with the current state of the digital industry.
To this effect, the most famous Chilean IRS pronouncement on the matter referred to the taxation of video games. This pronouncement, issued in 2017, surprised the tax arena, for the reasons we describe below.
Before the Chilean IRS released the referred pronouncement to the public, an important part of the local tax practice was of the opinion that a video game corresponds to standard software, and accordingly the payments were deemed exempted from Chilean withholding tax. Standard software is any software in which the transferred rights are only the necessary ones to allow solely for its use, and not its commercial exploitation, reproduction or modification, with a purpose different than enabling such a programme for its use.
Conversely, in the cited ruling, the Chilean IRS stated a different opinion on the matter, establishing that the standard software exemption does not apply to outbound payments performed per the concept of video games. In the Chilean IRS’s view, video games consist in a set of instructions, images and sounds, with the purpose of obtaining entertainment and recreation, for use on computers or other devices. Even though the Chilean IRS recognised that video games require software support, it stated that the real nature of the transaction is not software, but instead an artistic product through the creation of an environment, characters and histories, with the intention of communicating ideas and allowing the interaction of the user with the virtual world and other users.
Hence, the Chilean IRS concluded that the payment for the provision of a video games qualifies as a payment for an entertainment and recreation service, falling in the generic taxable event of “services rendered abroad”, subject to a 35% withholding tax.
The Chilean IRS took a similar approach in the past regarding the taxation applicable to online software, offered by a foreign entity, which allows users to upload and edit their marketing advertisement and customise it as requested. In this case, the tax authority qualified the transactions as advertisement services, generally levied with a 35% withholding tax rate. Nevertheless, as Chile has an in-force Double Tax Convention with Ireland, Article 7 therein applies to these transactions.
The above criteria differs significantly from previous pronouncements by the Chilean IRS, where it applied the concept of standard software, exempted from withholding tax, to most digital products. Importantly, all of this has definitely contributed to the creation of an uncertain environment regarding the taxation of digital activities, affecting the industry and Chilean customers.
The OECD addressed this subject through Action 1 of the BEPS Action Plan, dealing with the tax challenges of the digital economy; in particular, how to allocate among countries the taxation rights on income generated from cross-border activities in the digital age.
Action 1 analysed three possibilities, namely: (i) a new nexus rule in the form of a significant economic presence; (ii) a withholding tax on certain types of digital transactions; and, (iii) an equalisation levy. However, it further recommended the suspension of such measures until further implementation of other BEPS Actions within domestic law (i.e. designing effective CFC rules and modifying the definition of permanent establishment).
There is currently a new tax reform bill in the Chilean congress that aims to apply a sole tax on digital services. The legal foundations of the reform bill state that Chile has been studying the OECD guidelines regarding digital economy taxation, as well as European Commission practices, indicating that there is no final nor sole decision on how to address the subject.
According to its text, the reform bill aims for a modern tax treatment and assessment of the digital economy and its different manifestations. It also aims to pair new digital entrepreneurships that arise on a daily basis with traditional small-and-medium size companies. Nonetheless, it calls for the necessity of being especially careful in not affecting the development of the digital economy, whose eruption is generating new challenges all over the world, as well as new benefits for consumers.
The tax on digital services will work as a sole tax, substituting any other tax that may be levied on the transaction. It will apply, without any deduction, at a 10% rate over the gross amount of the payment made by Chilean individuals for digital services provided by individuals or entities domiciled or resident abroad. This will proceed independently of the location of the servers and technological platforms.
The proposed regulation would presume that Chilean individuals are the ones using the digital services when the issuers of the electronic payment methods are individuals or entities domiciled or with residency in Chile, or Chilean branches of such entities.
A service will qualify as a digital service, subject to this sole tax, if it falls within the following scenarios:
This sole tax would apply independently of the technological device used in order to connect to the internet or to any other adaptation or application protocol, platform or technology used through the internet or any other network.
The reform bill also states that if a digital service does not fall within the abovementioned criteria, even if they will not be subject to this sole tax, general taxation rules would still apply.
It is important to note that the withholding agent of this specific tax will be the issuers of the electronic payment methods utilised by the users of such digital services. If the payment of the digital services is in in cash, foreign entities will have to declare and pay the relevant tax following the guidelines that the Chilean IRS will issue.
Finally, the bill proposes that tax authorities maintain a list of withholding agents and digital services providers, which will help to identify such persons or entities for complying with this new provision.
The initiative of regulating the digital business provided by foreign companies and individuals is definitely a welcome one. However, there is no consensus at all regarding the real virtues the application of an indirect tax may have in order to regulate the digital activity, based on the specific characteristics of the Chilean market.
First, as an indirect tax, the one that finally will economically bear the cost of the taxation would be the local final consumer and not really the foreign provider (through an increment of price). Under this scenario, foreign companies operating a digital business will have no incentive to establish their operations in Chile, being more convenient to continue operating from abroad as the burden of the specific tax would only affect the local consumers’ pockets.
The application of a specific tax looks just as inappropriate in a jurisdiction like Chile that has an incipient involvement in the technological industry, being mostly an importer of such services. Furthermore, the differences between the taxation applied to foreign exporters of technology and local developers will continue to exist.
It seems that the objective of the creation of the tax is to increase tax revenues, rather than finding a comprehensive regulation for the importation of digital products. In addition, such regulation maintains the current uncertainties regarding digital products excluded from the aforementioned list.
One may ask if the significant economic presence criterion provided by the Action 1 of BEPS appears as a more suitable approach to regulate the taxation of the digital economy in Chile.