Thin capitalization rules apply a 35% tax to interest and other related payments to nonresident related parties, where the payer is in a debt situation in excess of a ratio 3/1 debt-to-equity.

Since withholding tax on interest payments may be decreased to 4% in relation to certain financial instruments, thin capitalization rules would have the effect of returning tax liability back to 35%, but interest deductions would not be disallowed.

Related parties rules:

  • The payer and payee are entities of the same Multinational Enterprise Group;

  • The payer or the payee participates directly or indirectly in 10% or more of the capital or profits of the other;

  • The same person participate directly or indirectly in 10% or more of the capital or profits of both the payer and the payee;

  • The payee is resident in a jurisdiction with a preferential tax regime;

  • Financing guaranteed by a nonresident related party (back-to-back loans);

  • A Party concluding transactions with a third person, where such person concludes similar transactions with another person related to the first party.

Other rules relevant for thin capitalization purposes:

  • Tax liability is imposed to the payer, therefore it would not be treated as a withholding tax but rather a thin cap tax. Tax liability is deductible for the payer;

  • Ratio 3/1 debt-to-equity includes all debt contracted by the payer, whether in the local or foreign market, from related or nonrelated parties, and also includes debt contracted for the purposes of a permanent establishment situated abroad;

  • Thin capitalization tax is calculated only on interest paid abroad to nonresident related parties;

  • Withholding tax of interest payments abroad is deductible from thin cap tax liability;

  • Thin capitalization rules do not apply to bank, insurance and other finance entities, and the financing of projects in Chile under certain conditions.